Rating Action: Moody's downgrades the issuer and debt ratings of the State of Nayarit, stable outlook
Global Credit Research - 30 Dec 2020
Mexico, December 30, 2020 -- Moody's de Mexico S.A. de C.V. ("Moody's") has concluded the review initiated on October 21, 2020 and has downgraded the issuer ratings for the State of Nayarit to Caa1 (Global Scale, local currency) and B2.mx (Mexico National Scale) from B3/B1.mx, confirmed its baseline credit assessment (BCA) at caa1, and changed the outlook to stable. In addition, Moody's downgraded Nayarit's senior secured debt ratings to Ba1/A1.mx from Baa3/Aa3.mx.
The downgraded debt ratings to Ba1/A1.mx apply to the following three enhanced loans of the State of Nayarit:
- MXN 5 billion (original face value) enhanced loan from Banobras
- MXN 500 million (original face value) enhanced loan from BBVA Bancomer
- MXN 247 million (original face value) enhanced loan from Santander
RATIONALE FOR THE DOWNGRADE OF THE ISSUER RATINGS AND STABLE OUTLOOK
The downgrade of the issuer ratings primarily reflects expectations that Nayarit will continue to face significant liquidity pressure stemming from its low cash balances, high upcoming short-term debt maturities and weak operating performance. Nayarit's weak liquidity caused the state to temporarily fall behind on debt service payments of its short-term loans in recent months, and it's continued tight liquidity raises risks that additional debt service payments could be delayed in the future. Nonetheless, the outlook was changed to stable based on expectations that creditors will likely not face losses or that any losses would be negligible. Recent delayed payments were ultimately made in full along with penalties. Nayarit's Caa1 Global Scale rating is based on a BCA of caa1 as well as Moody's assessment of a low level of extraordinary support coming from the Government of Mexico (Baa1 negative).
Nayarit's acute liquidity stress -- a product of significant revenue pressure amid the pandemic combined with certain rigidities in its operating expenses -- led it to fall behind on debt service payments on its 12 outstanding short-term loans during the period from September through November 2020. The state recently secured a bridge loan from the federal government that allowed it to then obtain new short-term financing from a private lender (Banorte). This allowed Nayarit to pay off five of its short-term loans, including penalty interest payments, and to fulfill past-due capital and interest payments on its remaining short-term debt.
Nonetheless, liquidity remains very tight, with available cash as of September 2020 down 43% from the same period a year earlier, and equal to 56% of its short-term debt payments due between December 2020 and June 2021. While the recent refinancing of short-term obligations alleviated immediate stress, liquidity pressure will persist through next year, especially given that the state is barred from contracting additional short-term financing during the final three months of an outgoing administration, in accordance with the Financial Discipline Law for States and Municipalities. Nayarit will therefore have to maintain a zero balance of short-term debt from July through September 2021 to comply with the legislation, reducing its flexibility.
In addition, Nayarit faces both declining revenue and spending pressures. Own-source revenue dropped 6% in the first nine months of 2020 compared with the same period a year earlier, while non-earmarked federal transfers (participaciones), which are equal to 85% of the state's operating revenue, fell 5.8% in the first 10 months. While Nayarit has been able to cut spending on supplies and services, personnel costs only fell 2.4%, in part due to rigidities in teachers' salaries and benefits. The state has budgeted modest increases in operating expenses in 2021 and is focusing cuts on capital expenditure. Moody's expects Nayarit's operating deficits will likely widen to -6.1% in 2020 and -6.6% in 2021 given ongoing revenue pressures and recurring spending needs.
RATINGS RATIONALE FOR THE DOWNGRADE OF THE ENHANCED LOANS RATINGS
The downgrade of the debt ratings reflects the downgrade of the state's Global Scale issuer rating. The enhanced loan ratings are directly linked to the credit quality of the issuer, which ensures that underlying contract enforcement risks, as well as economic and governance risks are embedded in the enhanced loan ratings. Nonetheless, it's important to note that despite significant liquidity pressures, payments on Nayarit's long-term bank debt continue to be made on time and in full, supported by structural credit enhancements which Moody's doesn't anticipate will be modified.
