The central government fiscal deficit for 2024 came in at 6.7% of GDP, sharply underperforming Fitch’s forecast of 5.6% of GDP, mainly due to revenue shortfalls and an inability to implement offsetting spending cuts.

Fitch’s assessment of the Operating Environment (OE) for Colombian banks remains unchanged, despite the negative outlook on the sovereign rating. This outlook is mostly driven by worsening fiscal and public debt dynamics, but not necessarily reflecting weaker economic activity or any other material headwind to the banks’ operating conditions.

The banking system’s sufficient capitalization, improving profitability, and reducing loan impairment charges provide adequate resilience to withstand stress from government and external shocks. GDP growth is projected to increase to approximately 2.7% in 2025, up from 1.7% in 2024.

This portfolio review includes Colombian banks with Issuer Default Ratings (IDR) rated at the same level or above that of the sovereign. Fitch believes these ratings are more sensitive to a potential downgrade of the sovereign rating. Furthermore, the agency will not rate Colombian FIs higher than the sovereign rating, based on their current intrinsic credit profiles, except for those with highly-rated parents. Fitch has affirmed all the ratings for the Colombian banks included in this review.

The Viability Ratings (VR) were not reviewed at this time, given that these ratings do not have explicit outlooks, and also considering the affirmation of the OE score with a stable outlook. However, VRs at the ‘bb+’ level would likely be downgraded in the scenario of a potential sovereign downgrade, as Fitch rarely rates a bank’s VR higher than the respective sovereign rating.

The banks’ national ratings, as well as those of other financial institutions rated in Colombia, are not directly impacted, as these ratings reflect the relative strengths and weaknesses of each institution in a specific jurisdiction.
Rating actions have also been taken on the Colombian FI’s Central American subsidiaries, specifically in Costa Rica, Guatemala, and Panama.

Fitch Ratings building Photo credit: Shashank457.

Fitch affirmed Ecopetrol S.A.‘s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at ‘BB+’ and revised the outlook to negative from stable, reflecting the change in the rating outlook of the Republic of Colombia’s IDR (BB+/Negative).

The strong linkage to the sovereign reflects Colombia’s credit profile. The ratings also reflect the Colombian government’s significant incentive to support Ecopetrol in the event of financial distress. This support stems from Ecopetrol’s strategic importance as a key liquid fuel supplier in Colombia and owner of 100% of the country’s refining capacity.

Fitch affirmed Interconexion Electrica S.A. E.S.P.’s (ISA) Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at ‘BBB’ and revised the outlook to negative from stable, in line with Ecopetrol. ISA’s credit profile matches its ‘BBB’ rating and is not limited by the credit profile of its controlling owner, Ecopetrol. According to Fitch’s “Parent and Subsidiary Linkage Rating Criteria,” because Ecopetrol owns more than 51% of ISA, linkage should be considered in the assessment. The presence of regulatory ring-fencing mechanisms, material minority shareholders, and a track record of strong governance practices prevents Ecopetrol’s capacity to extract value from its stronger subsidiary.

Fitch views ISA’s funding and cash management policies as highly autonomous from Ecopetrol, expects ISA to maintain its independence, positively reflected in the ratings. Consequently, ISA’s ratings result from a ‘consolidate plus two’ approach to an IDR of ‘BBB’. Any changes in ISA’s corporate governance, business, or financial strategy may exert downward pressure on the company, particularly in the event of a structural increase in its dividend payout ratio.

Fitch affirmed Oleoducto Central S.A. (OCENSA)‘s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at ‘BB+’ and revised the outlook to negative from stable, in line with Ecopetrol. OCENSA’s ratings reflect its linkage with Ecopetrol’s credit profile, the largest crude oil producer in Colombia and OCENSA’s main off-taker. OCENSA’s operations are integral to Ecopetrol’s core business due to operational synergies. Ecopetrol relies heavily on OCENSA’s infrastructure to transport crude oil from production fields to refineries and export terminals. Fitch considers OCENSA strategically important for Ecopetrol because it transported 82% of Ecopetrol’s crude oil production in 2Q24.

Fitch affirmed A.I. Candelaria (Spain), S.A.’s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at ‘BB’ and revised the outlook to negative from stable, in line with OCENSA. A.I. Candelaria’s outstanding notes will remain structurally subordinated to OCENSA’s outstanding $400 million USD notes. As the holding company, A.I. Candelaria depends on dividends from OCENSA to service its obligations. Therefore, a substantial leverage increase at OCENSA could increase the structural subordination of A.I. Candelaria’s creditors.

This risk is mitigated by OCENSA’s record of stable dividend distributions and A.I. Candelaria’s right to veto changes to OCENSA’s dividend policy and capex plans above $100 million USD. Fitch believes the projected dividend stream will be more than sufficient to cover interest expense and principal payments on A.I. Candelaria’s outstanding notes.

Fitch affirmed Grupo Energia Bogotá S.A. E.S.P. (GEB)‘s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at ‘BBB’ and revised the outlook to negative from stable, reflecting the change to the rating outlook of the IDR of Bogotá (BB+/Negative). Fitch assesses GEB’s Standalone Credit Profile (SCP) at ‘bbb’. GEB operates independently and autonomously, positively affecting its ratings.

Fitch believes regulatory ring-fencing mechanisms, material minority shareholders, and strong governance practices reduce the parent’s capacity to extract value from its stronger subsidiary. Under Fitch’s “Parent-Subsidiary Rating Criteria,” these factors lead Fitch to rate GEB two notches above Bogotá’s consolidated profile.

