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���������ֳ� - Mexico City - 30 Aug 2023: ���������ֳ� has affirmed the Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) of Honduras's Alcaldia Municipal del Distrito Central, Tegucigalpa (AMDC) at 'B'. The Rating Outlook is Stable. In addition, ���������ֳ� has affirmed AMDC's Short-Term IDR at 'B'.

The affirmation reflects ���������ֳ�'s unchanged view that AMDC's operating performance and debt ratios will remain in line with 'B' rated peers over the medium term. The assessment also takes into account AMDC's capex trend that, if maintained, will need to be financed with new debt in the rating case scenario. AMDC's standalone credit profile (SCP) has been assessed at 'b+'.

Key Rating Drivers

Risk Profile: Revised to 'Weaker' from 'Vulnerable'

In accordance with ���������ֳ�'s International Local and Regional Government (LRG) Rating Criteria, AMDC's Risk Profile has been reassessed at 'Weaker' due to a combination of three 'Midrange' (revenue robustness and expenditure sustainability and adjustability) and three 'Weaker' key rating factors (revenue adjustability, liabilities and liquidity robustness and flexibility). ���������ֳ� has reassessed the 'Revenue Robustness' Key Risk Factor to 'Midrange' from 'Weaker' due to low volatility and stable growth pattern on its own-revenue structure in tandem with negligible dependence on central government transfers (6.2% average 2014-2022).

The 'Weaker' risk profile reflects ���������ֳ�'s view that there is a high risk of the issuer's ability to cover debt service with the operating balance weakening unexpectedly over the scenario horizon (2023-2027) due to lower revenue, higher expenditure, or an unexpected rise in liabilities or debt-service requirements. It also reflects the weak institutional framework in which local and regional governments (LRGs) operate in Honduras.

Revenue Robustness: Revised to 'Midrange' from 'Weaker'

For 2018-2022, tax collection has remained fairly stable growing by 6.5% while nominal GDP grew by 7.8%. In 2022, tax collection grew by 21.1% in nominal terms, while operating revenue increased 8.8% versus 2021. In our rating case for a stressed economy, we forecast a nominal average increase in operating revenue around 8.6% in 2023-2027 driven by moderate economic growth prospects. AMDC's own revenues are correlated to political cycles and the implementation of tax relief programs; nonetheless, the city benefits from a stable and diversified tax and non-tax revenue structure that shows low correlation with the economic cycle. Own revenues represent 94.9% of its operating revenue at YE2022. AMDC is not reliant on government transfers, which account for a negligible 4.8% of total revenue.

Revenue Adjustability: 'Weaker'

AMDC's ability to generate additional revenue in response to possible economic downturns is limited. The city has formal tax-setting authority over several local taxes and fees that accounted for about 95.2% of total revenue in 2022. However, its affordability to raise revenue is constrained by the lower-middle income of residents by international standards and social-political sensitivity to tax increases.

Expenditure Sustainability: 'Midrange'

AMDC's main responsibilities are centered on providing public services (water services, waste collection, sewage, among other services) but not on providing health or education services, adding fiscal space. The city's control over operating expenditure is remarkable, with a track record of keeping spending growth (2.7%) below that of operating revenue (6.0%) for the period of 2018-2022, allowing for a stable operating margin of around 53.7% on average in 2018-2022. Overall, in comparison to 2021, opex increased 8.0% annually while operating balance grew 26.1% resulting in an operating margin at 57.1% of operating revenues.

Expenditure Adjustability: 'Midrange'

In its rating scenario, ���������ֳ� expects AMDC to continue to report large operating margins of 41.9%. Over the last three years, on average 40.0% of expenditure before debt service is capital outlays, keeping the share of inflexible expenditure below 70%, in line with the Midrange threshold for this factor. This represents a moderate flexibility to control and cut expenses in a scenario of lower revenues.

AMDC's high investment program, with capex averaging 45.9% of total in 2018-2022, eased in 2022 reaching 33.1% of total expenditure. ���������ֳ� estimates that capex outlays will recover its trend by YE 2023, as of July 2023, capex is growing 39% y-o-y. Over the medium to longer term, high level of capex is necessary to maintain local attractiveness amid demographic pressures calling for more spending on infrastructure such as water distribution and roads.

Liabilities and Liquidity Robustness: 'Weaker'

Our assessment reflects the weak national framework for debt and liquidity management. Besides bank loans, there is no track record of capital market access for financing. The central government sets a public debt ceiling for LRGs. However, this can be waived if Honduras' Congress allows subnational governments to acquire new debt. Their direct long-term debt has fixed interest rates, and the maturity profile of this debt has no concentration risk; however, there is a weak national framework for debt and liquidity management.

At YE 2022, direct debt totaled HNL5,522 million with no short-term bank loans. Average cost of debt is around 8.8%. Long- and short-term debt is paid through a trust mechanism that ensures timely debt service payments. All of AMDC's debt is with local commercial banks. As of July 2023, direct debt stood at HNL5,522 million, and there are no short-term bank loans registered. In our rating case, net adjusted debt is expected to increase towards HNL12,895 million by end-2027 underpinned by large infrastructure needs in sectors such as public transport, roads and water. We assume that the city's investment program will be maintained.