This view, and the Ba1/A1.mx debt ratings, are supported by the following credit enhancements embedded in the loan documentation:
1. A strong trust structure based on the transfer of the rights and flows of a portion of Nayarit's General Participations Fund revenues to the paying trusts. The structure is supported by both an irrevocable instruction and an irrevocable mandate, the latter of which is signed by the state, federal government and lenders. The mandate ensures that the Ministry of Finance will transfer Nayarit's pledged General Participations Fund revenue directly to the paying trust even if Nayarit unilaterally tries to alter the agreements. The structure of the trusts provides a level of insulation between the loan and the issuer's idiosyncratic risks.
2. Estimated cash flows that generate high debt service coverage (DSC) ratios:
i. MXN 5 billion (original face value) from Banobras: under Moody's base case scenario, cash flows are projected to provide 3.22x debt service coverage at the lowest point over the life of the loan. Under a stress case scenario, estimated cash flows are projected to provide 2.45x debt service coverage at the lowest point.
ii. MXN 500 million (original face value) from BBVA Bancomer: under Moody's base case scenario, cash flows are projected to provide 3.35x debt service coverage at the lowest point over the life of the loan. Under a stress case scenario, estimated cash flows are projected to provide 2.65x debt service coverage at the lowest point.
iii. MXN 247 million (original face value) from Santander: under Moody's base case scenario, cash flows are projected to provide 3.11x debt service coverage at the lowest point over the life of the loan. Under a stress case scenario, estimated cash flows are projected to provide 2.46x debt service coverage at the lowest point.
3. Solid level of reserves equal to 3.0x debt service coverage for all three loans, which provides an adequate cushion against payment delays.
ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS
Environmental considerations are not material to Nayarit's ratings.
Social considerations are material to Nayarit's credit profile. Importantly, the coronavirus outbreak poses substantial public health and safety implications and the risk of further spread of in the state, and has added to both revenue and spending pressures. In addition, social indicators measuring poverty, education levels and access to basic services are relatively weak in the state, and it has also experienced increasing levels of violence and crime in recent years. Social spending pressures, especially for public health, education and security, will represent a recurring pressure. In addition, Nayarit faces risks related to its unfunded pension liabilities.
Governance considerations are material to Nayarit's credit profile. The state exhibits weak governance in terms of planning and debt management, which is reflected in recent missed payments on short term debt and weak liquidity. However, its transparency practices are in line with national peers.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
While currently we do not expect upward pressures on the ratings given significant liquidity pressures, if the state is able to remain current on its short-term debt service payments through the change in administration in 2021, and significantly improve its liquidity position and operating results, the issuer ratings could face positive pressure. Conversely, if Nayarit's already weak liquidity deteriorates further and its operating results weaken more than expected, this would put additional negative pressure on the ratings.
Given the links between the loans and the credit quality of the issuer, an upgrade of Nayarit's issuer rating would likely result in an upgrade of the enhanced loan ratings. Conversely, a downgrade of the state's issuer rating, or a material decline in debt service coverage to levels below our expectations, could exert downward pressure on the ratings of the loans.
The methodologies used in these ratings were Regional and Local Governments published in January 2018 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1091595, and Enhanced Municipal and State Loans in Mexico Methodology published in May 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1157935. Alternatively, please see the Rating Methodologies page on www.moodys.com.mx for a copy of these methodologies.
The period of time covered in the financial information used to determine Nayarit, State of's rating is between 01/01/2015 and 31/12/2019 (source: State of Nayarit financial statements).
Moody's National Scale Credit Ratings (NSRs) are intended as relative measures of creditworthiness among debt issues and issuers within a country, enabling market participants to better differentiate relative risks. NSRs differ from Moody's global scale credit ratings in that they are not globally comparable with the full universe of Moody's rated entities, but only with NSRs for other rated debt issues and issuers within the same country. NSRs are designated by a ".nn" country modifier signifying the relevant country, as in ".za" for South Africa. For further information on Moody's approach to national scale credit ratings, please refer to Moody's Credit rating Methodology published in May 2016 entitled "Mapping National Scale Ratings from Global Scale Ratings". While NSRs have no inherent absolute meaning in terms of default risk or expected loss, a historical probability of default consistent with a given NSR can be inferred from the GSR to which it maps back at that particular point in time. For information on the historical default rates associated with different global scale rating categories over different investment horizons, please see https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1216309.
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The date of the last Credit Rating Action was 21/10/2020.
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