Fitch affirmed Transportadora de Gas Internacional S.A. ESP (TGI)‘s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at ‘BBB’ and revised the outlook to negative from stable, in line with GEB. Fitch caps TGI’s SCP at Colombia’s ‘BBB-‘ country ceiling, as 100% of the company’s 2024 EBITDA was generated in Colombia.

TGI’s ratings receive a one-notch uplift considering GEB’s medium-to-high operational and strategic incentives to support TGI, equalizing their ratings, per Fitch’s Parent-Subsidiary Linkage Criteria. These incentives reflect GEB’s nearly 100% ownership of TGI and the substantial financial contribution to GEB of approximately 45% of GEB’s operating EBITDA. Fitch also expects investment in Colombia and midstream businesses, such as TGI’s, to remain a strategic focus for GEB’s future growth.

Fitch affirmed Empresas Publicas de Medellín E.S.P. (EPM)‘s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at ‘BB+’ and revised the outlook to negative from stable, reflecting the change to the rating outlook of Medellín’s IDR (BB+/Negative). The linkage reflects the financial relevance of the company to Medellín, the lack of effective documentation that limits dividend distribution, and the city’s influence on the company’s administration and operations. EPM’s distributions contribute an average of 20% or more of government revenues and a material 20%-30% of the city’s investment budget.

Fitch affirmed Enel Colombia S.A. E.S.P.’s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at ‘BBB’ and revised the outlook to negative from stable, reflecting the change to the rating outlook of the Republic of Colombia’s IDR. The company is headquartered in Colombia (BB+/Negative), and its operation in this country represented approximately 90% of its consolidated EBITDA accumulated for the LTM ended September 2024.

Fitch caps Enel Colombia’s SCP at Colombia’s ‘bbb-‘, given the substantial cash flow generation from the country. Cash flows from the operations in Panama (BB+/Stable), Guatemala (BB/Positive), and Costa Rica (BB/Positive), exceed the company’s hard currency debt service coverage for the next 12 months by more than 1.5x.

Hidroituango hydroelectric dam. (Photo credit: EPM)

Fiscal Performance and Projections

In 2024, Colombia’s central government reported a fiscal deficit of 6.7% of its Gross Domestic Product (GDP), surpassing Fitch’s earlier projection of 5.6%. This shortfall was primarily due to revenue declines and the government’s inability to implement offsetting spending reductions. Consequently, the general government debt-to-GDP ratio rose to an estimated 58% from 53% in 2023.

Fitch has adjusted its deficit forecasts for the coming years, now anticipating a central government deficit of 6.2% of GDP in 2025 and 5.8% in 2026, up from previous estimates of 5.1% and 4.7%, respectively. The agency projects that the general government debt-to-GDP ratio will continue to increase, reaching 62% by 2026, diverging from the projected ‘BB’ median of 55.4%.

Government Response

Finance Minister Diego Guevara acknowledged the fiscal challenges but reaffirmed the government’s commitment to maintaining fiscal sustainability and meeting financial obligations. He projected that the deficit would decrease to 5.1% of GDP this year.

Economic Outlook

Fitch expects Colombia’s economic growth to accelerate to 2.7% in 2025 from 1.7% in 2024, driven by resilient consumer spending and a recovery in investment. Inflation is anticipated to continue its downward trend, reaching the upper band of the central bank’s 3% (+/- 1 percentage point) target by the end of 2025, down from 5.2% at the end of 2024. The current account deficit is projected to widen slightly to 2.1% of GDP in 2025 from 1.8% in 2024, remaining well below its 2022 peak of 6.1%.

Structural Reforms

The pension reform enacted last year is expected to have an annual fiscal cost of 0.3% of GDP. Additionally, a constitutional reform will increase central government transfers to local and regional governments from 27.2% to 39.6% of current revenues over 12 years starting in 2027. These measures may further constrain fiscal flexibility.

External Buffers

Colombia’s central bank has bolstered its external liquidity position, with reserves reaching $61.9 billion USD as of the end of 2024. In April 2024, the International Monetary Fund approved a new two-year flexible credit line of $8.1 billion USD for Colombia, providing an additional buffer against external shocks.

Future Considerations

Fitch indicates that a continued deterioration in Colombia’s debt-to-GDP ratio, driven by persistently high fiscal deficits or weak growth, could lead to a downgrade. Conversely, successful fiscal consolidation that stabilizes the debt ratio, along with reforms enhancing fiscal and monetary credibility, could result in a positive outlook revision.

This outlook revision underscores the importance of effective fiscal management and structural reforms in maintaining Colombia’s economic stability.

Photo credit: danielgamboabogota from Pixabay.

Fitch maintained Medellín’s Long-Term Local and Foreign Currency Issuer Default Ratings (IDR) at ‘BB+’ with a Stable outlook, while the National Long-Term Rating (NLTR) is affirmed at ‘AAA(col)’. Additionally, the National Short-Term Rating (NSTR) remains at ‘F1+(col)’ and senior unsecured notes issued in 2014 continue at ‘AAA(col)’.

Fiscal Overview and Risk Profile

Medellín reported a robust 2023 fiscal performance, with tax revenue growth and an operating margin around 21.5%. EPM dividends remain essential to funding the city’s capital expenditures, yielding a positive fiscal surplus before net financing. Fitch assessed the city’s risk profile as ‘Low Midrange,’ indicating a moderate capacity to manage potential fiscal challenges.

Revenue growth from Medellín’s diversified economy—especially the service and tourism sectors—underpins a stable outlook. Property tax contributions, however, are limited by geographic constraints.

Key Rating Factors

Revenue Robustness and Adjustability: Fitch rated Medellín’s revenue as ‘Midrange,’ supported by its moderately diverse tax base. Despite political reluctance for tax hikes, property tax adjustments may aid in covering potential revenue gaps.

