Public Finance. City of Gliwice. Poland. Full Rating Report. Key Rating Drivers. Rating Sensitivities. Ratings

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1 Poland Full Rating Report Ratings Foreign Currency Long-Term IDR Local Currency Long-Term IDR National Long-Term Rating A A AA (pol) Key Rating Drivers Ratings Upgrade: The s continued sound operating performance and prudent financial management, which together with a high share of earmarked capital grants and healthy liquidity support the implementation of its investment plans, led Fitch Ratings to upgrade the city s ratings in May 216. The upgrade also factored in healthy debt ratios and debt/current revenue well below 5%. Outlooks Foreign-Currency Long-Term IDR Stable Local-Currency Long-Term IDR Stable National Long-Term Rating Stable Financial Data City of Gliw ice 31 Dec Dec 14 Operating rev enue (PLNm) Debt (PLNm) Operating balance/ operating rev enue (%) Debt serv ice/current rev enue (%) Debt/current balance (y rs) Operating balance/ interest paid (x) Capital expenditure/total expenditure (%) Surplus (def icit) bef ore debt v ariation/total rev. (exc. new debt) (%) Current balance/capital expenditure (%) Related Research Institutional Framework f or Polish Subnationals (March 214) Interpreting the Financial Ratios in Local and Regional Gov ernment Rating Reports (October 215) Fitch: Income Tax Ruling, Pledge Could Hit Polish Local Gov ts (Nov ember 215) Polish LRGs Debt Dashboard (December 215) Analysts Maury cy Michalski maury cy.michalski@f itchratings.com Magdalena Mikolajczak magdalena.mikolajczak@f itchratings.com Opex Growth Under Control: Fitch expects Gliwice to continue to demonstrate solid operating performance in , with an operating margin around 14%. This will be underpinned by Gliwice s financial flexibility and the city authorities effective policy to limit opex growth, coupled with increasing revenue from taxes, supported by the expansion of the city s tax b ase. Sound Operating Performance: In 215, Gliwice posted a high operating margin of 15.7% (214: 16.7%), which was above our expectations and above the average of (12.7%). This result was supported by, among other things, higher-than-budgeted tax revenue, especially from personal income tax, and continued strict monitoring and rationalisation of spending. The high operating balance and proceeds from asset sales allowed the city to generate a surplus of PLN54m (4% of total revenue) in 215, despite significant capex. Modest Direct Debt Growth: Fitch expects the city s direct debt to hover around 35%-4% of current revenue in , up from 33% or PLN291m in 215. However, this should not put much pressure on Gliwice s budget, due to the city s continued solid budgetary performance and the dominance of low-cost and long-term financing from the European Investment Bank (EIB). Healthy Debt Ratios Maintained: Fitch projects that, despite debt growth, the city s debt service and debt payback ratios will remain strong in Debt servicing will be around 15% of the operating balance and the debt/current balance is likely to stay below three years (215: 2.1 years), well below the city s final debt maturity of 18 years. Limited Debt Financing Needs: Fitch s base-case scenario envisages Gliwice s investment spending declining to 25% of total spending on average in , from a high 44% in Currently, the city is preparing to roll out new investments under the EU programming period. As in the previous years, Fitch expects the city to finance the majority of its capex from the current balance and non-returnable investment grants available to Polish LRGs under the EU budget, which will limit Gliwice s recourse to debt. Solid Financial Management: The city s authorities follow a prudent budgetary policy, which Fitch views positively. Prudent financial management guarantees solid operating performance despite persistently high pressure on opex, which arises mainly from underfunded responsibilities transferred to local governments by the state and the structural inflexibility of opex, which is dominated by education and social care. Rating Sensitivities Contained Debt Growth: The ratings could be upgraded if Gliwice maintains sound operating performance, leading to a debt payback ratio of less than two years on a sustained basis. Deteriorating Operating Results: A downgrade could result from a material deterioration in operating performance, leading to the operating margin declining below 1% on a permanent basis. 27

