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Scope Ratings GmbH has today assigned Garantiqa Hitelgarancia Zrt. (GHG) a long-term issuer rating of BBB+ in both local and foreign currency. The agency also assigns a short-term issuer rating of S-2 in both local and foreign currency. GHG’s senior unsecured debt in both local and foreign currency was also rated BBB+. All Outlooks are Stable.

Summary and Outlook

Garantiqa Hitelgarancia is a credit guarantee institution that was established by the Hungarian government to improve the access of small and medium-sized enterprises (SMEs) to bank financing. GHG performs this role through its provision of credit guarantees to Hungarian SMEs.

Scope’s assignment of the BBB+ rating on GHG reflects: i) the majority ownership and provision of a counter-guarantee scheme by Hungary (BBB+/Stable); ii) a high likelihood of exceptional support given GHG’s critical strategic importance; and iii) low balance sheet vulnerabilities, owing to an absence of debt, strong asset quality, and robust business performance. GHG’s modest earnings alongside a markedly growing guarantee portfolio are challenges. The Stable Outlook reflects Scope’s assessment that the risks GHG faces are manageable and remain balanced. The ratings could be upgraded if: i) the sovereign rating of Hungary is upgraded. The ratings could be downgraded in the event of: i) a downgrade of Hungary’s sovereign rating; ii) changes to the ownership or guarantee framework, leading to weaker government support; and/or iii) a deterioration in GHG’s loss-absorbing capacity in conjunction with substantial debt issuance.

Rating drivers

The first driver of the BBB+ rating reflects the various governmental support mechanisms that underpin the expansion of GHG’s non-profit activities and its ability to fulfil its public policy mandate. The most important is the state’s counter-guarantee programme, through which the government assumes 85% of GHG’s risk exposure up to the limit set in the government’s annual budget. In 2018, an extension of the counter-guarantee programme, granted through the Hungarian Development Bank, allowed GHG to expand its activities beyond the statutory ceiling of HUF 650bn. The government has consistently increased the statutory limit every year and has currently set it at HUF 1,070bn for 2020, of which HUF 870bn is dedicated to the core activity and HUF 200bn to bond guarantees. This underscores the sovereign’s ability and willingness to support GHG’s activities. Furthermore, GHG is exempt from corporate income tax, it does not distribute dividends to shareholders and the government subsidises fees for the borrower, which provides additional direct and indirect financial support to the entity.

GHG also benefits from majority ownership by the Hungarian state, which has a 31% direct share as well as a 47% indirect share through the Hungarian Development Bank (100% state-owned). As the majority owner, the government is pivotal in setting GHG’s strategic objectives as well as its annual and multi-year business plans. Hungary also regulates the entity’s activities through public law. The Annual Budget Act determines the total amount of outstanding (state-counter-guaranteed) guarantees that GHG can issue. Similarly, the opening of new business lines, such as GHG’s own-risk portfolio activities, is subject to government approval and is regulated by government decrees. Scope notes, however, that GHG retains the ability to manage its day-to-day operations without direct government intervention, including its tariff policies.

The second driver supporting GHG’s BBB+ rating is the high likelihood that timely exceptional government support would be provided if needed. This reflects GHG’s central role in: i) achieving key economic policy objectives, and ii) providing an important public service by ensuring SMEs can access financing, thus iii) supporting the development and competitiveness of an economic sector that accounts for almost 70% of total employment. This view is further underpinned by the market dominance of GHG as Hungary’s main credit guarantee institution, with no meaningful direct competition. Its guarantee portfolio represented over HUF 700bn in 2018, amounting to 1.9% of GDP and covering one in every five loans disbursed to SMEs. Risks to the entity’s market position are deemed remote. Therefore, Scope views the likelihood of exceptional support to be high in view of the adverse social, economic and political consequences of a default on GHG’s liabilities.