Expenditure Sustainability and Adjustability: Health and education spending, primarily financed by EPM dividends and national transfers, are countercyclical. Fitch anticipates Medellín’s operating margins to align with historical levels, although inflationary pressures could impact healthcare and education costs.

Liabilities and Liquidity: Medellín has access to diversified funding, but 72% of debt is linked to floating rates, increasing exposure to interest rate risks. Liabilities linked to Medellín’s metro infrastructure add to its obligations, with most short-term liquidity stemming from EPM dividends.

Debt and Financial Structure

Medellín’s debt plan includes long-term borrowing projected at COP1.97 trillion by 2027. Fitch’s forecast incorporates Medellín’s adjusted debt, which includes COP1.9 trillion in long-term debt and approximately COP2.5 trillion for the metro system infrastructure. Medellín’s debt management includes measures to alleviate cash flow pressures.

Potential Rating Actions

A downgrade could result if Medellín’s enhanced payback ratio nears 9.0x or if Colombia’s sovereign rating declines. Conversely, an upgrade would be contingent on improvements in Colombia’s sovereign rating.

For more information, visit Fitch Ratings and Medellín’s financial updates.

The affirmation reflects Fitch’s expectations that Medellin will maintain an adequate operating performance and manageable debt levels in spite of the economic impact of the coronavirus pandemic. The payback ratio (net adjusted debt/operating balance) is expected to be around 9x over a five-year rating horizon. Secondary metrics are actual debt service coverage ratio (ADSCR) and the fiscal debt burden, which are expected to be below 1x and close to 90% in 2024, respectively. Medellin’s ratings reflect the combination of a ‘Midrange’ risk profile and a debt sustainability score of ‘a’ under Fitch’s rating case.

• Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘BBB-‘; Outlook Negative;
• Long-Term Local-Currency IDR at ‘BBB-‘; Outlook Negative;
• National Long-Term Rating (NLTR) at ‘AAA(col)’; Outlook Stable;
• NLTR of the senior unsecured notes for COP248,560 million issued in 2014 at ‘AAA(col)’.
• National Short-Term (NSTR) Rating at ‘F1+(col)’.

While Medellin’s most recently available data may not have indicated performance impairment, material changes in the central government’s debt, revenue and costs are occurring across the sector and likely to worsen in the coming weeks and months as economic activity suffers and government restrictions are maintained or broadened. Fitch’s ratings are forward-looking in nature, and the ratings firm indicates that it will monitor developments in the sector for their severity and duration and incorporate revised base- and rating-case qualitative and quantitative inputs based on performance expectations and assessment of key risks.

Risk Profile: ‘Midrange’

Fitch has assessed Medellin’s risk profile at ‘Midrange’, reflecting that all six key risk factors are assessed as midrange: revenue robustness and adjustability, expenditure sustainability and adjustability, liabilities and liquidity robustness and flexibility. In other words, Medellin’s risk profile is assessed as ‘Midrange’ because the municipality has presented a solid operating performance, a moderate level of indebtedness and high levels of capex, mainly financed with tax revenues, a significant amount of resources stemmed from Empresas Públicas de Medellín E.S.P. (EPM) and long-term debt. Furthermore, this risk profile is in line with that of the Colombian territorial entities rated highest by Fitch.

Revenue Robustness: ‘Midrange’

Medellin’s operating revenue is mostly made up of predictable and growing tax items (notably property tax and tax on industry and commerce) and stable transfers from the Colombian state (BBB-/Negative). Tax revenue rose at a nominal CAGR of 6.2% in the period 2015-2019, similar to the nominal GDP growth of 6.8% in the same period. Medellin’s tax revenues accounted for 45.9% of operating revenue on average in the last five years (2015-2019). According to their contribution to tax revenue, the most important taxes are property tax (IPU, its Spanish acronym) and tax on industry and commerce (ICA, its Spanish acronym), which accounted for 41.1% and 35.8%, respectively, in 2019. Fitch foresees a slower growth pace in Medellin’s operating revenues in 2020 and 2021, due to the effect of the coronavirus, but also considers recovery prospects afterwards due to the municipality’s economic strength. As of September 2020, the tax revenue of the municipality has fallen close to 10% year over year (yoy), in accordance with Fitch’s expectations for the sector. ICA has been the most affected tax revenue, decreasing by nearly 17% as this tax is closely linked to the economic cycle.

On the other hand, national transfers come from a sovereign counterparty rated at ‘BBB-‘/Outlook Negative. Fitch considers that the transfers framework and its evolution are stable and predictable. However, the fiscal pressures national government faces may lead to stagnation or even a reduction of transfers and could worsen in the current scenario of economic downturn caused by the coronavirus lockdown. Nonetheless, the city’s operating revenue structure presents a low dependence on transfers, so the exposure to this risk is lower for Medellin than for municipalities with lower fiscal autonomy.

Moreover, the total ownership of EPM has been a key factor in the municipality’s financial performance and an outstanding source of resources, as the significant amount of common and special financial surpluses transferred to the entity have increased its flexibility to finance capex and social investment (around 55% of EPM’s net income). This gives the city an incomparable position with respect to other Colombian entities during the pandemic. Financial surpluses transferred from EPM to Medellin in 2019 totaled COP1.3 trillion. For 2020, Medellin will receive COP1.5 trillion. If EPM’s financial transfers decrease, Medellin might eventually delay its capex plan or decrease social transfers. It is worth mentioning that EPM’s transfers are not used to pay debt service and liabilities with financial institutions.

