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Rating action

Scope Ratings has today affirmed the City of Milan's long-term local- and foreign-currency issuer and senior unsecured debt ratings at BBB+, with a Negative Outlook. The agency has also affirmed the short-term issuer ratings at S-2 with a Stable Outlook in local and foreign currency.

Summary and Outlook

The affirmation at BBB+ reflects Milan’s: i) high budgetary reserves and large own cash holdings stemming from effective governance, underpinned by prudent budgeting and sound financial management, which help compensate for the significant revenue loss and pressure on municipal finances caused by the Covid-19 economic shock; ii) supportive institutional framework, enabling municipalities to balance revenues and expenditures under adverse conditions with secured access to liquidity facilities and funding support at reasonable rates via the state-owned development bank Cassa Depositi e Prestiti (CDP); and iii) high wealth levels and strategic importance as Italy’s economic and financial hub, which will support a fast economic recovery going forward. Credit challenges relate to Milan’s high but declining debt stock, limited revenue flexibility, as well as sizeable, yet manageable, contingent liabilities.

The Negative Outlook reflects Scope’s view that the risks to the ratings are tilted to the downside over the next 12 to 18 months. The Negative Outlook on the City of Milan reflects the weakening of Italy's credit profile as captured by the Outlook change to Negative from Stable on Italy’s BBB+ rating on 15 May 2020. Under the current institutional framework, Scope caps its rating on Milan at the level of Italy’s, as the city lacks sufficient financial autonomy and budgetary flexibility to withstand a deterioration in the sovereign’s credit profile, given the close intergovernmental links between Italian cities and the central government.

The ratings could be downgraded if, individually or collectively: i) Italy’s sovereign rating were to be downgraded; ii) changes to the institutional framework resulted in a notably weaker individual credit profile; or iii) the city’s operating performance deteriorated, leading to a substantial increase in the debt stock. Conversely, the rating Outlook could be revised back to Stable if, individually or collectively: i) the Outlook on Italy’s sovereign rating were to be revised back to Stable; or ii) changes to the institutional framework resulted in higher revenue flexibility.

Rating rationale

The BBB+ rating is supported by Milan’s ample liquidity, with a sizeable cash balance vis-à-vis national peers stemming from its sound budgetary and financial management. Cash reserves reached EUR 1.9bn at the end of 2019, up from EUR 1bn in 2016, covering annual debt service by over six times. The relatively low cyclicality of Milan’s growing tax base vis-à-vis its sovereign, coupled with realistic estimates of cash collection regarding revenues and credits, underpin the city’s ability to generate cash flow. In terms of cash planning, Milan is more accurate than national peers, with current revenues in cash terms averaging 81% of the initially budgeted amount during 2017-19, higher than the 70% peer average. Milan also outperforms in terms of timely cash collection, which supports the city’s strong liquidity profile: cash collected as a share of current revenues in the same fiscal year averaged 74% over the last three years, against 65% in other major Italian cities. Scope expects Milan’s cash position to remain broadly stable this year, with cash holdings at EUR 1.7bn by end-September and cumulative cash movements in line with last year. In addition, the city has ample access to external liquidity. Facilities at the city’s treasurer (Banca Intesa) could advance up to EUR 820m. Milan also has a credit line with the European Investment Bank to finance the metropolitan train line M4. In the wake of Covid-19, moreover, additional compensation from the central government in the form of EUR 12bn in liquidity advances from CDP has been made available to the regions, cities and healthcare entities for the payment of commercial debt.