2 Rating History Date Long-Term Foreign IDR Long-Term Local IDR 2 May 16 A A 2 Nov 15 BBB+ BBB+ 22 May 15 BBB+ BBB+ 21 Nov 14 BBB+ BBB+ 23 May 14 BBB+ BBB+ 28 Nov 13 BBB+ BBB+ 5 Feb 13 BBB+ BBB+ 7 Feb 12 BBB+ BBB+ 1 Feb 11 BBB BBB 21 Dec 9 BBB BBB 11 Dec 8 BBB BBB Long-Term Date National Rating 2 May 16 AA (pol) 2 Nov 15 A+(pol) 22 May 15 A+(pol) 21 Nov 14 A+(pol) 23 May 14 A+(pol) 28 Nov 13 A+(pol) 5 Feb 13 A+(pol) 7 Feb 12 A+(pol) 1 Feb 11 A(pol) 21 Dec 9 A(pol) 11 Dec 8 A(pol) Principal Rating Factors Summary: Strengths and Weaknesses Institutional framework Debt and other liabilities Economy Finances Management and admin Status Neutral Strength Neutral Strength Strength Trend Stable Stable Stable Stable Stable Source: Fitch Overall Strengths Sound operating results due to prudent financial and strategic management High liquidity and long, smooth maturity debt profile Wealthy local economy Overall Weaknesses Pressure on operating spending due to expanding infrastructure, wh ich generates maintenance costs Institutional Framework There is a stable regulatory regime for Polish local and regional governments (LRGs), which include regions, counties and municipalities (cities combine the functions of a county and a municipality). Their activities and financial statements are closely monitored and reviewed by the central administration. There is good disclosure in the LRGs accounts. LRGs are obliged to publish their budgets and annual and interim execution reports on their websites, as well as long-term financial projections. LRGs budgets and budget execution reports regarding revenue and expenditure are based on cash accounting. All revenue sources for all tiers of LRGs and the formulae for their distribution are defined in law, limiting the national government s scope for discretionary decisi ons. There are also revenue equalisation schemes in place. Gradual decentralisation of responsibilities affects the LRGs budgets, as financial resources assigned to new responsibilities have often been insufficient. This has increased the size of the LRGs budgets, but is gradually shrinking their financial flexibility. LRGs are not allowed to adopt a budget with an operating deficit, but there are no restrictions on running capital deficits. LRGs may place outstanding cash on deposits with banks established on Polish territory and invest it in treasury bonds or bonds issued by other LRGs. LRGs can incur short-term debt to cover their liquidity shortages during a year, but it has to be repaid by year-end. Since 214, each LRG has had to comply with an individual debt limit calculated specifically for it. The debt service/total revenue planned in an LRG s budget must not exceed the last three years average current balance plus revenue from asset sales /total revenue. This should encourage LRGs to improve their operating results, which will support their creditworthiness. LRGs cannot go bankrupt. In a situation of financial distress, an LRG can be granted loans from the state budget. However, it cannot be ruled out that an LRG might default on its financial obligations. Related Criteria International Local and Regional Gov ernments Rating Criteria Outside the United States (April 216) Debt and Other Long-Term Liabilities Long-Term EIB Financing Enhances Debt Structure Fitch expects the city s direct debt to hover around 35%-4% of current revenue in , up from 33% or PLN291m in 215. In the same period, the debt-service and debt-payback ratios will remain strong. Debt servicing (interest and principal repayment), albeit increasing to PLN3m by 218 from an average of PLN4m in , due to expiration of grace periods 2

