S&P Global Ratings incorporates the impacts of the COVID-19 pandemic into its ratings in part through the lens of environmental, social, and governance (ESG) credit factors. These factors are integrated into our rating criteria using our "Methodology For Rating Local And Regional Government Outside Of The U.S.," published July 15, 2019. We incorporate ESG factors into our assessment of an LRG's institutional framework, economy, and financial management. Public policy decisions that governments take, including those spurred by ESG factors, can affect budgetary performance and debt burdens. As a result, ESG factors can contribute to rating and outlook changes.

With the COVID-19 pandemic, we believe that the prolonged health and safety measures implemented in large cities will result in weakened fiscal performance over the next few years and a moderate increase in debt levels. However, highly rated cities have strong liquidity positions to facilitate debt repayment and ongoing access to external liquidity, and are also bolstered by support from upper levels of government, which creates a very important buffer to sustain credit quality. The largest capital cities we rate are overwhelmingly at investment-grade ratings (chart 1), but there was a shift in the proportion of negative outlooks in 2020 compared with 2019 (charts 2 and 3). Any financial impacts would likely be more pronounced for higher levels of government--provinces, states, or regions--considering their already limited budgetary flexibility and ongoing responsibilities. Fiscal packages or support received in 2020 will eventually ebb, and should this support run out prior to a full recovery, financial stress could increase. We will continue to assess the effectiveness of the cities' financial management to ensure healthy and sustainable public finances because any meaningful path in a different direction could lead to rating changes in coming years.

Chart 1

Chart 2

Chart 3

With high population densities and lockdown measures, cities' finances will remain under pressure in 2020 and 2021. Consumer spending dynamics, sensitivity to travel, and tourism receipts will take time to regain traction despite the recent success of vaccine trials and expected rollouts in 2021. In addition, there is rising uncertainty about the speed and full extent of a recovery next year. The temporary freeze in the property transaction market in some European cities and additional support for transit and other businesses could also take a toll on budgets. Although the social factor will continue putting at risk cities' fiscal performance over the next few years, the governance factor will become increasingly important to maintain ratings. Local governments will be tested during the next few years, especially those that were already on a weak fiscal path pre-pandemic. Governments' capacity and willingness to take difficult decisions could vary as long as the pandemic remains a threat and a vaccine is not necessarily widely available. Whatever governments decide, it will reflect their views and commitment to a path of sustainable public finances.

ESG Factors Affected Ratings On Capital Cities, Especially In Europe, in 2020

We rate more than 30 capital cities, from the most to least populous, throughout different regions. In 2020, S&P Global Ratings took at least seven rating actions on major cities related to ESG health and safety risks due to the COVID-19 pandemic, while a similar number of cities were indirectly affected by COVID-19-triggered sovereign rating actions.

Ratings on European capital cities were more affected by health and safety risks during the first wave of COVID-19, than capital cities in North America, which have shown resilience with higher operating surpluses, strong liquidity, and lower debt levels. In Asia-Pacific, capital cities were affected due to sovereign rating actions, especially Tokyo, given that ratings on the sovereign constrain those on Japan's LRGs. On June 9, 2020, we revised the outlook on Japan to stable from positive due to increased uncertainty around debt stabilization.

In Canada, we affirmed the 'AA' rating with a stable outlook on Toronto on Oct. 28, 2020. In this latest review, we recognized that the city has been affected by the COVID-19 pandemic and pressures will remain to keep delivering essential services. Toronto is the largest city in Canada and one of the most populous in North America. However, we believe that the deep and diversified economy, as well as prudent financial management and robust liquidity will help to sustain the city's creditworthiness, especially as it has a strong overall governance framework. For more details on Canadian cities, see "Prudent Financial Management And A Strong Institutional Framework Are Helping Canadian Municipalities Negotiate The Impact Of COVID-19," published Nov. 30, 2020, on RatingsDirect.

Table 1

Prior to the pandemic, S&P Global Ratings already had a negative outlook on some major cities. On Nov. 13, 2020, we affirmed the 'AAA' rating on Stockholm and maintained the negative outlook, as there are still doubts about the ability of the city's leadership to contain its rising debt. Smaller cities like Malmo also had negative outlooks before the pandemic, while Orebro's and Jonkoping's budgetary performance came under pressure as a result of the outbreak. In the case of Swedish cities, we believe the extensive central government support will mitigate the expected weaker fiscal performance in the next few years.

Among the European capital cities, the pandemic led us to revise the outlooks on ratings due to expected weaker budgetary performance. On April 10, 2020, we affirmed our 'AA/A-1+' rating on the City of Paris, but revised the outlook to negative from stable. We estimate that the pandemic will have a significant impact on Paris' operating revenue and, coupled with increasing contributions to equalization, the city's operating balance will remain stressed. Our negative outlook on the 'AA/A-1+' rating on the Greater London Authority reflects the uncertainties about budgetary performance and debt burden, given the macroeconomic risks including the COVID-19 pandemic and Brexit. On May 1, 2020, we revised the outlook to negative from stable on the 'BBB-' rating on the City of Rome, due to the higher risk of deterioration in its budgetary performance and increased debt.