The City of Milan’s BBB+ rating also reflects strong budgetary performance, with high operating surpluses averaging 19% of operating revenue in 2016-19, improved from 15.5% in 2016 to 20.9% in 2019. The management has shown a strong commitment to fiscal consolidation through effective spending-control mechanisms and good tax collection rates, with operating expenditure growth remaining on average below operating revenue growth in the past five years. This is despite frequent central government reforms to the municipal tax system and growing expenditure pressures from a rising population in the city. Prudent budgetary management has resulted in high budgetary buffers, which help compensate for the likely substantial revenues loss caused by the Covid-19 crisis. Also, the stable local political environment underpins Scope’s expectation that the city’s administration will focus on long-term oriented policy responses to the current crisis. The administration reacted promptly to the crisis by adjusting the budget for 2020 and ensuring access to emergency funds allocated to counter the current crisis. At the same time, the city implemented spending controls to limit the damage to its finances.

As is the case for all Italian sub-sovereigns, the Covid-19 lockdowns will negatively affect Milan’s budget. The surrounding region has been one of the most severely hit areas in Italy in both waves of the pandemic, and consequently has been subject to a strict regime of containment measures. The city is set to record a revenue loss of around EUR 740m (equivalent to 23% of 2019 operating revenue), mostly related to fees (transport tickets, cars and parking fines), and own taxes (especially those related to tourism). The impact of Covid-19 on Milan’s budgetary metrics will be partially mitigated by additional compensation from the central government of about EUR 450m (or 14% of 2019 operating revenue). In addition, Scope expects Milan to maintain a tight grip on expenditure. In a prudent response to the emergency situation, the city decided in March to implement a 78% limit on initially budgeted expenditure for all departments, which has then been gradually relaxed over the year. The city can also count on accumulated previous surpluses to cover current expenditure. Overall, Scope expects Milan to achieve an operating surplus averaging 15% of operating revenue in 2020-21. This would be in line with mandatory requirements as set by the framework to cover the city’s debt service with current revenue, but with a lower margin than in previous years. For 2021, a gradual economic recovery and less severe containment measures will support a recovery in revenue, assuming the pandemic situation allows for it. While the extraordinary support from the central government is likely to be scaled back in 2021, Milan’s local finances should also benefit from the transfer of extraordinary recourses from the EU recovery fund, which would allow for higher public investment without putting an additional burden on the city’s budget.

Milan’s BBB+ rating is further underpinned by its wealthy, well-diversified and highly competitive economy, supporting the city’s ability to generate its own revenues in the long term, as reflected by its high wealth levels, with GDP per capita in Milan’s province at 180% of the European average. The city’s multi-sectoral economy ranges from technology-intensive manufacturing and biological sciences to financial services, culture and design. It also benefits from thirteen prestigious universities, which support the city’s attractiveness for higher-value-added industries. The city's appeal to foreign investors is reflected by the fact that more than 30% of foreign multinational companies active in Italy are located in Milan. The competitive economy also underpins a solid labour market, which outperforms the national average in terms of the unemployment rate (6% versus 10%, in 2019) and the employment rate (above 70% versus 60%, in 2019). Demographic trends are also favourable vis-à-vis Italy’s. These factors support the prospects of a robust recovery for the city’s economy. While Scope expects Milan to suffer a worse GDP contraction than Italy (10%-12% of GDP), the rating agency expects a faster recovery compared to national peers, given the city’s strategic role at the national and international level as well as its diversified economic base, with specialisation in competitive, high-value added sectors.

Finally, the BBB+ rating is underpinned by a supportive institutional framework for Italian municipalities, which contributes to budgetary discipline at the local level, with a prudent fiscal policy defined by the central government. The presence of preventive checks in the context of the ‘dissesto’ procedure and a track record of systemic public funding support via CDP, the main creditor of Italian sub-sovereigns and a lender of last resort, is balanced by Italian cities’ need to adhere to strict fiscal targets, including rigid expenditure limits set by the central government, while facing frequent municipal tax reforms and cuts to the equalisation system that weigh on cities’ revenue autonomy and predictability. In the context of the current crisis, several financial support measures have been reinforced, including restorations of cities’ revenue losses by the central government and liquidity advances from the equalisation fund and CDP, as well as debt renegotiations with CDP aimed at reducing debt servicing costs and increasing repayment flexibility.

