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Rating action

Scope Ratings GmbH (Scope) has assigned a first-time issuer rating of B+/Stable to Kopaszi Gát Kft. Scope has also assigned a first-time rating of B+ to the company’s senior unsecured debt.

Rating rationale

The rating reflects the company’s industry risk as a real estate developer with limited recurring income and strong focus on homebuilding activities. Most revenues are from the sale of newly developed residential units and office buildings, the remainder is from rents from retained commercial units within mixed-use projects.

The business risk profile (assessed at B+) is driven by the high asset quality in the form of a newly developed quarter – BudaPart Project – in the Kopaszi Dam neighbourhood in Budapest. The BudaPart mixed-use project is the largest real estate development in Budapest. It consists of 26 buildings including residences, offices and a hotel. The development has a progress rate of 23%, with seven buildings (134,000 sq m) already completed as of December 2021.

Credit-positive is the diversified customer base due to retail residential core business as well as the asset quality with buildings that meet recognized standards – namely LEED (gold or above) and Hungarian EPC level BB. The development portfolio includes premium and standard residential units, which Scope deems to have above-average liquidity within the real estate market. Similarly, Scope believes that demand for newly built, energy-efficient offices will remain robust, compared to more obsolete supply. Looking at completed projects in the issuer’s (limited) history, Scope-adjusted EBITDA margins are expected in a range of 20% to 30% from residential and commercial development. Due to the timing mismatch between cash outflows and inflows (expenses and revenues), Scope also looked at profitability as measured by the internal rate of return on a project-by-project basis. Kopaszi’s profitability from this perspective is relatively stable, providing certainty that profitability is sustainable at around 12% yearly (standard residential buildings: yearly return average of 9%; premium residential, 18%; office, 9%).

On the other hand, Kopaszi Gát is a relatively small property company in both the European context and the fragmented real estate market in Hungary, with total Scope-adjusted assets of about EUR 235m as of December 2020. This implies greater sensitivity to unforeseen shocks, greater volatility in cash flows and a heightened sensitivity to the performance of single projects due to existing cluster risks (five projects currently). The limited size is also evident in: i) the concentrated development pipeline of 19 projects with around 1,900 apartments and nine office buildings to be developed until 2028 (40% of residential units and 50,000 sq m of office/hotel space to be delivered by 2024); and ii) the full geographical concentration on Budapest (100% of expected sales). The decent pre-sale ratios of between 30% to 90% for projects under development partially mitigate the risk of a liquidity shortfall posed by the high working capital allocated to these projects. The Hungarian state’s introduction of incentives to promote private home ownership in the country should also support demand.

The financial risk profile (assessed at B+) reflects the expectation of continuous growth, which will keep free operating cash flows negative and Kopaszi dependent on external financing. Scope-adjusted debt (SaD) is expected to rise from around EUR 73m in 2020 to EUR 174m by the end of 2023, due to the planned bond placement of HUF 32bn (equivalent to around EUR 87.7m) in Q1 2022 and EUR 94m in additional development loans until 2023. Scope’s assumption is that the bond will be priced with a fixed coupon of maximum 6%. This will result in a Scope-adjusted debt/EBITDA ratio of close to 10x in 2022 in Scope’s rating case scenario and a Scope-adjusted EBITDA interest coverage of around 1.9x in 2022 and 2023.

Liquidity is assessed as adequate, supported by an unrestricted cash balance (around EUR 17.8m as of December 2020; EUR 17m estimated for YE 2021) that exceeds short-term debt (EUR 9.9m). Even if free operating cash flow remained negative due to planned investments (net capex of EUR 60m until 2023) and working capital requirements (mainly EUR 50m in inventories), open credit lines (more than EUR 69m as of December 2021) would still be able to finance the specific developments.

Outlook and rating-change drivers

The Outlook is Stable and incorporates the completion and disposal of one office building in 2022 and two residential buildings in 2023. It also incorporates the redemption of current first-ranked bank loans and the shareholder loan in 2022 but an increase in debt due to the additional development loans and the bond placement (HUF 32bn). Scope anticipates SaD/EBITDA to increase to around 10x, adequate interest cover in the next few years and ongoing adequate access to external financing to finance the negative Scope-adjusted free operating cash flow in the next few years.

A positive rating action is remote but may be warranted if the company grew significantly in size, as measured by its development pipeline, leading to greater diversification and more stable cash flows, while leverage as measured by SaD/EBITDA stabilised below 8x on a sustained basis.

A negative rating action is possible if SaD/EBITDA were to reach well above 10x or if liquidity weakened, for example, due to weaker access to bank financing.

Long-term and short-term debt ratings

The rated entity plans to issue a senior unsecured corporate green bond under the Hungarian National Bank’s Bond Funding for Growth Scheme. There is an amortising repayment of 10% yearly between the fifth and ninth anniversaries and a 50% balloon payment at maturity. Bond proceeds are earmarked for: i) ensuring financing of future developments (50% of total funding); ii) refinancing the actual outstanding amount at bond issuance of the first-ranking mortgage-backed loan provided by EXIM Bank; and iii) partially refinancing the second-ranking mortgage-backed shareholder loan (remaining proceeds). The remaining part of the shareholder loan will be repaid upon the sale of the office building BOE – BudaPart City – and a delayed sale will result in the shareholder loan being extended.

Scope’s recovery analysis is based on a hypothetical default scenario at year-end 2023. This scenario shows an average recovery value on senior unsecured debt with a high sensitivity to attainable prices in a distressed sales scenario and factors in the structural subordination of the rated entity’s senior unsecured creditors below future secured creditors at property SPV level (development loans). This translates into a B+ rating for senior unsecured debt, in line with the issuer rating.

Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.

Methodology
The methodologies used for these Credit Ratings and/or Outlook, (Corporate Rating Methodology, 6 July 2021; Rating Methodology: European Real Estate Corporates, 15 January 2021), are 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 Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity and Scope Ratings' internal sources.
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 the 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 Outlook and the principal grounds on which the Credit Ratings and/or Outlook are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlook are UK-endorsed.
Lead analyst: Rigel Scheller, Director
Person responsible for approval of the Credit Ratings: Philipp Wass, Executive Director
The Credit Ratings/Outlook were first released by Scope Ratings on 19 January 2022.

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.
Scope Ratings provided the following Other Services to the Rated Entity and/or its Related Third Parties within the two years preceding this Credit Rating action: Rating Assessment Service.

Conditions of use/exclusion of liability
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