Fitch Ratings: Coronavirus Will Put Pressure on Sub-Sovereign Finances

Fitch Ratings-Paris/London-25 March 2020: The coronavirus pandemic will put pressure on sub-sovereign issuers’ financial profiles, Fitch Ratings says. The main transmission channel to sub-sovereign ratings would be through potential sovereign rating actions rather than the direct impact, but this will vary between local and regional governments (LRGs) and government-related entities (GREs).

Fitch rates approximately 300 LRGs and 325 policy-driven GREs globally on its international rating scale. Policy-driven GREs are those whose policy missions are traditionally devolved from governments and whose commercial activities contribute less than half of their revenues. The implications for other GREs are beyond the scope of this commentary.

At present, up to 70% of Fitch’s LRG ratings could be affected by weakening credit profiles due to the medium-to-long-term impact on their own fiscal performance, without a change in sovereign credit risk. In contrast, the vast majority of Fitch-rated policy-driven GREs have ratings-driven solely by the relationship to their sovereign or LRG sponsor or owner, not by their standalone financial performance. Possible changes to our assessment of sovereign support will be one factor in determining the eventual rating impact of coronavirus-related disruption and policy responses.

LRGs have tended to be more resilient to economic downturns than many other sectors. For example, in 2009 and 2012, the Standalone Credit Profiles (SCPs) of French, Italian and Spanish municipalities were not materially affected by steep GDP declines. In many countries, central governments assume the role of a natural stabilizer, absorbing the costs of higher unemployment and supporting economic output. LRG revenues are often de-linked from spot fluctuations in economic activity, being less reliant on VAT or market-driven property valuations. Meanwhile, a material proportion of capital expenditure can be rescheduled or resized.

However, in light of the evolving macroeconomic impact from the coronavirus and policy responses, Fitch is reassessing its LRG rating scenarios. If we judge that the shock would cause a sustained downturn in revenues and tax collection or widespread unemployment exceeding the five-year operating and financial stresses already incorporated into our existing rating scenarios (net of offsetting measures by local or central authorities), and if we did not expect credit fundamentals to recover within 12-18 months towards levels commensurate with the existing rating, the ratings could be lowered or placed on a Negative Outlook.

Our assessments would also incorporate our expectations of extraordinary state support as part of governments’ policy responses. These responses are developing and final credit impacts may vary from country to country. For approximately 30% of Fitch-rated LRGs’ ratings, a deterioration of their intrinsic credit metrics would not currently affect their ratings. These LRGs are either constrained (financial performance may be healthy but the rating cannot be higher than their sovereign) or supported by the sovereign (financial performance may be weak but the rating is enhanced by the sovereign).

For policy-driven GREs, Fitch applies a top-down rating approach in 90% of cases, meaning that the key driver of the final rating is the rating of the owner or sponsor. The remaining 10% of cases are rated on their standalone performance while factoring in expected potential state support on top of this. Under the top-down approach, the final rating is directly dependent on a rating change of the sponsor, which happens to be the sovereign in 46% of cases (80% outside of China).

As such, a downgrade of sovereign or LRG ratings may also drive down the ratings of GREs. Unless the SCP is at the edge of changing the rating approach (in 4% of total cases), the rating is not sensitive to the GRE’s intrinsic performance.

Even among the credits rated bottom-up, and theoretically exposed to changes in revenue and expenditure, it is possible that the coronavirus shock may result in enhanced levels of extraordinary support from central governments, which could result in a reassessment of the support drivers under our criteria and limit rating impacts. This could be the case for critical public entities, such as hospitals or not-for-profit NGOs (eg the French Red Cross) with a key role in the crisis response.

Contact:

Nicolas Painvin

Global Head, International Public Finance

+33 1 44 29 91 28

Fitch France SAS

60 rue de Monceau

75008 Paris

Roelof Steenekamp

Group Credit Officer, International Public Finance

+44 20 3530 1452

Mark Brown

Senior Director, Fitch Wire

+44 20 3530 1588

Media Relations: Elizabeth Fogerty, New York, Tel: +1 212 908 0526, Email: elizabeth.fogerty@thefitchgroup.com; Athos Larkou, London, Tel: +44 20 3530 1549, Email: athos.larkou@thefitchgroup.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.