Finally, GHG benefits from its low-risk balance sheet. First, the entity has no liabilities other than share capital, retained earnings, and provisions. The absence of debt other than pre-paid guarantee fees (HUF 2.8bn in 2018) further reduces balance sheet risks. Second, GHG’s liquid assets cover 36% of its own-risk portfolio and 200% of the total non-performing guarantee portfolio (stage three), including the counter-guaranteed portfolio. Finally, GHG provides different guarantee products across all major economic sectors in Hungary, which further diversifies its risks. These considerations justify a credit rating alignment of GHG with Hungary.

Despite these credit strengths, the BBB+ rating is challenged by GHG’s modest earnings, markedly growing guarantee portfolio, and private legal form (which means it can become insolvent).

First, the low return on average assets of 1.3% and the decreasing capital coverage of the guarantee portfolio at1.6% in 2018, reflect GHG’s non-profit nature as defined by its policy mandate. At the same time, lower profitability constrains GHG’s ability to accumulate retained earnings to use as provisions against the strongly growing guarantee portfolio. Also, the growth in retained earnings, while steady, remains well below that of the guarantee portfolio. In 2018, total provisions for financial risks stood at 1.2% of the total guarantee portfolio, down from 3.5% in 2013. During the same period, GHG’s own risks of the portfolio markedly increased from HUF 80bn to HUF 141.5bn.

Second and finally, GHG’s private legal form presents a challenge to its BBB+ rating. As a limited corporation, GHG is in theory subject to insolvency and resolution frameworks under Hungarian law. This, coupled with a lack of an explicit state guarantee on GHG’s liabilities, means that creditors have no direct and unconditional claim against Hungary in cases of financial distress. Nevertheless, GHG’s strong financial position and Scope’s view that the government would provide timely financial support offset these risks.

Qualitative Scorecard (QS1 and QS2)

Provided that a government-related entity benefits from an ‘integral/strong’ level of integration with its government, Scope may apply the ‘top-down’ approach, which takes the government’s rating as the starting point and then negatively adjusts it by up to three notches (although exceptions can apply). Equalisation of a government-related entity’s rating with that of its government is possible if an explicit guarantee exists.

Scope assigns a ‘strong’ level of integration between GHG and Hungary (QS1), reflecting i) majority public ownership by the central government; and ii) a clear public policy mandate with the main purpose of providing a key service in the public interest.

Scope does not apply the rating equalisation factor because the Hungarian government provides no explicit, direct, unconditional, irrevocable and statutory guarantee for GHG’s obligations.

Scope assigns a ‘medium’ assessment to the ‘control and regular government support’ for GHG (QS2) as a result of: i) the ‘high’ ability of the government to control GHG, given its majority stake and the entity’s business activities being defined and regulated by law; ii) the various support mechanisms provided by the government, including the counter-guarantee programme; and iii) the ‘limited’ track record of support for GHG, a result of its low balance sheet vulnerabilities and robust business performance.

Scope assigns a ‘high’ assessment to the ‘likelihood of exceptional government support’ if GHG were to experience difficulties in payment (QS2), reflecting GHG’s i) ‘high’ strategic importance to the government, ii) ‘low’ substitution risk; and iii) ‘medium’ potential economic and political costs if the provision of GHG’s services was interrupted. This assessment captures the fact that the state’s counter-guarantee allows GHG to expand its activities, reflecting that continuous regular support would be provided to GHG if needed. Even so, the company’s strong financial standing makes it highly unlikely that exceptional support would even be needed.

For further details, please see Figures 2 and 3 of the rating report.

Rating committee
The main points discussed during the rating committee were: i) integration with government; ii) guarantee structure; iii) control and regular government support; iv) likelihood of exceptional support; and v) supplementary analysis: GHG’s fundamentals.

Methodology
The methodology applicable for this rating and/or rating outlook, Rating Methodology: Government Related entities, is available on www.scoperatings.com.
Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerepweb/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com. The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rated entity participated in the ratings process.
The following substantially material sources of information were used to prepare the credit rating: the rated entity, public domain. Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead Analyst: Rating prepared by Dr Bernhard Bartels, Associate Director.
Person responsible for approval of the rating Dr Giacomo Barisone, Managing Director.
The ratings/outlook was first released by Scope on 13 March 2020.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
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