3 f 217f 218f Public Finance Budgetary Performance Operating balance (LHS) (PLNm) Operating margins (RHS) (%) f: Fitch projections Source: Fitch calculations based on City's budgets on European Investment Bank (EIB) loans, will be covered around 6x by the operating balance. The debt/current balance ratio is unlikely to exceed three years, which would be well below the city s final debt maturity of 18 years. Gliwice s debt structure does not put pressure on the city s budget, as almost all of the debt is drawn from the EIB. The low-cost and long-term financing from the EIB will limit Gliwice s annual debt-service burden. Fitch believes this is positive. At end-215, more than 75% of Gliwice s direct debt had fixed rates, which limits the city s exposure to interest rate risk. All of Gliwice s debt is denominated in Polish zloty; therefore, the city is not exposed to foreign - currency risk. Future Debt Financing Needs Secured In December 215, the EIB s Board of Directors approved a loan facility of up to PLN4m to be drawn by the city in The loan will be directed to investments to be co-financed by the EU budget investment grants during the EU programming period. The lowcost and long-term financing from the EIB will allow the city not only to secure debt financing for the upcoming investment plan, but also to maintain its healthy debt service ratios despite the nominal increase in debt. Track Record of Good Liquidity Management Gliwice maintained good liquidity in 215, with average month-end funds of PLN8m. The city may also access a PLN6m low-cost liquidity credit line (committed until end-216) if it encounters liquidity stress. Due to its low interest rate, the city uses the line to postpone incurring investment loans. Additionally, Gliwice has a consolidated bank account (cash - pooling), which supports its liquidity and minimises the cost of bank services. Low Contingent Liabilities The city s contingent liabilities are low, and Fitch expects them to remain so in the medium term. They are composed solely of public-sector entities debt (end-214: PLN148m), most of which belongs to housing associations (ZBM TBS I & II) and the city s water and sewerage company (PWiK). These companies are self-supporting and repay their debt from rents paid by social housing tenants or water tariffs paid by end-users, alleviating any risk to Gliwice s budget. The city supports some of its companies with capital injections (PLN9.6m budgeted for 216, or.7% of total spending). At end-215, Gliwice had not reported any guarantees outstanding, and the city does not plan to issue any guarantees in the medium term. Economy Direct Debt Repayment As of 31 December 215 Year PLNm % of debt outstanding Total Source: Gliwice s multi-y ear f inancial projection Fitch projects that Poland s real GDP will grow by 3.2% in 216 and 3.5% in (2.5% pa in ). This stable economic growth at the national level should support the development of Gliwice s tax base. In addition, the city s well-developed local economy will benefit from the improving local infrastructure, which stimulates business activity within the city and may provide Gliwice with higher tax revenue. Gliwice is located in the Slaskie region, about 3km west of Katowice (A /Stable), the regional capital. With a population of 183,392 at end-215, it is a medium-sized city by Polish standards. The city s economy benefits from its location at the crossroads of the main Polish rail and road corridors, and from its well-educated and highly qualified labour force. These attributes make the city attractive to investors. GDP per capita for the Gliwicki sub-region, which includes Gliwice, Zabrze (BB+/Stable) and surrounding towns and villages, was 118.4% of the national average in 213 (last available data). The city s wealth indicators should be even better, as Gliwice is the strongest area in the sub-region, with 48% of total registered companies, over 53% of capital expenditure allocation and an unemployment rate (5.6% at end-215) that is lower than that of the overall sub-region (7.5%) and considerably lower than the national average (9.8%). 3

4 f 217f 218f Public Finance Debt and Payback (PLNm) Debt (LHS) Payback (RHS) (Yrs) 5 f: Fitch projections Source: Fitch calculations based on City's budgets Gliwice s services sector is growing. In 214, it produced about 54% of gross value added (GVA) and employed 6% of the local workforce (Poland: 63% and 52%, respectively). However, industry still plays an important role in Gliwice, as more than 45% of the city s GVA is generated by industry and the construction sector, which employ 39% of the local workforce (Poland: 34% and 27%, respectively). The city s main industrial sectors are automotive, construction, iron and steel, chemicals and metal-processing. The number of companies in Gliwice grew to about 24,1 at end-215 from 21,37 at end- 26. The number of companies per 1, inhabitants (13 in 215) is above the national average of 19, but below most of the city s peers, which have more diversified local economies. Foreign capital is represented in 493 commercial companies (a high 15% of total commercial companies registered in the city). Finances Strong Operating Performance In its base-case scenario, Fitch expects the city to continue to post a stable operating balance of above 14% of operating revenue in (about PLN13m in nominal terms), despite pressure on operating spending. These results will derive from the city authorities cautious financial policy and cost control measures, coupled with increasing revenue from income and property taxes, supported by the expansion of the city s tax base. An investment peak is not expected before , so we assume Gliwice to post budgetary deficits of up to 6% in On 1 April 216, the Family 5+ programme commenced. This is a central governmentdelegated task, with transfers from the central budget to the budgets of municipalities. Each LRG in Poland will pay out monthly cash benefits of PLN5 per child to families with more than one child. Besides the benefits, the transfers include compensation for administration of the process. The flow of funds from the central government will inflate both sides of the LRGs budgets and will therefore be neutral to the operating balance. However, comparability of operating and current margins, as well as the debt/current revenue ratio, between 216 and 215 will be limited. In Gliwice s case, the city estimates PLN47m passing through the budget in 216 (for nine months), and about PLN63m pa in In 215, Gliwice again posted a high operating margin of 15.7% (214: 16.7%), which was above our expectations and above the average of (12.7%). This result was supported by, among other things, higher-than-budgeted tax revenue, especially from personal income tax, as well as continued strict monitoring and rationalisation of spending. High operating balance and proceeds from asset sales allowed the city to generate a surplus of PLN54m (4% of total revenue) in 215, despite a significant level of capex. Operating Revenue (PLNm) ab PIT CIT Property tax Civil law transaction tax Other local taxes and fees Current transfers Other operating revenue Total ab Budget as amended April 216 Source: Fitch s own calculations based on the city s budgets Operating Revenue Fitch expects Gliwice s operating revenue to grow by 3%-4% a year on average in This increase will come from the growing national economy and the city s developing tax base, as well as the expiration in 216 of some tax reliefs granted to companies located in the Special Economic Zone. In 215, Gliwice s operating revenue rose by 1.4% to PLN872m. However, comparability with 214 is limited, as operating revenue that year was inflated by a one-off PLN2m VAT return on capex from previous years. Excluding this, Gliwice s operating revenue increased by 3.8% in 215. This growth was supported mainly by growth in income tax revenue and local taxes and fees collected by the city. Current transfers will remain the city s largest source of operating revenue (33% of total operating revenue or PLN285m in 215). Current transfers, although increasing annually, do not provide the city with much flexibility. Besides the educational subsidy (63% of total current transfers in 215), about 26% is for targeted grants to finance state-delegated responsibilities, 4