Revenue Adjustability: ‘Midrange’

Given the relatively high proportion of local collection of total revenues, Medellin’s ability to cover a reasonably expected revenue decline is estimated to be above 50%. Medellin can set the rates for most of its taxes within the limits established by National Law. Besides, it has property tax rates that are far below the legal limit and its taxpayers can relatively easily afford potential rate hikes.

During the last five years, Medellin’s tax collection has shown a positive trend. This is because of good management of the fiscal model, the payment culture of taxpayers and the region’s economic performance. The economic base and activity are diverse, limiting risks of concentration in taxpayers. The municipality has implemented important fiscal strategies in order to continue its strong revenue collection using technology, in addition to new payment methods and regulatory and monitoring actions. In 2020 the municipality implemented specific fiscal stimuli or tax benefits to ease the impact of the coronavirus pandemic on taxpayers such as deferral of tax payments, discounts on taxes and reductions in interest and charges (Decree 678 of 2020).

Expenditure Sustainability: ‘Midrange’

Medellin’s main responsibilities are the provision of basic services such as education (payroll of both teachers and administrative personnel), healthcare (insurance and subsidies to low-income people), water supply, sanitation and transportation, among others; all of which are mainly addressed with transfers. In 2015-2019, even though operating expenditure growth has been superior to that of operating revenue in real terms (3.3% vis a vis 1.8%), Medellin’s operating margin, as per Fitch calculations, has been adequate and averaged 16.7% in the reference period. Fitch believes these responsibilities are moderately countercyclical and expects stable growth in the mid-term.

Despite extraordinary expenses related to health, Fitch expects that operating expenses will remain under control for the rest of the current administration. To tackle health contingencies, Medellín has allocated resources of COP236.5 billion (equivalent to 4.2% of total revenue in 2019). As of September 2020, total expenditure has decreased by 4.2% yoy despite a 37.5% yoy rise in health expenditure due to the pandemic.

Expenditure (Adjustability): ‘Midrange’

Medellin’s expenditure structure is relatively flexible despite the limited ability to cut some transfers earmarked for health and education as policies are decided at the national level. Medellin has moderate expenditure adjustability, given that operating expenditure for the central administration as well as for investment sectors was slightly above 58.3% of total expenditure from 2015 to 2019; while capex accounted for 40.1% of total expenditure in the same period. The observed expenditure composition includes adequate capex, financed with operating balances and EPM’s resources, which in Fitch’s view denotes a moderate margin to cut expenditure.

Medellin is about to sign a co-financing agreement with the national government in order to finance an important transport infrastructure project, Metro de la Via 80. Medellin has assumed Future Budget Allocations (FBA, authorizations against tax revenues in future budgets for paying certain expenses) for up to COP1.3 trillion for this project between 2020 and 2034, which adds some inflexibility to the expenditure structure. The current administration is planning to increase capex, as a countercyclical measure to boost the local economy amid the coronavirus pandemic.

Liabilities and Liquidity (Robustness): ‘Midrange’

Although the local framework imposes debt limits, rules and restrictions on some debt instruments, some loopholes exist for treating off-balance-sheet risks, since prudential limits only consider the direct debt of local and regional governments (LRGs). As a response to the coronavirus pandemic, decree No. 678 eased the solvency (interest payment to operating balance) and sustainability (outstanding debt to current revenue) limits during 2020 and 2021. Thus, the municipality will surpass the limit of 80% of the sustainability metric only in 2021 with the aim of reactivating local economy. For 2021, Medellin will take COP344.3 billion.

As of August 2020, Medellin’s outstanding long-term debt balance was COP1.92 trillion. Around 35.9% of Medellin’s long-term debt was denominated in foreign currency (taken with AFD) and close to 73% was tied to a floating interest rate. In addition, the balance of bonds outstanding reached COP248.6 billion, accounting for 13% of total direct debt. The interest rate on the floating rate tranche of Medellin’s external debt (six-month Libor + 1.7%) will be changed to a fixed interest rate, hence, the municipality would save in interest expenditure and eliminate the exposure to interest rate risk. In December 2020 Medellin will take COP120.0 billion of additional debt. Metro de Medellin, project manager, will take on debt due in 2034 in order to finance Metro de la Via 80. This debt will be covered 70% by the national government and 30% by Medellin with FBAs. At this moment, the financing mechanism that will be used and the debt amount are uncertain. Fitch will monitor the final characteristics of the project in order to assess debt sustainability metrics in a timely manner.

Liabilities and Liquidity (Flexibility): ‘Midrange’

Fitch believes Medellin has better liquidity management, as it has both a larger liquidity position and better access to short/long-term loans with local banks whose counterparty is rated in the ‘BBB-‘ category. In addition, in the short term, the city may borrow up to 1/12th of its current revenue and must repay these loans before the end of the fiscal year. Finally, the Colombian government does not provide emergency liquidity support when LRGs are under pressure. At the end of the year, the city has a high proportion of restricted cash, which moderates its liquidity position. This is offset by adequate guidelines in terms of excess liquidity management.

It is worth mentioning that Decree 678 of 2020 allows territorial entities to contract short-term debt in 2020 and 2021 the purpose of which is exclusively to deal with temporary cash shortages in both operating and capital expenses. These loans may not exceed 15% of current revenue and must be repaid before next fiscal year end and will not be included in calculations of legal limits.

Debt Sustainability: ‘a’ Rating Category

Under Fitch´s rating case the debt payback ratio (net adjusted debt/operating balance), the primary metric of debt sustainability for Type B LRGs, is expected to be around 9x over a five-year rating horizon with a score of ‘a’. Secondary metrics are actual debt service coverage ratio (ADSCR) and the fiscal debt burden, which are expected to be below 1x and close to 90% in 2024, respectively. Fitch includes in its analysis Medellin’s recognition of the obligation with the national government for Medellin’s metro infrastructure financing and considers it an intergovernmental obligation. Thus, the enhanced synthetic coverage ratio, which does not include Metro’s financial obligation, is roughly 2x.

