Scope affirms the Erftverband's A+ rating with Stable Outlook
Scope Ratings GmbH (Scope Ratings) has today affirmed the Erftverband’s long-term issuer and senior unsecured debt ratings at A+. Scope has also affirmed the short-term issuer ratings at S-1+. All ratings are expressed in both local and foreign currency. All Outlooks are Stable.
Summary and Outlook
The A+ rating of the Erftverband reflects the following factors which support its creditworthiness: i) the high regional systemic relevance as a water management association in North Rhine-Westphalia (NRW), with the legal structure of a corporation under public law (Körperschaft des öffentlichen Rechts), due to its central role of managing the regional water supply, wastewater disposal and critical infrastructure; ii) the stable, predictable revenues in the form of legally obligated membership fees; and iii) the regional, natural monopoly over the entire course of the river Erft.
However, the rating also takes into account several challenges: i) an increased debt and interest burden; and ii) high investment needs due to the early lignite phase-out and impacts from climate change, such as more frequent extreme drought or flooding.
The Stable Outlook reflects Scope’s assessment that the risks to the Erftverband are balanced over the next 12 to 18 months.
The ratings/outlooks could be upgraded if: i) the average credit quality of the public sponsors were upgraded; ii) changes in the legal framework would significantly strengthen the investment capacity of the Erftverband or the liability guarantees of the public sponsors; and/or iii) there were a significant and sustained improvement in the Erftverband’s indebtedness metrics.
The ratings/outlooks could be downgraded if: i) the average credit quality of the public sponsors were to be downgraded; ii) there were unfavourable legal changes to the financing model through member contributions; and/or iii) there were a significant deterioration in the business and/or financial risk profile of the Erftverband.
The first rating driver of the Erftverband’s A+ rating is the close strategic, operational and financial integration with the cities, municipalities and districts that are part of the membership. For the rating analysis, Scope therefore applies the top-down rating approach under its rating methodology for Government-related Entities. The starting point and rating anchor for the Erftverband is a credit estimate of AA to assess the creditworthiness of the 48 public sponsors of the Erftverband, weighted according to their membership fee contributions in 2022. This estimate is robust and unlikely to change given the wide diversification of sponsors, the legal requirement of sponsors to be within the membership, and the stable membership fee contributions which drive the conservative rating approach applied by Scope.
The Erftverband is a water management association that was founded in 1859 as a cooperative. Since 1959 it has operated as a corporation under public law in the state of NRW under the "Gesetz über den Erftverband" (Erftverband Law). The corporate objective of the Erftverband and its public-law mandate are regulated by the Erftverband Law. Tasks include the support of water management in connection with lignite mining, the management of water discharge including flood discharge, the supervision of groundwater levels and the maintenance of surface waters, the supply of water to the population and the economy, as well as wastewater disposal. The Erftverband thus provides essential public services on behalf of the public sponsors, which serve to implement political goals and are not profit-maximising. As it is a member-based organisation that regulates its tasks in self-administration, the association has no ownership structure.
As a public corporation, the Erftverband has a special legal status which legally exempts it from insolvency procedures. Any changes to the entity’s legal form are only permissible via a legal act of the federal state of NRW. Scope deems this scenario to be unlikely. Members are legally obliged to pay contributions to ensure a stable financial management. The majority of member contributions is paid by cities, municipalities and districts located along the river Erft. Together, these therefore represent the public sponsor of the Erftverband for Scope’s rating approach. Other members include lignite mines, power plants, water pumping plants, as well as industrial and commercial enterprises with relevant wastewater volumes.
The financing model of the Erftverband is primarily based on member fee contributions which accounted for approximately 93.6% of revenues in 2022. 94.5% of the member contributions are provided by cities, municipalities and districts, with ten members accounting for more than half of the contributions. The high share of membership contributions from the public sponsors is due to 82% of the fee income in 2022 being allocated to wastewater disposal, which is particularly needed by more densely populated regions. According to the Erftverband Law, members are obliged to pay their contributions in advance on a quarterly basis. These contribution payments are therefore fundamental for the creditworthiness of the Erftverband.
The second driver for the A+ rating is the high level of control exercised by the public sponsors and the supportive governance framework that ensures stable revenues. As the central decision-making body, the Assembly of Delegates consists of a total of 102 members. The allocation key to determine which member groups are represented with how many delegate seats results in the cities, municipalities and districts occupying the majority of seats (71 out of 102) although they only make up 48 of the total 300 members. The Erftverband Law requires the assembly of delegates to decide on the business plan for each financial year. This determines the total amount of loans to be taken out, the commitment appropriations and the maximum amount of loans to secure liquidity. The business plan must be balanced and submitted to the supervisory authority. In the event that the business plan is no longer balanced, a new plan with amendments must be prepared without delay. The public sponsors thus exercise a high degree of control over the governance of the Erftverband while providing most of the financing through membership fees.
Furthermore, the strategic relevance of the Erftverband to the public sponsors is a supporting rating factor. The Erftverband has an important strategic role for the cities, municipalities and regions along the river Erft with its key position for regional water supply and wastewater disposal. Through the anchoring in the state law for NRW and the specifications in the Erftverband Law, the mission of the organisation is clearly set in the public interest.
The geographic conditions secure the Erftverband a regional, natural monopoly position and make a change in the distribution of tasks to other water management companies unlikely. Since its establishment as a public corporation in 1959, the Erftverband's area of competence has expanded. The association is responsible for the entire course of the Erft and has also assumed responsibility for smaller waterways and tributaries.