5 such as family allowances and social assistance benefits, or to co-finance some of the city s own responsibilities, mainly in social care. Operating Expenditure by Sector in 215 Opex (PLNm) Structure (%) Education Social care Housing economy Public transport and roads Public administration Environment protection Public safety Other Total Source: Fitch s own calculations based on the city s budget In light of the expected gradual expansion of the economy, Fitch projects Gliwice s revenue from personal and corporate income taxes (PIT and CIT) will grow by 5%-6% per year in , similar to the average growth reported in Income taxes will remain the second-largest source of operating revenue, accounting for 3% of the total (a smaller share than in most cities of Gliwice s peer group). Fitch assumes revenue from property tax to rise steadily in by 3% a year, following the expansion of the tax base, as new commercial investments are completed. Additionally, an estimated by the city PLN7m pa is expected to be received starting in 216, as real estate tax reliefs to companies in the Special Economic Zone begin to expire. Pressure on Operating Expenditure Will Persist Fitch believes that Gliwice will keep its operating expenditure growth in line with operating revenue growth in , which will allow the city to comply with the individual debt limit, and finance new investments under the EU programming period. The city s authorities demonstrated their ability to keep opex growth below operating revenue growth in This was despite the strong pressure on operating spending that all Polish LRGs face (see Management and Administration section below). Education Most Costly Responsibility As in other Polish cities, education will remain Gliwice s largest expenditure item in the medium term, consuming 35% of total opex. This is lower than the 38%-42% share of most of its peers. The educational subsidy and other operating revenue generated in this sector do not cover all of the sector s operating costs, which puts pressure on the city s budget as the rest ( 215: about 25%) must be financed from its own sources. However, Gliwice s participation in financing this sector is one of the lowest among its peers. Operating Expenditure (PLNm) ab Education Social care Housing economy Public administration Public transport and roads Other Total ab Budget as amended April 216 Source: Fitch s own calculations based on the city s budgets Capital Revenue and Expenditure Roll-out of New Investments Ahead Fitch s base-case scenario envisages Gliwice s investment spending declining to 25% of total spending on average in , from a high 44% in , when the city was constructing within its boundaries a large regional motorway co-financed by state and EU investment grants. Currently, the city is preparing to roll out new investments under the EU programming period. However, the scope of investments implemented after 216 and Gliwice s debt needs for financing them will depend on the amount of EU grants available to the city. As in previous years, Fitch expects the city to finance the majority of its capex from the current balance, proceeds from asset sales and the non-returnable investment grants available to Polish LRGs under the EU budget, which will limit Gliwice s recourse to debt. The city is continuing construction of the Podium exhibition and sports hall (an estimated PLN397m, including VAT and a PLN4m capital injection to PWiK a city-owned company to be responsible for operating Podium; to be accomplished in ). The city is using its own means to finance this investment, after the decision of the Slaskie region to remove the project from the Regional Operational Programme priority list and to terminate the contract for EU support with the city. Currently, the city and the region are in dispute as the city authorities believe the contract termination was unlawful and Gliwice has filed a suit for compensation. 5

