For the rating action annex, click here.

Rating action

Scope Ratings GmbH (Scope) has today affirmed the City of Milan’s long-term local- and foreign-currency issuer and senior unsecured debt ratings of BBB+, with the Outlook revised to Stable from Negative. Scope has also affirmed the short-term issuer ratings of S-2 in both local and foreign currency with a Stable Outlook.

Summary and Outlook

The revision of the Outlook to Stable on Milan’s BBB+ ratings is driven by the stabilisation of Italy's creditworthiness, as captured by the revision of the Outlook on the sovereign’s BBB+ rating back to Stable from Negative on 20 August 2021. The institutional framework under which Italian cities operate binds Milan’s financial and budgetary prospects to the sovereign’s credit profile, given tight institutional and fiscal interlinkages with the central government. The Stable Outlook reflects Scope’s view that the risks to the ratings will be balanced over the next 12 to 18 months.

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

The ratings/Outlooks could be upgraded if, individually or collectively: i) the ratings/Outlooks on Italy are upgraded; and/or ii) changes to the institutional framework result in higher revenue flexibility. Conversely, the ratings/Outlooks could be downgraded if, individually or collectively: i) Italy’s sovereign ratings/Outlooks are downgraded; ii) changes to the institutional framework adversely affect the city’s individual credit profile; and/or iii) the city’s debt stock increases notably.

Rating rationale

The revision of the Outlook to Stable on Milan’s BBB+ rating is driven by the stabilisation of Italy's creditworthiness, as captured by the revision of the sovereign’s Outlook to Stable from Negative in August 2021. This reflects Scope’s view that Milan’s creditworthiness is tightly bound to the sovereign’s credit profile, as it is for all Italian cities, given the tight institutional and financial ties between these two levels of government. The intergovernmental interlinkage with the central government shapes the cities’ financial and funding management and prospects, 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 CDP. These aspects are common to all Italian municipalities.

The affirmation of Milan’s long-term ratings at BBB+ 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, strict borrowing conditionalities, and a track record of systemic public funding support via CDP (the main creditor of Italian sub-sovereigns and a lender of last resort) limit cities’ budgetary imbalances and refinancing risk. At the same time, however, Italian cities must adhere to tight fiscal targets, while facing frequent municipal tax reforms and cuts to the equalisation system, which weigh on their long-term revenue 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 via supplementary transfers, liquidity advances from CDP, as well as debt renegotiations aimed at reducing debt servicing costs and increasing repayment flexibility.

The City of Milan’s BBB+ rating also reflects its strong budgetary performance, with high operating surpluses averaging 19% of operating revenue in 2016-20, improved from 15.5% in 2016 to 20.9% in 2019, and only slightly reversed last year (20.5%). The management has shown a strong commitment to fiscal consolidation through effective spending-control mechanisms and good tax collection rates. This has resulted in high budgetary and cash buffers, placing Milan in a strong position to mitigate the adverse impact of the coronavirus crisis. Operating expenditure growth has, on average, remained below operating revenue growth in the past five years before the pandemic. This is despite frequent central government reforms to the municipal tax system and growing expenditure pressures from a rising population in the city.

The Covid-19 shock has significantly affected Milan’s budget. The surrounding region was one of the areas in Italy most severely hit by the pandemic in 2020 and was consequently subject to a strict and prolonged regime of containment measures. Last year, the city recorded a decrease in tax and fee revenue of EUR 650m (20% of 2019 operating revenue) from 2019. This was considerably mitigated by a EUR 560m increase in transfers, incorporating substantial central government extraordinary support. In addition, Milan has maintained a tight grip on spending, with operating expenditure decreasing by EUR 60m (2.4% of operating expenditure) from the previous year. The city has also made use of accumulated budget surpluses (EUR 110m) to cover part of current spending related to the pandemic. Thanks to conservative budgeting and a rapid reaction in terms of cost control measures in a difficult environment, the city has been able to comply with fiscal targets and increase investment spending without significantly raising its debt levels.

Scope expects the city to achieve an operating surplus averaging 17% of operating revenue in 2021-23, which would comfortably cover debt service with current revenue. Scope expects a robust economic rebound, supporting the city’s own revenue recovery as direct support from the central government is gradually withdrawn. In addition, Milan’s economic prospects and local finances should benefit from the EU funded national recovery and resilience plan, set to inject over EUR 200bn into public investment projects in Italy in the next five years, of which EUR 87bn should directly involve local governments. On the other hand, a lower-than-expected economic rebound hampering Milan’s tax revenue recovery prospects, while central government transfers are gradually reduced, could weigh on the city’s ability to fulfil its commitment to further debt reduction.

