Fitch Affirms Metropolitan Municipality of Istanbul at 'BBB-'; Outlook Negative
The affirmation reflects Istanbul's solid operating performance, which we expect to continue, despite heightened risks to the political stability after a failed coup, significant FX risk and increasing, large capex until 2019 before the next local elections, due to Istanbul's well diversified and well above-average local economy.
The Negative Outlooks reflects the Outlook on Turkey (BBB-/Negative/F3) as Istanbul's IDRs are aligned with those of the sovereign.
KEY RATING DRIVERS
Fitch projects Istanbul to post strong, albeit declining, operating margins in the high 40s in 2016-2018 (5Y median at 60%). We expect operating margins to fall on the back of a slower national economy in 2016 and higher operating expenditure ahead of the local elections in 2019.
Fitch expects the national economy to slow down sharply in 3Q16 before stabilising over in 2017. Consequently, we forecast a 10% yoy nominal growth of the tax revenues for Istanbul in 2016-2018 (5Y median at 16%).
Despite heightened risks to the macro economic environment Fitch expects overall local economic growth to support Istanbul's operating performance in the medium term. By end-2Q16, the city had achieved a reported 52% of its budgeted operating revenue for the whole year, reflecting continued robust local economic growth.
In line with Fitch's expectations, Istanbul budgeted for 2016-2018 higher debt financing of its ongoing and planned large scale public transport projects. We forecast the push for large capex before local elections will worsen the budget deficit before debt variation on average by 10% in 2016-2018, which is credit-negative if it continues beyond our forecast period of 2016-2018.. However, expected solid operating margins should support direct risk-to-current balance at below two years during 2016-2018.
Fitch expects Istanbul to continue to increase intercompany borrowing at zero cost from its water management affiliate ISKI to TRY3.3bn at end-2018, from TRY2.26bn at end-2015, for which payment is postponed. We expect this debt will be netted against the sale of ISKI assets that belong to Istanbul and we classify this debt as direct risk. Accordingly Fitch projects direct risk-to-current revenue to increase on average to 82.4% at end-2019 from 79.5% at end-2015.
Istanbul faces significant foreign exchange risk in times of elevated financial volatility as 97% of its debt at end-2015 was foreign currency-denominated and unhedged, up from 95% in 2014. Istanbul has been increasing its FX borrowing due to high domestic interest rates and the short-term maturity profile of domestic loans.
Fitch expects direct debt to increase to TRY6.3bn at end-2018, from TRY4.7bn at end-2015, equal to 51% of current revenue. Fitch expects the debt-to-current balance to remain slightly over one year in 2016-2018, but well below the weighted average maturity of its debt stock of 8.9 years. Istanbul's lender portfolio consists mainly of multilateral banks and international and domestic commercial banks.
Istanbul is Turkey's main economic hub, contributing on average 25.5% of the country's gross value added in 2006-2012 (latest available statistics). Rapid urbanisation and continued immigration flows challenge the province with a continued need for infrastructure investments. In 2015, the population grew 2% yoy to 14.7 million.
A downgrade of Turkey's sovereign ratings would prompt a downgrade of Istanbul's ratings. Material deterioration of the debt servicing capacity of the city, as a result of persistent financial instability and further depreciation of the Turkish lira, or a deterioration of the budget deficit before debt to more than 15% of total revenues (2015: 6.9%) could also prompt a downgrade, although this is not Fitch's base case scenario.