The Negative Outlook on Milan’s BBB+ rating reflects the weakening of Italy's credit profile as captured by the Outlook change to Negative from Stable on Italy’s BBB+ rating. It reflects Scope’s view that Italian cities are not shielded from central government legislation regarding their revenues, expenditures and funding, given: i) strong budgetary intervention rights of the central government, as reflected by frequent reforms affecting Italian municipalities’ revenue and expenditure bases; and ii) mandatory authorisations by the central government for debt issuances coupled with a large share of public funding in the form of loans obtained from the state-owned development bank CDP. These aspects are common to all Italian municipalities.

The rating is balanced by several challenges. The city’s indebtedness is high, at EUR 3.5bn by end-2019, or 108% of operating revenue, despite a sizeable reduction in the debt stock, by over EUR 500m since 2015. Scope expects debt metrics in relative terms to deteriorate in the coming years, with the overall debt burden increasing from 108.5% in 2019 to around 114% and 135% of operating revenue in 2020 and 2021 respectively. This is due to the impact from lost revenue related to the Covid-19 crisis and the structural revenue reduction in the city’s budget in view of the re-allocation of transport services to the provincial level. Scope expects, however, a continued gradual reduction in the debt stock, in absolute terms, to about EUR 3.4bn by 2022, bringing the debt-to-operating revenue ratio back below 130%. This is thanks to limited financing needs that can be largely covered by flexible loans and accumulated budget surpluses, lowering recourse to new debt. In addition, a favourable debt profile limits refinancing risk. CDP is the main creditor (53% of total debt), which strengthens the long-term nature of the creditor base. Also, Milan prudently manages its refinancing risk by setting aside an annual provision of EUR 50m for a sinking fund to repay a bullet bond maturing in 2035, which represents a third of its total debt stock.

Challenges to Milan’s rating also relate to the city’s limited revenue flexibility with little room for revenue increases via own taxes. As Milan has already reached the maximum rates set by the central government and is a net contributor to the municipal equalisation fund, Scope assesses the city’s revenue flexibility as moderate vis-à-vis national peers, despite positive net migration and a growing local tax base. As of 2021, the reallocation of the local transport function to the provincial level will result in transfer revenue decreasing by around 270m and fees revenue by 450m. As consequence, the composition of operating revenue will shift towards a larger share of own taxes than in previous years, while the transfer share will be halved.

Finally, due to the city’s extensive shareholdings, the high level of contingent liabilities is a challenge, which is partially mitigated by valuable assets and the solid financial performance of the companies partially or wholly owned. The aggregated financial debt of Milan’s main shareholdings is elevated with respect to the city’s budget size, at EUR 4.8bn in 2019 or 150% of operating revenue. Scope assesses risks to the city’s balance sheet stemming from these entities as low because the most-indebted entities are self-supporting and have reported positive financial results in the past three years. In particular, 77% of Milan’s shareholdings’ debt relates to A2A Spa, the largest Italian multi-utility. The City of Milan owns 25% of A2A Spa, which saw improving net income in the past three years together with increasing dividends and budgetary reserves paid back to the city’s budget. Scope expects companies in the transport sector (Sea Spa, Atm Spa) to be the most adversely exposed to Covid-19-related shocks and believes they may require higher levels of support from the City of Milan. Atm Spa is less affected by immediate risks, as it benefits from regular grants from the city for its services. Sea spa will retain most part of the dividends and budgetary reserves it usually deposits with the city, as a precautionary buffer. Outstanding contractual guarantees issued by Milan have been declining to around EUR 250m in 2019, from EUR 340m in 2015, and primarily relate to Atm Spa, in the context of metropolitan equipment renovation co-financed by the European Investment Bank.

Institutional framework assessment

Scope’s institutional framework assessment determines the intergovernmental integration between sovereign and sub-sovereign levels. Scope uses three key analytical factors to assess systemic support: i) institutionalised support; ii) fiscal interlinkage; and iii) political alignment between government tiers. The outcome of this assessment results in a downward rating range between the sovereign rating and the rating of the sub-sovereign entity of between 0 notches (high integration) and 10 notches (low integration).