The BBB+ rating is also supported by Milan’s large cash holdings, stemming from its sound budgetary and financial management. The city’s cash balance stood at EUR 2bn at the beginning of 2021, up from EUR 1bn in 2016, and can comfortably cover debt service through to 2025. 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 80% of the initially budgeted amount during 2017-19, higher than the 70% average. Milan also outperforms peers in terms of timely cash collection: cash collected as a share of current revenues in the same fiscal year was 75% on average over the last three years, compared to 65% in other major Italian cities. In addition, the city has good access to external liquidity. Its treasurer, Banca Intesa, could advance up to EUR 800m per year in 2021-23, though in the past five years Milan has not needed to recur to this liquidity source. The city also has a credit line with the European Investment Bank to finance the metropolitan train line M4 and can count on CDP, its main creditor with around 53% of total debt.

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. This is 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 its attractiveness for higher value-added industries. More than 30% of foreign multinational companies active in Italy are located in Milan – demonstrating the city's appeal to foreign investors. The competitive economy also underpins a solid labour market, which outperforms the national average in terms of the unemployment rate (6% versus 9% in 2020) and the employment rate (close to 70% versus 58% in 2020). Demographic trends are also favourable vis-à-vis Italy. These factors support the prospects of a robust recovery for the city’s economy. While Milan has suffered a worse economic contraction than Italy (11% in terms of gross value added), Scope expects a robust recovery of about 6%, given the city’s strategic role at the national and international level as well as its diversified economic base, specialised in high value-added sectors.

On the other hand, Milan’s BBB+ rating is balanced by several challenges.

The city’s indebtedness is high, at EUR 3.6bn by end-2020, or 113% of operating revenue, despite a sizeable reduction in the debt stock, by over EUR 500m in 2015-19. In 2020, the city activated new debt for EUR 150m to support investment in view of the weakened economic outlook. After a contained increase last year of EUR 30m, Scope expects the city’s nominal debt stock to continue decreasing gradually, although at a slower pace than expected before the Covid-19 pandemic, to about EUR 3.3bn by 2023. This should be achieved thanks to limited financing needs that can largely be covered by flexible loans already included in the debt stock (EUR 340m) and accumulated budget surpluses lowering recourse to new debt. Scope expects that Milan’s debt burden will peak in relative terms at around 130% of operating revenue by 2022, reflecting the structural reduction in the city’s budget (about EUR 700m) due to the re-allocation of transportation services to the provincial level. A favourable debt profile limits refinancing risk, with CDP as the main creditor strengthening the long-term nature of the creditor base. Also, Milan prudently sets 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, despite its above-average revenue autonomy. 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. The Covid-19 pandemic has temporarily altered structural revenue composition, with transfer revenue accounting for a double share in total operating revenue last year vis-à-vis pre-crisis. As of 2022, the reallocation of local transport responsibilities to the provincial level will reduce transfer revenue by around EUR 270m and fees revenue by EUR 450m. As a consequence, the composition of operating revenue should 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, a high level of contingent liabilities is a challenge. This 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 185% of operating revenue. Scope assesses risks to the city’s balance sheet stemming from these entities as manageable because the most indebted entities are self-supporting and have in general reported positive financial results in recent years. 75% 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 paid to the city’s budget. Companies in the transport sector are the most exposed to Covid-19-related shocks. In particular, Sea Spa and ATM Spa have reported financial losses last year, which could be absorbed by their own reserves. As of end-2020, Milan’s key shareholdings have not caused any loss in the city’s budget, however, they paid dividends of only EUR 63m compared to EUR 151m in 2019. Outstanding contractual guarantees issued by Milan have been declining to around EUR 240m in 2020, from EUR 340m in 2015. They 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+/Stable) 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 75 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. They are included in Scope’s institutional framework assessment and its assessment of Milan’s individual credit profile, which highlight the high quality of governance alongside the administration’s good 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 its healthy labour market and favourable demographics in a 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 via the conversion of the transport vehicles operated by ATM Spa to electric as well as A2A’s strategic focus on circular economy sectors.

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

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Rating Methodology: Sub-Sovereigns, 12 May 2021), is available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other 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 Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 Ratings’ definitions of default and Credit 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 factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party participation NO
With access to internal documents                               NO
With access to management                                         NO
The following substantially material sources of information were used to prepare the Credit Ratings: public domain.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data. Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Giulia Branz, Analyst
Person responsible for approval of the Credit Ratings: Dr Giacomo Barisone, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 29 November 2019. The Credit Ratings/Outlook were last updated on 4 December 2020.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
© 2021 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Analysis GmbH, Scope Investor Services GmbH, and Scope ESG Analysis 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.