Additional Rating Factors: Fitch calculates enhanced debt sustainability metrics that exclude the metro obligation from debt sustainability metrics to assess a subsequent improvement in the SCP. At present, Medellin’s SCP is strong enough to support current ratings, so this improvement is not used. However, if there were a moderate deterioration in the SCP, an uplift could be considered by using the enhanced payback ratio. According to Fitch’s rating case, the enhanced payback ratio would be below 5.0x.

The City of Medellin is considered Colombia’s second-most important city, after Bogota, contributing approximately 7.3% of GDP, according to the National Administrative Department of Statistics (DANE). The local economy is mainly based on services and commerce, although Medellin is a hub for many industries relevant to national and international trade. The city sustains strong socioeconomic indicators with higher coverage of public services, education and health than national standards. Due to inward migration, Fitch has observed the need for infrastructure in various social sectors. Fitch classifies Medellin, as for all Colombian LRGs, as type B as it covers debt service from its cash flow on an annual basis.

Derivation Summary

Medellin’s ‘bbb+’ SCP is derived from a combination of a ‘Midrange’ risk profile and adequate debt metrics, which result in a debt sustainability score of ‘a’ under Fitch’s rating case. The SCP also factors in a comparison of Medellin with peers, particularly with Barranquilla, Colombia whose SCP is ‘bbb’. Medellin’s IDR is not affected by any asymmetric risk or extraordinary support from the Colombian government. Finally, Fitch applied a rating cap on Colombia’s sovereign rating of ‘BBB-‘/Outlook Negative in recognition of a certain degree of interdependence between subnational finances; given the fairly centralized framework. Hence, the municipality’s IDRs are ‘BBB-‘/Outlook Negative. The NLTR of ‘AAA(col)’ was derived from the ‘BBB-‘ IDR, while the NSTR of ‘F1+(col)’ was derived from the NLTR.

Key Assumptions

Fitch’s rating case scenario is a “through-the-cycle” scenario, which incorporates a combination of revenue, cost and financial risk stresses. It is based on the 2015-2019 figures and 2020-2024 projected ratios. The key assumptions for the scenario include:

• Growth in taxes and other operating revenues (fees, fines and others) in real terms is similar to the national GDP in the long term, with a drop in 2020 followed by a full recovery in 2022.
• 6% nominal growth of transfers, according to the national budget. From 2021, growth is a four-year moving average of nominal national GDP growth;
• Real operating expenditure growth of 3% in the long run, with a temporary real growth rate of 6% in 2020.
• Capital revenue will perform as EPM’s financial surpluses do, hence it will be COP1.5 trillion in 2020 and as from 2021 it will increase linked to inflation rate.
• Capex is adjusted according to the decrease in the operating margin, capital revenue and new borrowing with a five-year moving average floor.
• Debt level considers Medellin’s projections.
• Fitch’s adjusted debt includes an estimate of Medellin’s obligations with the national government for the financing of the original infrastructure of the city’s metro system.
• Interest expenditure does not include that related to intergovernmental debt.
• Apparent cost of debt at 9%.
• All cash is considered restricted.

Rating Sensitivities

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

• Medellin’s IDR is capped by the sovereign rating. A stabilization of the outlook would be possible only if the sovereign outlook is stabilized.

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

• Medellin’s Long-Term IDRs could be downgraded if the sovereign rating is downgraded. If the enhanced payback ratio exceeds 9.0x steadily under Fitch’s rating case coupled with an actual debt service coverage ratio below 1.5x and assuming no changes in the risk profile Fitch could consider a downgrade. This could happen if the entity incurs long-term debt in addition to that considered by Fitch or an important deterioration in the operating balances.
• A prolonged pandemic impact and a much slower economic recovery lasting until 2025 would pressure municipality tax receipts. Should Medellin be unable to proactively reduce expenditure or supplement weaker receipts from increased central government transfers, this may lead to a downgrade.

 Best & Worst Case Rating Scenarios

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 [https://www.fitchratings.com/site/re/10111579].

Summary of Financial Adjustments

• Net adjusted debt considers other Fitch classified debt.
• Adjusted debt considers the difference between net adjusted debt and unrestricted cash.
• All cash is considered restricted.
• Operating revenues do not include a fiscal surplus from previous years and expenditure does not include fiscal deficits from previous years.
• Fitch does not consider cash proceeds from Fondo Nacional de Pensiones de las Entidades Territoriales (Fonpet) used for pension payments or other expenditure made with these resources.
• Fitch’s adjusted debt includes an estimate of Medellin’s obligation with the national government for the financing of the original infrastructure of the city’s metro system.
• Fitch classifies as capex some operating expenses linked to investment expenditure and financed with EPM’s surpluses.

The outlook revision to negative reflects deterioration of asset quality metrics, which has added pressure on already modest profits and loss absorption capacity. The entity has recently taken on several strategies to reduce impairments and charge-offs such as reducing credit card portfolio proportion of loans, tightening cut off levels and underwriting adjustments in the most impacted regions. Fitch believes if these actions are not strong enough to revert asset quality and profitability trends, which could add some stress to leverage metrics, ratings could be downgraded.

Key Rating Drivers

Credivalores’ IDRs are highly influenced by the company’s profile and concentrated nature within the financial system, which, despite is small size, benefits from its role as one of the largest non-bank financial institutions engaged in consumer lending to the low-to-mid income population not usually served by banks in small and mid-sized cities, and its pressured asset quality metrics. The ratings also consider the company’s relatively ample risk appetite due to its focus on low to middle income segments, modest profitability and increased leverage along with the company’s funding flexibility.