6 Management and Administration Zygmunt Frankiewicz has held the post of city president since His party does not have a majority on the city council and there is no formal coalition supporting the president. However, there is cooperation within the council to support projects that are beneficial to the city. Creating Good Conditions for Business Development is Priority The authorities are focused on creating favourable conditions for business development in the city and attracting new investors. They are improving local infrastructure, particularly roads. There is also an emphasis on developing land for commercial and residential investment, by expanding development plans and constructing utilities infrastructure. The administration is determined to limit any non-obligatory operating spending to maximise the city s operating balance. This should support the process of raising its own funds to be used for co-financing investments during the EU budget programming period. Fitch views Gliwice s overall strategic and financial management as a strength. Successful Spending Rationalisation Programme Gliwice, like many other Polish subnationals, faces strong pressure on operating spending, due to underfunded responsibilities transferred to local governments by the state and the structural inflexibility of opex, which is dominated by education and social care. Additional growth pressure is likely to stem from maintenance costs from completed investments. To counteract this pressure, the city s administration is focused on spending rationalisation and cost control. Fitch assumes the city s policy of opex control will be maintained and will result in a continuing sound operating performance. To limit spending growth in the most rigid sectors, the local authorities are implementing cost-saving measures, with a focus on employment, optimising the school network and modernisation of public buildings. In addition, in the event of financial stress, Gliwice can curtail some discretionary expenditure, such as one-off operating spending on the promotion of the city or limiting the scope of repairs. Municipal Shareholdings Key Financial Data (PLNm) 214 Net profit/loss Long-term debt Company City s stake (%) Equity Total assets PRUiM sp. z o.o. (renovation of streets and bridges) ZBM I TBS sp. z o.o. (housing society) ZBM II TBS sp. z o.o. (housing society) PSiUO sp. z o.o. (solid w aste company) PEC- Gliw ice sp. z o.o. (heating company) SŚM sp. z o.o. (fibre-optics, monitoring systems, internet) GCM sp. z o.o. (municipal medical centre) GAPR sp. z o.o. (agency for local development and entrepreneurship) PWiK sp. z o.o. (w ater and sewerage company) PKM sp. z o.o. (public transport company) SCL S.A. (logistic centre) Piast S.A. (football club) PNT Technopark Gliw ice sp. z o.o. (technological park) Total Source: 6

7 Appendix A (PLNm) Taxes Transfers received Fees, fines and other operating revenue Operating revenue Operating expenditure Operating balance Financial revenue Interest paid Current balance Capital revenue Capital expenditure Capital balance Surplus (deficit) before debt variation New borrowing Debt repayment Net debt movement Overall results Debt Short-term Long-term Direct debt Other Fitch classified debt pre-financing..... Direct risk Cash, liquid deposits, sinking fund Net direct risk Guarantees and other contingent liabilities Net indirect debt (public sector entities exc. gteed amount) Net overall risk Memo for direct debt (%) In foreign currency..... Issued debt..... Fixed interest rate debt ª Fitch Estimates Source: Issuer and Fitch calculations 7

8 Appendix B Fiscal performance ratios Operating balance/operating revenue (%) Current balance/current revenue a (%) Surplus (deficit) before debt variation/total revenue b (%) Overall results/total revenue (%) Operating revenue growth (annual % change) n.a Operating expenditure grow th (annual % change) n.a Current balance grow th (annual % change) n.a Debt ratios Direct debt grow th (annual % change) n.a Interest paid/operating revenue (%) Operating balance/interest paid (x) Direct debt servicing b /current revenue (%) Direct debt servicing b /operating balance (%) Direct debt/current revenue (%) Direct risk/current revenue (%) Direct debt/current balance (yrs) Net overall risk/current revenue (%) Direct risk/current balance (yrs) Direct debt/gdp (%) Direct debt per capita (PLN) ,255 1,269 1,579 Revenue ratios Operating revenue/budget operating revenue (%) Tax revenue/operating revenue (%) Modifiable tax revenue/total tax revenue (%) Current transfers received/operating revenue (%) Operating revenue/total revenue c (%) Total revenue c per capita (PLN) 4,257 4,681 5,671 7,135 7,694 Expenditure ratios Operating expenditure/budget operating expenditure (%) Staff expenditure/operating expenditure (%) Current transfer made/operating expenditure (%) Capital expenditure/budget capital expenditure (%) Capital expenditure/total expenditure (%) Capital expenditure/local GDP (%) Total expenditure per capita (PLN) 4,654 5,94 6,54 7,376 7,43 Capital expenditure financing Current balance/capital expenditure (%) Capital revenue/capital expenditure (%) Net debt movement/capital expenditure (%) n.a.: Not av ailable a Includes f inancial rev enue b Debt serv icing = interest + principal repay ment c Excluding new borrowing Source: Issuer and Fitch calculations 8

9 Public Finance Appendix C Peer Comparison Operating Balance % Operating Revenue Surplus (Deficit) % Total Revenue Taxes % Operating Revenue Capital Expenditure % Total Expenditure A Peer Group Median Debt To Current Revenue (%) 214 Debt Servicing To Curent Revenue (%) 214 City of Poznan (A-) City of Gdansk (A-) City of Katowice (A-) Median (A) Autonomous Region of Valle d'aosta (A) (A-) Autonomous Region of Sardinia (A-) City of Poznan (A-) City of Gdansk (A-) Autonomous Region of Valle d'aosta (A) Median (A) Autonomous Region of Sardinia (A-) City of Katowice (A-) (A-)

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