Training on sovereign risk credit analysis, October 24

ACRA affirms A-(RU) to the Kemerovo Region, outlook Stable, and A-(RU) to bond issue

The credit rating of the Kemerovo Region (hereinafter, the Region) is based its minimal debt load and accumulated budget liquidity, allowing it to finance budget expenditures on the back of lower coal prices, which production forms the basis of the Region’s economy. The rating is under pressure from the Region’s low flexibility of budget expenses, low economic diversification and ill-diversified tax revenues, as well as low per capita economic indicators.

The Region is a part of the Siberian Federal District, bordering six other administrative entities of the Russian Federation. The Region’s population is 2.7 million people (1.8% of Russia’s total population). According to the Region’s estimates, its gross regional product (GRP) amounted to RUB 1.21 trillion in 2018 (it makes up nearly 1.2% of the total GRP of Russian regions annually).

Key rating assessment factors

High dependence of tax revenues on the coal industry. According to ACRA estimates, dependence of tax revenues on the coal industry was nearly 40% in 2017–2018 (low diversification). According to the Agency’s estimates, annual tax revenues from the coal mining industry in 2017–2018 were more than twice as high as those in 2015–2016. The price of thermal coal in 2017–2018 was on average 60% higher than in 2015–2016, allowing the Region to almost halve its debt to the ratios corresponding to the minimal level of risk, and build a significant amount of deposits, which currently exceeds the debt volume. ACRA believes that coal prices will decrease by some 40% in 2019–2020 against the average price for 2017–2018, which will negatively affect the budget tax revenues over that period, but this effect will be lagged (around six months). Thus, the current decline in prices (by one third since the start of the year) has not yet affected the dynamics of budget revenues (income tax revenues for the first six months of 2019 are equal to those seen during the same period last year). At the same time, income tax revenues in May and June, 2019, decreased by more than half compared to May and June, 2018.

Given this, ACRA expects a gradual decline in the Region’s operating balance from 31% of regular income (the highest observed level) in 2018 to an average of 17% in 2019–2020.

The flexibility of budget expenditures is limited by their structure: the share of mandatory (according to the ACRA methodology) expenditures is high and will average 84% in 2016–2019.

In 2019, the Region plans to double capital expenditures (a proportional growth of expenses financed through own funds and transfers). Current expenditures will also increase (mainly due to the growth of socially important expenses), while revenues will decrease (by 6%, according to the forecast). Under the circumstances, a deficit can occur, although ACRA believes that the accumulated liquidity will be enough to finance a possible deficit in 2019–2020 without additional borrowings, even in case of the outperforming growth of budget expenditures.

Comfortable repayment schedule and low debt service costs. As of January 1, 2019, and July 1, 2019, the Region’s public debt was made up of: 1) bonds (27%, or RUB 9 bln) repayable in 2021-2024; 2) restructured budget loans (50.9%, or RUB 17 bln); 3) other debt obligations (22.1%, or RUB 7.3 bln) repayable by 2035. Given this debt structure, the debt repayment will amount to 3–6% of the total debt in 2019–2020 annually. Therefore, the operating balance after interest is many times higher than the amount of debt repayment during that period.

The debt to operating balance ratio is forecasted at 1.2 at the end of 2019, while interest expenses are not expected to exceed 3–4% of the operating balance.

Key assumptions

  • Conservative debt policy;
  • Decline in coal prices in 2019-2021, which will lead to a decrease in income tax revenues;
  • Decline in property tax revenues in 2019.

Potential outlook or rating change factors

The Stable outlook assumes that the credit rating will most likely stay unchanged within the 12 to 18-month horizon.

A positive rating action may be prompted by:

  • Significant decline in the share of mandatory expenses in the budget;
  • Increase in the Region’s operating balance;
  • Improvement in the Region’s socio-economic development parameters.

A negative rating action may be prompted by:

  • Significant growth of expenditures amid a fall in the Region’s TNTR, leading to the decline in its operating balance;
  • Long period of declininig coal prices, as a result of which the Region will get deprived of a liquidity cushion in case the need arises to finance the deficit.

Issue ratings

Kemerovo Region, 35002 (ISIN RU000A0ZYB40), maturity date: September 26, 2024, issue volume: RUB 9 billion — A-(RU).

Rationale. ACRA is of the opinion that the above bonds issued by the Kemerovo Region are senior unsecured debt instruments, which credit rating is equal to that of the Kemerovo Region.

Regulatory disclosure

The credit ratings have been assigned to the Kemerovo Region and bonds (ISIN RU000A0ZYB40) issued by the Kemerovo Region under the national scale for the Russian Federation based on the Methodology for Credit Ratings Assignment to Regional and Municipal Authorities of the Russian Federation, and the Key Concepts Used by Analytical Credit Rating Agency within the Scope of Its Rating Activities. In the course of assigning a credit rating to the bond issue above, the Methodology for Assigning Credit Ratings to Individual Issues of Financial Instruments under the National Scale of the Russian Federation has also been used.

The credit rating assigned to the Kemerovo Region and the credit rating assigned to the government bonds (ISIN RU000A0ZYB40) issued by the Kemerovo Region were first published by ACRA on August 29, 2017, and October 2, 2017, respectively.

The credit rating of the Kemerovo Region and its outlook, as well as the credit rating assigned to the government bonds (ISIN RU000A0ZYB40) issued by the Kemerovo Region are expected to be revised within 182 days following the publication date of this press release as per the Calendar of planned sovereign credit rating revisions and publications.

The credit ratings were assigned based on data provided by the Kemerovo Region, information from publicly available sources (the Ministry of Finance, the Federal State Statistics Service, and the Federal Tax Service), as well as ACRA’s own databases. The credit ratings are solicited, and the Kemerovo Region Administration participated in their assignment.

No material discrepancies between the provided data and data officially disclosed by the Kemerovo Region in its financial reports have been discovered.

ACRA provided no additional services to the Kemerovo Region Administration. No conflicts of interest were discovered in the course of credit rating assignment.

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