Recent quarters have seen an increase in non-performing loans and charge-offs, especially in the credit card segments. This, along with the adoption of IFRS 9, has resulted in higher credit costs that affected the company’s profitability. To mitigate the deterioration in asset quality, the company has imposed tighter underwriting policies and made additional system improvements that Fitch expects will reverse the impairment trend.

Credivalores’ ratio of non-performing loans past due over 60 days (NPL) deteriorated to 15% as of March 2019 mainly due to the credit card portfolio affected by insufficiently tight cut off levels and weaknesses in certain cities’ unemployment affected by immigration. The overall loan loss coverage ratio also declined to 87% from 94%, but still remains satisfactory in view of the lower risk of its payroll loan segment, which represents nearly 59% of the total managed loan portfolio.

Credivalores’ profitability remained modest for 2018 and the first quarter of 2019 with pre-tax income to average assets ratios of 0.7% and 0.1%, respectively, affected by higher credit costs, lower loan growth and higher investments. The company expects the remainder of 2019 to be lackluster in terms of profitability.

To mitigate the low level of internal capital generation and effects from IFRS adoption on tangible leverage, the company’s shareholders made a capital infusion of $15 billion COP combined during the last quarter of 2018 and the first quarter of 2019. Despite this increase, the rating also considers Credivalores’ relatively higher leverage ratios for its concentrated and higher-risk business model. Fitch believes future leverage metrics could be relatively pressured due to expected on-balance sheet loan growth if the modest earnings levels fail to generate additional capital growth.

Current funding and liquidity metrics remain at satisfactory levels with average maturity tenors of close to three years. The company has been able to expand its sources of funding from both domestic and foreign lenders. The main source of funding comes from its U.S. dollar medium-term note issuances that come due in July of 2022. Sources of funding appear sufficient to cover upcoming 2019 debt amortizations and fund future growth.

Fitch believes management needs to prove effective in executing its strategies in enhancing asset quality, profitability and leverage metrics that have deteriorated over the past few years. Tightening of its underwriting policies, the addition of a new chief risk officer, new alliances with utility companies, together with an increased credit granting agility should prove to be strong enough to enhance financial performance. However, these improvements are subject to the continued strengthening of the operating environment, the degree of competition and other unforeseen events.

Rating Sensitivities: IDR’s & Senior Debt

Credivalores’ IDRs could be downgraded if deterioration in asset quality metrics do not revert, resulting in a low capacity to internally generate profits or from an increase in leverage that reduces the company’s ability to absorb unexpected losses (Tangible Leverage sustainably above 8.5x).

The Rating Outlook could be revised to Stable if asset quality metrics improve and allow the company to increase profits and capital metrics. Ratings continue to be sensitive to significant changes in Credivalores’ company profile.

Senior unsecured debt is at the same level as the IDR and will mirror any change to the IDR. Fitch is maintaining the existing Recovery Rating at ‘RR4’, which is considered average.

Frequent medium-term budget revisions in recent years, the recent dilution in Congress of permanent tax revenue-raising measures amid rigid expenditure demands and relatively low fiscal buffers are reducing the predictability and credibility of medium-term fiscal policy. Furthermore, Colombia’s external metrics are deteriorating amid a higher current account deficit, lower external liquidity and rising net external debt.

Fitch does not currently anticipate developments with a high likelihood of leading to a positive rating change.

Fitch expects the Financing Law passed in 2018 will weaken government revenues. The initial reform included cutting the corporate tax rates, increasing personal income taxes and broadening the value-added tax (VAT) base. Amid legislative opposition, Congress eliminated or modified many key elements of the reform, most notably the extension of the VAT to basic food items. The final bill therefore will yield roughly half of the revenues of the original proposal, at about 0.7% of GDP. The corporate tax rate cuts and incentives for capital investments incorporated in the law will begin to have a negative impact on tax revenues in 2020, with a reduction of around 0.8% of GDP (and falling further in 2021-2022 as corporate tax rates continue to be cut).

Revenue losses under the Financing Law will hamper fiscal consolidation. The lost revenues will be difficult to make up with the government’s planned tax administration and anti-evasion efforts alone, in Fitch’s view. To fill the budget gap, the government proposes to sell state-owned assets as well as adjust expenditures and improve cash management. Fitch expects the government to meet its 2019 and 2020 central government targets, but only when sales of assets are included in government revenues (nearly 0.6% of GDP in each year). However, these revenues will not recur, and, in order to achieve a sustainable revenue increase and comply with the medium-term fiscal consolidation targets, further fiscal policy adjustments would likely be needed to build the non-oil revenue base (although oil revenues have risen in the last two years due to productivity enhancements at Ecopetrol and some rebound in oil prices, government revenues are still vulnerable to oil price shocks). There is little political appetite for a tax reform currently, though successive governments have built a track record of passing several tax bills over the last two decades.

While the deficit has narrowed, structural improvements in government finances have been relatively modest, with progress somewhat reliant on one-off measures. Colombia’s fiscal rule adopted in 2012 sought to reduce the central government structural deficit to 1% of GDP by 2022. The downward revisions in long-term growth potential and oil price estimates have led to frequent revisions to the actual original targets set out in the rule (but in compliance with the rule). There were revisions in 2016 and 2017 to the actual target. In 2018, the Council revised the fiscal targets again for the entire 2018-2027 period. In 2019, the Council again revised the target to address the significant costs associated with migrants from Venezuela (although the government has pledged to meet the original 2.4% of GDP target). The frequent changes have undermined the predictability and credibility of fiscal policy in Colombia. Furthermore, the government has relied on one-off measures to meet its targets in 2017-2018 with a 0.5% of GDP fine on the telecom sector in 2017 and pre-payment of income taxes from Ecopetrol (0.3% of GDP) in 2018.