Liabilities and Liquidity Flexibility: 'Weaker'

AMDC's available liquidity is weaker with respect to payables (end-2022: 0.17x; average 2018-2022: 0.10x). In addition, the city has exhibited high concentration of counterparty risk on bank credit lines (bank ratings) below 'BBB' category, triggering a 'Weaker' assessment for this factor. Historically, local governments in Honduras prefer to tap bank loans rather than other funding options due to shallow capital markets. As of July 2023, AMDC had no outstanding short-term debt.

Debt sustainability: 'a' category, unchanged

AMDC's benefit from a stable fiscal performance with a sound operating margin above 50% supported by a low volatile own-revenue structure and an opex growth rate that has remained subdue. Our rating case envisages a progressive reduction of the operating margin towards 38%-46%, incorporating a larger increase in opex, underpinned by the need to strengthen the provision of public services, in comparison to operating revenue.

Under ���������ֳ�'s rating case scenario, AMDC's payback ratio (net adjusted debt to operating balance) is forecast at 7.7 years in our 2023-2027 projections; this is the primary metric of debt sustainability, and is assessed in the 'aa' category. ���������ֳ� overrides the primary metric by one rating category, to incorporate an actual debt service coverage ratio (operating balance to debt service) below 1.0x in our rating case. The overall final score for debt sustainability is 'a'.

AMDC's net ���������ֳ�-adjusted debt is expected to reach HNL12,895 million by 2027, or 293% of revenue. ���������ֳ� estimates capex outlays of HNL2,251 million along the rating case scenario, largely funded by the city's own revenues and long-term debt. This assumption is underpinned in AMDC's large infrastructure needs.

Derivation Summary

AMDC's SCP is assessed at 'b+', reflecting a combination of weaker risk profile and debt sustainability in the 'a' category. The notch-specific rating positioning factors in comparison with international peers, including Argentine, Turkish and Nigerian peers. ���������ֳ� factors in the credit quality of the sovereign but does not apply any asymmetric risk or extraordinary support from upper-tier government, which results in an IDR of 'B'. The short-term rating of 'B' is derived from AMDC's Long-Term IDR.

Key Assumptions

Qualitative assumptions:

Risk Profile: 'Weaker' from 'Vulnerable'

Revenue Robustness: 'Midrange' from 'Weaker'

Revenue Adjustability: 'Weaker'

Expenditure Sustainability: 'Midrange'

Expenditure Adjustability: 'Midrange'

Liabilities and Liquidity Robustness: 'Weaker'

Liabilities and Liquidity Flexibility: 'Weaker'

Debt sustainability: 'a' category

Support (Budget Loans): 'N/A'

Support (Ad Hoc): 'N/A'

Asymmetric Risk: 'N/A'

Sovereign credit quality: 'Yes'

Sovereign Floor: 'N/A'

Quantitative assumptions - Issuer Specific

���������ֳ�'s rating case is a 'through-the-cycle' scenario, which incorporates a combination of revenue, cost and financial risk stresses. It is based on 2018-2022 figures and 2023-2027 projected ratios. The key assumptions for the scenario include:

--Operating revenue growth 2022-2027: 8.6%, in tandem with nominal GDP growth;

--Opex growth 2022-2027: 16.9%, considering the historical trend of operating margins and assuming higher growth in opex in comparison to that of operating revenue, underpinned by the need to strengthen the provision of public services;

--Net capital expenditure (average per year): HNL2,228. Capex is expected to grow at least in line with inflation in the rating case, which is to be financed with operating margins and new debt. The starting amount for 2023 is the five-year average for 2018-2022. The city's large infrastructure needs and requirements underpinned this assumption.

--Cost of debt for 2023-2027 at 9.3%; long-term debt has a fixed interest rate.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

--The SCP could be raised if the debt sustainability score improves such that the payback ratio remains between 5x and 9x with an improved debt service coverage ratio between 2.0x and 4.0x and coupled with a fiscal debt burden between 50% and 100%;

--Improvement in ���������ֳ�'s internal assessment on the sovereign's credit quality, provided that AMDC maintains its debt sustainability metrics.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

--A sustained deterioration of the payback ratio above 9x due to a weakened operating balance;

--An actual coverage ratio consistently below 1.0x;

--If AMDC compares unfavorably with peers;

--A lowering of ���������ֳ�'s credit quality of the sovereign.

Best/Worst Case Rating Scenario

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit /site/re/10111579.

Liquidity and Debt Structure

���������ֳ�-adjusted debt include AMDC's direct debt at end-2022 of HNL5,522 million. Liquidity includes a HNL351.7 million of total cash, which ���������ֳ� deems as earmarked to offset payables.

Issuer Profile

Tegucigalpa, AMDC is Honduras's capital city. With 1.1 million citizen, its GDP per capita is estimated to be 89% above Honduras USD3,528, but it is low by international standards. AMDC's economic structure is well diversified, fueled by public and private investment, which supports robust internally generated revenues. AMDC covers debt service with its operating balance.

Summary of Financial Adjustments

���������ֳ�'s net-adjusted debt corresponds to the difference between ���������ֳ�'s adjusted debt and AMDC YE cash that ���������ֳ� views as unrestricted. Unrestricted cash is calculated as cash net of earmarked items or payables.

Sources of Information

The principal sources of information used in the analysis are described in the Applicable Criteria.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. ���������ֳ�'s ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on ���������ֳ�'s ESG Relevance Scores, visit /topics/esg/products#esg-relevance-scores.

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