Finally, the A+ rating takes into account a supplementary analysis of the fundamentals of the Erftverband, including its business and financial risk profile.
The Erftverband’s business profile benefits from the regional, natural market monopoly and largely regulated market environment. It is also supported by stable, predictable revenue flows due to regular adjustments in membership fees to ensure costs are covered. Risks exist due to the consequences of climate change including increased frequency of drought and flood disasters, which could also lead to legal mandate changes, as well as increased investment needs related to opencast mining. Appropriate capital reserves have been accumulated in response to such risks.
Scope assesses risks in the financial profile of the Erftverband as slightly elevated. The organisation has a below-average equity ratio and elevated indebtedness compared with other water management associations in NRW. As of 31 December 2022, all but one of the outstanding variable-interest loans were hedged against rising interest rates, with the final loan having been converted into a fixed interest rate loan in 2023. As bank borrowings mainly finance property, plant and equipment, the higher debt also reflects the increasing investment volume of the Erftverband for the modernisation and maintenance of its technical equipment and machinery. This reduces the risk of an investment backlog and more expensive repairs in the medium term. Compared to other water management associations in NRW, the Erftverband has a relatively stable interest cover, a high debt ratio and an elevated interest burden. The EBIT interest cover in 2021 of 1.4x remained stable compared with previous years, while three other water management associations suffered losses during the year. While the Erftverband's debt-to-assets ratio (59% in 2021) has been stable in recent years, it remains higher than the average of similar water management companies in NRW (50%). Finally, the Erftverband is confronted with increased interest costs due to the elevated level of debt. Interest expenses in comparison to liabilities to credit institutions are the second highest (1.9%) and thus above the average of 1.6% in other water management associations in NRW.
Qualitative Scorecards (QS1 and QS2)
Provided that the GRE benefits from a sufficiently high level of integration with the public sponsor, Scope applies the Top-Down approach that takes the public sponsor’s rating as the starting point and then negatively adjusts it by up to three notches (although exceptions can apply).
Scope applies a ‘Top-Down’ approach (QS1) in assessing the creditworthiness of the Erftverband, which takes the public sponsor’s rating as the starting point. To determine the AA credit estimate which forms the rating anchor, Scope applies the sub-sovereign rating methodology.
The adoption of the top-down approach (QS1) reflects a strong level of integration between the Erftverband and the public sponsors resulting from: i) a ‘High’ integration assessment for Legal status, ii) a ‘High’ integration assessment regarding the Erftverband’s Purpose & activities; and iii) a ‘High’ integration assessment on Financial interdependencies. Given the Erftverband’s legal form as a public corporation, Scope does not assess Shareholder structure in line with its methodology.
The initial rating is then adjusted negatively, based on the assessment of i) ‘High’ Control and regular support from the public sponsors; and ii) ‘Medium’ Likelihood of exceptional support (QS2). The assessments under QS2 lead to an indicative AA- rating for the Erftverband.
Scope assesses Control and regular support for the Erftverband as ‘High’ as a result of: i) a ‘High’ level of control by the public sponsors over Strategic and operational decision making; ii) a ‘High’ control over its Key personnel, governing & oversight bodies; and iii) ‘High’ Ordinary financial support.
Scope assesses the Likelihood of exceptional support at ‘Medium’, reflecting: i) a ‘High’ assessment for Strategic importance for the public sponsor; ii) ‘Medium’ Substitution difficulty; and iii) a ‘Medium’ assessment on the political and reputational Default implications in the event of a hypothetical default.
The rating assessment also includes a supplementary analysis of the business and financial risk profile of the Erftverband. The supplementary analysis leads to a downward notching from the indicative AA- rating of one notch, and thus to the final A+ rating of the Erftverband.
Factoring in of Environment, Social and Governance (ESG) Factors
Scope considers the following ESG factors in the rating analysis.
Governance factors are relevant for the rating of the Erftverband and are included in the assessment of the integration with the public sponsors and in the assessment of the Erftverband’s business and financial risk profile. These factors are supported by the high quality of management and governance structures, and sound and conservative liquidity and financial management.
Social and environmental factors are included in the assessment of the strategic relevance of the Erftverband. The association is not only responsible for water supply and wastewater disposal, but also for regulating water runoff and groundwater levels, maintaining surface waters, waste disposal and preventing ecological damage. After the flood disaster of July 2021, the Erftverband facilitated the coordination between municipalities to cooperate on inter-municipal flood protection. The aim of this cooperation is to reduce the flood risk through increased coordination and the development of protective measures in all municipalities. The flood protection concept is to be developed by 2025.
The main points discussed by the rating committee were: i) integration with the public sponsor, ii) control and regular support assessments, iii) likelihood of exceptional support, and iv) stand-alone factors under the supplementary analysis and business and financial risk profiles.
The methodologies used for these Credit Ratings and Outlooks, (Government Related Entities Rating Methodology, 13 July 2023; Sub-Sovereigns Rating Methodology, 11 October 2022), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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-governance/definitions-and-scales. 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://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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.
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 Outlooks and the principal grounds on which the Credit Ratings and Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.
These Credit Ratings and Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlooks are UK-endorsed.
Lead analyst: Eiko Sievert, Director
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Executive Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 30 September 2022.
See https://scoperatings.com/ under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.
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