Scope considers the institutional and financing framework under which the Italian cities operate to display high integration for: i) institutionalised support and medium integration for ii) fiscal interlinkage and iii) political alignment. Consequently, Scope’s assessment results in an indicative downward rating distance of a maximum of four notches between the Italian sovereign (BBB+/Negative) and the rating of an individual city. In a medium-integrated institutional framework, a strong individual credit profile is necessary to assign a sub-sovereign rating close to that of the sovereign.

The results have been discussed and confirmed by a rating committee.

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

Scope assesses the individual credit profile based on a qualitative and quantitative analysis of four key risk categories: i) debt burden and liquidity profile; ii) budget performance and flexibility; iii) economy and social profile; and iv) quality of governance. This risk assessment is conducted on a scale from 1 to 100, whereby a high (low) score is associated with a strong (weak) credit profile.

Scope assesses Milan’s individual credit profile as strong, reflecting the outcome of the quantitative Core Variable Scorecard and the qualitative assessment in the four respective categories as defined above (individual credit profile score equal to 76 of 100).

The review of potentially exceptional circumstances that cannot be captured by the quantitative and qualitative scorecards did not lead to further adjustments of Milan’s indicative rating of BBB+.

The results have been discussed and confirmed by a rating committee.

Factoring of Environment, Social and Governance (ESG)

Governance considerations are material to Milan's rating and are included in Scope’s institutional framework assessment, as well as in its assessment of Milan’s individual credit profile, highlighting the high quality of governance alongside the administration’s track record of sound budgetary management and prudent liquidity management with conservative debt management practices.

Social considerations are included in Scope’s assessment of Milan’s ‘economy and social profile’, highlighting a healthy labour market and favourable demographics in the national context. Scope notes the city’s plans to improve mobility and increase social housing facilities, as underpinned by its territorial plan.

Alongside Scope’s assessment of rating-relevant credit risks, the rating agency also considers long-term environmental developments which did not play a direct role in this rating action. Scope acknowledges the city’s targets for the reduction of greenhouse emissions (to 45% by 2030) and waste management (a 70% recycling rate by 2030). Milan and the companies owned by the city plan to invest in these objectives, including EUR 2bn to convert the transport vehicles operated by Azienda Trasporti Milanesi to electric as well as EUR 700m for circular economy sectors.

Rating committee
The main points discussed by the rating committee were: i) institutional framework for Italian cities; ii) liquidity profile and debt burden; iii) budget performance and flexibility; iv) contingent liabilities; v) socio-economic profile; and vi) peer considerations.

Methodology
The methodology used for this rating and/or rating outlook (Rating Methodology: Sub-Sovereigns, 18 May 2020) , is available on https://www.scoperatings.com/#!methodology/list.
Information on the meaning of each rating category, including definitions of default and recoveries can be viewed in the “Rating Definitions - Credit Ratings and Ancillary Services” published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. 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/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how Environmental, Social or Governance factors (ESG factor) are incorporated into the rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
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 rating was not requested by the rated entity or its agents. The rating process was conducted:
With Rated Entity or Related Third Party Participation YES
With Access to Internal Documents                              YES
With Access to Management                                        YES
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 the issuance of the rating, 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, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0.
Lead analyst: Jakob Suwalski, Director
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director
The ratings/outlook were first released by Scope on 29 November 2019. The ratings/outlooks were last updated on 22 May 2020. 
As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on the City of Milan are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Sovereign Ratings Calendar of 2020" published on 14 May 2020 on www.scoperatings.com). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case the deviation from Scope’s published calendar was due to the first-time publication of the ratings.

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
© 2020 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions 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. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5 D-10785 Berlin.
Scope Ratings GmbH, Lennéstraße 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Director: Guillaume Jolivet.