The outlook on the 'AA' rating on the Region of Brussels-Capital was revised to negative from stable on June 26, 2020, and the outlook on the 'A-' rating on Madrid was revised to stable from positive on Oct. 23, 2020. In the latter case, we believe that central government support should mitigate COVID-19-related effects, but we estimate that the recovery of the budgetary metrics will take longer than previously expected, delaying the prospects of continued decreases in debt levels. In the case of Brussels-Capital, we also expect after-capital deficits will remain high at about 16% of total revenues in 2020 and more than 10% in 2021, causing the region to increase its debt burden.

We lowered the rating on Zagreb, the capital of Croatia, to 'BB-' from 'BB' on Sept. 25, 2020 and maintained the negative outlook. Zagreb faces significant reconstruction costs related to the March 2020 earthquake, which significantly increased its contingent liabilities, in addition to COVID-19-related shortfalls in tax revenue and other expenditures. This occurred within a governance context that remains unfavorable to Croatian municipalities, given unpredictable changes to their institutional frameworks. We assign the latter a score of '5', on a six-point scale where 1 is the strongest and 6 the weakest score. Most other capitals, however, face the consequences of the pandemic from a much stronger governance footing. In summary, risk related to COVID-19 measures affected capital cities and other LRGs in Europe in the same proportion as sovereign rating movements during 2020.

Most U.S. Cities Have Shown Resilience To ESG Risks During 2020

U.S. large LRGs with populations over 500,000 received federal fiscal stimulus that has helped offset costs associated with health and safety measures implemented to curtail the virus transmission rate. Cities that benefit from a governance system with financial support, to date, have been mostly resilient to rating changes, and institutional framework and financial management scores remain strong.

Reserves built during the longest period of economic expansion following the Great Recession as well as governance opportunities in major U.S. cities provided, in most cases, sufficient cushion to support credit quality through the first year of the pandemic despite the costs and revenue loss associated with COVID-19.

Major cities in the U.S. have experienced fewer pandemic-related rating actions than U.S. states. Most city rating actions in the past year resulted when a precipitous decline in taxes generated by discretionary spending (sales, hotel, and gaming) led to fiscal stress or budgetary imbalances, or declining debt service coverage. Key U.S. rating actions related to the pandemic on major cities have occurred when an existing budgetary or liquidity pressure further exacerbated challenges brought on by the pandemic-driven recession. S&P Global Ratings revised the outlook on Chicago to negative from stable, and revised the outlook on Philadelphia to stable from positive. We also revised the outlook on New York City on Dec. 8, 2020 (table 2). U.S. states and cities with the greatest exposure to tourism and oil have been the most affected, given the direct economic pressures stemming from lockdown measures that varied across the U.S.

Table 2

Strong Governance Will Be Key To Rating Stability

Global capital cities seem to be more resilient and could recover faster than upper levels of government. Even as new waves of COVID-19 hit many countries, we expect strong governance and liquidity support will be available to cope with immediate needs over the next few years. Major North American cities' finances could be stressed without a rebound in revenues or further state or federal support. More broadly, it is uncertain how all of this will play out once federal government support ebbs, or if liquidity levels start to weaken and financial needs increase meaningfully. Social risks remain high and governance risks could become more significant if governments do not think strategically for the future and take timely actions to ensure sustainable public finances.

Sabrina Rivers and Deepanshu Goyal contributed research to this report.

Related Research

• New York City GO Rating Outlook Revised To Negative On Pandemic-Related Uncertainty, Dec. 8, 2020.
• Prudent Financial Management And A Strong Institutional Framework Are Helping Canadian Municipalities Negotiate The Impact Of COVID-19, Nov. 30, 2020
• The ESG Pulse: COVID-19 Vaccine Hope As Second Wave Sets In, Nov. 19,2020
• Global Debt Leverage: Risks Rise, But Near-Term Crisis Unlikely, Oct. 27, 2020
• The ESG Pulse: Social Factors Could Drive More Rating Actions As Health And Inequality Remain In Focus, July 16, 2020
• Japan COVID-19 Emergency Pressures Tokyo, Aichi Prefecture, And Osaka City Budgets, April 8, 2020
• COVID-19: A Closer Look At How It Affects 10 Major U.S. Cities, April 2, 2020
• ESG U.S. Public Finance Report Card: Tri-State Region Governments And Not-For-Profit Enterprises, Oct. 28, 2020
• The Role Of Environmental, Social, And Governance Credit Factors In Our Ratings Analysis, Sept. 12, 2019