Mother City gets a positive outlook from Moody’sAn upgrade hinges on sound financial and operating performance. By Liesl Peyper

Moody’s Ratings has changed the outlook for the City of Cape Town from stable to positive, the agency said in a media release on Friday.

The city’s current Ba3 rating, which is below investment grade and where debt obligations are judged to have speculative elements and are subject to substantial credit risk, was affirmed.

“The positive outlook reflects our view that Cape Town’s financial performance could further strengthen over the next 12 to 18 months, surpassing our baseline forecasts,” it noted.

Moody’s says it may consider upgrading Cape Town’s ratings if the operating and financial performances strengthen further and without excessive debt accumulation. A rating downgrade could follow if there were to be a deterioration in its operating performance and liquidity. “We would also consider a ratings downgrade if the sovereign ratings were downgraded.”

Revenue collection and debt management 

In the rating agency’s view, the city’s progress in improving revenue collection should contribute to the strengthening of its financial performance and mitigate its reliance on debt for its investment programme.

The city recently announced that it has received R3.5 billion in funding from Nedbank as part of a three-year comprehensive infrastructure spending project.

Its infrastructure spending is by far the largest of any metro in South Africa, according to Cape Town Mayor Geordin Hill-Lewis.

“The positive outlook on the City of Cape Town reflects our view of a strengthening operating performance going forward, which should help the city curb debt accumulation despite significant investment requirements,” Moody’s says.

It adds that the city’s proactive approach – not only with revenue collection, but also in terms of expenditure control – demonstrates strong governance and effective budget management.

“Recent initiatives, such as the more active utilisation of prepaid electricity payments from residential properties, are expected to further diminish the risks of non-payment or late payment, which are persistent challenges for South African municipalities.”

Three-year forecast

Moody’s forecasts that the city’s operating margin should improve in the next two to three years and its liquidity ratio should remain strong.

“The city’s primary operating margin has gradually yet consistently improved to a sound 11% in fiscal 2023 from 9% in fiscal 2022, with positive repercussions on the city’s liquidity position, [which is] expected to remain above 25% of operating revenues in fiscal year 2025.”

Although there are challenges because of higher investment requirements for water management and drought risk mitigation, Cape Town’s improved revenue collection should also “bolster its self-funding capabilities” and help to contain debt accumulation, according to Moody’s.

“The city’s capital expenditure plan demonstrates a strong commitment to infrastructure-led growth, which will be achieved with an additional R9.4 billion in new borrowing over the 2024-2025 period.”

Debt trajectory

Moody’s expects the city’s debt to rise from 15% of operating revenues in 2023 to 23% in 2025.

The city has good access to funding and has a more diverse pool of funders than other South African municipalities, according to the agency.

Cape Town follows a blended finance model that includes funding from its balance sheet as well as local and international markets.

Moody’s says the city’s cash and cash equivalents balances cover 170% of its net debt and indirect debt, and its strong liquidity will help to keep its debt burden moderate despite a sizeable capital expenditure plan. The plan will see R49 billion invested in infrastructure projects, primarily in water and sanitation, urban mobility and electricity access, over the next five years.

“The Ba3 rating also incorporates a low likelihood of extraordinary support from the Government of South Africa (rated at Ba2 with a stable outlook) in the event that the City of Cape Town faced severe liquidity stress.”

ESG considerations

The City of Cape Town’s ESG (environmental, social and governance) Credit Impact Score (CIS-4) reflects highly negative exposure to environmental and social risks, driven by water stress and weak labour and income, and neutral-to-low governance risks.

Its primary environmental risk (E-4) stems from physical climate change, particularly water shortages caused by droughts, which directly impact the city’s revenue.

To address this, the city collaborates with the central government’s department of water but it still bears part of the fiscal responsibility to implement and maintain water supply, Moody’s notes.

“Following a severe three-year drought that significantly depleted the city’s dam system levels, Cape Town has initiated a strategy to develop an integrated water management system for more diverse water sources.”

In 2018, Cape Town faced a ‘Day Zero’ scenario where it would have been the first major city in the modern world to run out of water.

The city successfully managed to avert this with active water-saving measures such as getting residents to cut their water use by half.

Moody’s cautions that the city faces significant social risks (S-4) due to high labour and income risks, health and safety concerns, limited access to basic services, and housing shortages.

“High unemployment rates impair residents’ ability to pay for services, increasing the dependence on the city for basic provisions. South Africa’s high inequality rate, one of the highest globally, also impacts local governments, leading to potential social unrest.”

The city’s governance risk (G-2) reflects high data transparency – with all “financial statements, along with medium-term budgets, published publicly on its website, as well as that of National Treasury’s websites”.

SOURCE:Mother City gets a positive outlook from Moody’s – Moneyweb