Fitch Revises Outlook on City of Strasbourg to Stable; Affirms at 'AA'
The revision of the Outlook reflects the revision of Fitch's scenario since December 2014 when we placed the city's IDRs on Negative Outlook. According to our revised scenario, Strasbourg's budgetary and debt profile will remain sound in the medium term, despite a slight weakening due to the combination of slightly declining revenue trends and growing debt levels.
KEY RATING DRIVERS
The ratings reflect the city's tax flexibility and moderate debt, despite an operating performance rather low for the 'AA' category. The ratings also benefit from the city's sound governance and a well-diversified economy.
The rating action reflects the following key rating drivers and their relative weights:
According to Fitch's base case scenario, Strasbourg's operating margin will remain above our guideline for a downgrade (8%), although it will weaken somewhat to 8.5% on average in 2016-2019, from 10% in 2012-2015. This is due to slightly declining revenue (-0.2% per year) following state transfer cuts, which will not be fully compensated by a forecast rise in tax revenue of 3% per year. The rise will be driven by a rate increase in 2016 and a growing tax base. The deterioration is less harsh than we initially expected, due to stronger performance in 2015 (11.2%, from 8.6% in 2014), driven by tax hikes and the introduction of a new tax on electricity consumption. Operating spending has also been controlled, most notably staff costs, which have stabilised in accordance with the guidelines set by management. In the medium term, operating spending is expected to grow moderately, as Strasbourg has implemented a series of structural spending cuts, along with the objective of continued frozen staff costs in the medium term, outside any national measures or change of competencies.
Moreover, the administration still retains revenue flexibility, as tax leeway remains significant due to average tax pressure, although the city has made a commitment not to use its tax leeway after the 2016 tax increase. The city may also be able to raise some additional revenue through higher fees for municipal services (car parking, school meals). The potential proceeds from these measures are not factored into our central scenario at this stage. The city's objective is to keep the current margin above 8% in the medium term.
We expect capital expenditure to decline progressively, to EUR71m on average in 2016-2019, from EUR105m in 2010-2015, as Strasbourg has been scaling down its multi-year investment programme in view of the expected decline in operating performance. However, Fitch believes the city may not be able to scale back its capital outlays rapidly enough to align with the tighter operating performance. Therefore, the self-financing share of capital expenditure, after debt repayment may decline somewhat, although it will remain constantly above 50% in 2016-2019, after debt repayment (2015: 68%).
Between 2011 and 2015, direct debt has grown constantly, to EUR239m, from EUR136m. According to our scenario, this trend will slow down, with direct debt expected to reach around 70% of current revenue in 2019, up from 63% in 2015. The debt payback ratio will be around 8.4 years, up from 4.9 years on average in 2012-2015, but without reaching our rating sensitivity for a downgrade (a debt payback ratio consistently above 10 years). Fitch considers that the risk from contingent liabilities is low.
Strasbourg benefits from sound governance, as its full integration with the Eurometropole of Strasbourg (AA/Stable/F1+) facilitates economies of scale and policy co-ordination. Strasbourg's ability to bolster operational efficiency and contain operating cost growth is underpinned by a skilled administration. Cash flows are predictable and prudently managed. Short-term funding is adequate and relies on committed credit lines totalling EUR49m.
The City of Strasbourg's ratings also reflect the following key rating driver:
The city benefits from a well-diversified economy, high-quality infrastructure and outstanding transportation networks. Long-term growth prospects are underpinned by the city's location within one of Europe's most industrialised areas, and the city's special status as the seat of several European institutions.
An operating margin below 8% and a debt payback ratio consistently above 10 years could lead to a downgrade.
An upgrade is unlikely even if the sovereign rating (AA/Stable/F1+) is upgraded, unless the City of Strasbourg strengthens its budgetary performance and debt metrics well above Fitch's expectations.