GG debt/GDP continues to rise despite lower fiscal deficits over last three years, reaching 42.3% in 2018 up from 39.7% in 2017. Pre-financing, crystallization of contingent liabilities and a weaker exchange rate were key drivers of debt increase in 2018. Although Fitch expects a primary surplus to be achieved at the central government level beginning in 2019, it may not lead to stabilization of the debt to GDP ratio, given the potential for further materialization of contingent liabilities, and exchange rate movements (nearly 30% of GG debt is denominated in foreign currency).

Fitch expects Colombia’s current account deficit to widen to 4.2% of GDP in 2019, up from 3.8% of GDP in 2018 and 3.3% in 2017. A key driver of the widening deficit was an increase in the repatriation of dividends and interest payments as well as some deterioration in the trade balance. Foreign direct investment only covered roughly half of the deficit in 2018.

The widening current account deficit has led to an increase in external debt and fall in external liquidity indicators. Net external debt has risen to 10.6% of GDP, somewhat above the current ‘BBB’ median of 7.9% of GDP, and external debt service accounts for an increasing share of current account receipts. Coverage of international liquidity has weakened due to rising short-term private debt, higher non-resident holdings of local debt (25% of COP treasury bonds at end-2018) and rising external public and private debt amortizations. Fitch’s international liquidity ratio indicator fell below 100% for the first time since 2005. The international reserve coverage of current account payments also reduced to 7.1 months in 2018 from 7.9 months in 2017 (but still above the current ‘BBB’ median of 4.9 months).
In September 2018, the Central Bank announced a policy to accumulate international reserves, partly to strengthen its liquidity position. As of the end of April 2019, the central bank accumulated over USD4 billion in international reserves. The policy should help improve the external liquidity ratios over the forecast period. The central bank maintains an IMF Flexible Credit Line for USD11.4 billion to mitigate external risks.

After growing 2.6% in 2018, Fitch expects economic growth to accelerate to 3.3% in 2019 driven by domestic demand. Investment is expected to grow with private investment into the 4G infrastructure network accelerating and a boost from local governments (responsible for the majority of public investment). Private investment is expected to pick up as a result of the Financing Law. Weaker than expected first quarter growth, resulting from a fall in construction indicates downside risks to the 2019 forecast. However, Colombia’s five-year growth average at 2.7% is now below the current ‘BBB’ median of 3.6% and is expected to remain so over the forecast horizon.
Colombia’s ratings reflect its long track record of prudent and consistent macroeconomic policies that have underpinned macroeconomic and financial stability. The ratings are constrained by high commodity dependence, limited fiscal flexibility and structural weaknesses in terms of low GDP per capita and weaker governance indicators relative to peers.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns Colombia a score equivalent to a rating of ‘BBB-‘ on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
– Macroeconomic: +1 notch, reflects Colombia’s long track record of prudent and consistent macroeconomic policies, despite a decline in the credibility and predictability of fiscal policymaking.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centered averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within the agency’s criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES
The main factors that could individually, or collectively, lead to a downgrade include:
–Failure to implement credible structural measures to put government debt on a stable or downward trajectory;
–A sustained deterioration in Colombia’s external imbalances that lead to a continued rise in the external debt burden and weak external liquidity indicators;
–Growth underperformance relative to the ‘BBB’ median that detracts from per capita income convergence with similarly rated sovereigns

The Rating Outlook is Negative. Consequently, Fitch does not currently anticipate developments with a high likelihood of leading to a positive rating change. However, the main factors that could lead Fitch to Stabilize the Outlook include:
–Fiscal consolidation through credible and predictable policies consistent with an improved trajectory for public debt dynamics;
–Reduced external imbalances that improve external debt and liquidity ratios;
–Higher economic growth that reduces Colombia’s income gap with higher rated sovereigns.

Fitch assumes the oil price averages USD65 per barrel in 2019 and USD62.50 per barrel in 2020.

Fitch has affirmed the following ratings and revised the Rating Outlooks as follows:

–Long-Term Foreign-Currency IDR affirmed at ‘BBB’; Outlook to Negative from Stable;
–Long-Term Local-Currency IDR affirmed at ‘BBB’; Outlook to Negative from Stable;
–Short-Term Foreign-Currency IDR affirmed at ‘F2’;
–Short-Term Local-Currency IDR affirmed at ‘F2’;
–Country Ceiling affirmed at ‘BBB+’;
–Issue ratings on long-term senior unsecured foreign-currency bonds affirmed at ‘BBB’;
–Issue ratings on long-term senior unsecured local-currency bonds affirmed at ‘BBB’.

This article is substantially based on a statement issued by Fitch Ratings today. Photo credit: O12 from Pixabay

Though the Toronto-based company continues a difficult adjustment to its new reality since the expiration of its holdings in Colombia’s Rubiales oilfield in mid-2016, the New York-based “big three” rating agency upgraded Frontera Energy’s issuer default ratings (IDRs) from B to B+ with a stable outlook.

The improvement applies to both the company’s long-term foreign current IDR and long-term local currency IDR. Fitch also upgraded the company’s $250 million USD of senior secured notes from B+/RR3 to BB-/RR3.

Assessing the Improvement for Frontera Energy

“The rating upgrade reflects Frontera’s ability to stabilize its operational and financial performance over the last year after completing a significant debt restructuring towards the end of 2016,” stated Fitch in a statement. “The debt restructuring materially improved the company’s capital structure, which is strong and not a constraint for the rating category.”

In the restructuring, Frontera Energy’s creditors converted some $5.4 billion USD of financial debt into a 56.6% equity stake in the company. The Catalyst Capital Group Inc. and others injected some $250 million USD into the company as part of the arrangement.

In addition to these moves, and other efforts to rein in the breadth of operations, Frontera Energy recently sold off what it calls a “non-core asset” in order to focus on primary operations. It is now using $56 million USD from the sale of Petroelectrica de los Llanos in Colombia to help fund its recent full acquisition of Pacific Midstream Limited in a move aimed at reducing transportation costs.

This is part of an overall “plan to reduce costs, rationalize our portfolio, and allow for a dedicated focus on high return opportunities on our core [exploration and production] assets in Colombia and Peru,” CEO Barry Larson, who assumed the position in February, said earlier this year in a statement.

Ongoing Challenges for Frontera Energy

Though Fitch Ratings’ assessment does praise the company’s improved capital structure, liquidity, and leverage position, it also acknowledges that “Frontera’s cash flow generation may remain neutral as a result of the slower than expected oil price recovery and its increasing average production costs after the expiration of its main concession, Piriri-Rubiales, in June 2016 and the decrease in production.”

Overall, Fitch Ratings expects Frontera’s free cash flow to end the year negative, although this should “gradually improve” if oil and gas prices continue to recover. The company reported free cash flow of negative $196 million USD in June, according to Fitch.

The B rating also reflects that Frontera’s short reserve life, “low” asset diversification, and “small-scale oil and gas production profile,” stated Fitch. The company’s production is now currently down to less than 75,000 barrels of oil equivalent per day — well below the roughly 150,000 barrels per day it managed at its peak before the expiration of its marquee oilfield concessions in Colombia.

“Frontera’s production and reserves are concentrated in a few blocks, most of which are in Colombia, and its proved reserve life is short at 4.3 years, which is considered…a concern for the company’s credit quality,” stated Fitch. “The company’s reduced investment capacity due to the low-price environment has forced it to reconsider its investments in international assets, and its concentration in Colombia could increase.”

Frontera Energy has just 117 million barrels of proved reserves and 171 million barrels of probable reserves. Upwards of 95% of these are located in Colombia.

The rating is based upon the Colombian bank’s issuer default rating, which Fitch recently improved from a negative to stable outlook. The notes will be used to repay a senior bridge loan due next year on January 11, with “any excess proceeds” planned to go toward “general corporate purposes,” according to Fitch Ratings.

The agency said that Banco de Bogotá’s BBB issuer default rating, among others, is rooted in its “solid and consistent” financial performance, “sound” asset quality, “ample and diversified” funding base. The firm’s conservative credit and risk policies are also a factor in its BBB rating.

On the downside, Banco de Bogotá still has credit weakness due to its capitalization level compared to international peers. “More importantly, its ratings remain constrained by Fitch’s assessment on the operating environment of the jurisdictions in which Bogota’s businesses are performed,” stated the credit rating agency.

The notes, which will mature in 10 years and include semi-annual interest payments at a fixed interest rate, “will rank pari passu in right of payment with all of the bank’s existing and future senior unsecured indebtedness,” according to Fitch Ratings. “The settlement amount paid to the investors will be denominated in U.S. dollars.” The notes may be called at the option of the Grupo Aval-controlled bank.

In full, Fitch Ratings has set the following ratings for Banco de Bogotá:

• Long-Term Foreign Currency IDR ‘BBB’; outlook stable
• Short-term foreign currency IDR ‘F2’
• Long-term local currency IDR ‘BBB’; outlook stable
• Short-term local currency IDR ‘F2’
• Viability rating ‘bbb’
• Subordinated debt rating ‘BBB-‘
• Support rating ‘2’
• Support rating floor ‘BBB-’

Photo credit: Jared Wade

Banco Agrario (Banagrario), a state-run development bank that aims to finance projects and offer services tied to agriculture, livestock, fishing, forestry, and other rural activities, also had its long-term foreign currency and long-term local currency issuer default ratings affirmed at BBB. Fitch changed the outlook on its ratings from negative to stable.

“Banagrario’s viability rating is highly influenced by the bank’s business model and its low, although
improving, asset quality,” stated Fitch Ratings in its assessment. The agency added that Banagrario’s rating was moderately influenced by its consistent profitability, high income diversification, strong capital position, and low cost funding structure.

“In Fitch’s views, Banagrario’s business model is consistent with its key role for the development of
the government’s agricultural policy,” stated Fitch. “The bank maintains a clear focus and a strong franchise in the small and medium-sized agricultural producer markets. However, its market share in the Colombian banking system is moderate, at 3.2% of total loans and 2.5% of total deposits. In the agency’s opinion these elements strengthen the bank’s franchise in its specific segment but limit the scope of its business model and challenge the asset quality metrics.”

Fitch also noted that, while Banagrario displayed improving asset quality in 2016, it continues to lags the rest of the nation’s banking industry while its net profits also decreased last year and it remains tied to Colombia’s higher-risk agriculture sector.

But on the positive side of the ledger, according to Fitch Ratings, the Bogotá-based institution has achieved high income diversification — through stable income “generated by valuation of held-to-maturity instruments” — and lowered its non-performing loans ratio to 5.89% on the strength of an improved collections process.

“Banagrario’s profitability is consistent and supports a stable internal capital generation and good
capital levels,” stated Fitch Ratings. “The bank’s profitability is underpinned by high income diversification, as an important proportion of stable income is generated by valuation of held-to-maturity instruments. In Fitch’s opinion, Banagrario’s profitability is sustainable in the medium term but remains sensitive to changes in asset quality.”