OREANDA-NEWS. Fitch Ratings has affirmed the Polish City of Rzeszow's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB'. Fitch has also affirmed the National Long-term Rating at 'A+(pol)'. All ratings have Stable Outlooks.

The affirmation reflects Fitch's unchanged baseline scenario regarding the city's satisfactory operating performance and moderate debt levels.

KEY RATING DRIVERS
The 'BBB' IDR reflects the city's improving operating performance, in line with Fitch's expectations, its healthy debt ratios and low contingent risk. The ratings also take into account expected direct debt increase driven by large investment projects.

Fitch's base case scenario expects Rzeszow to demonstrate stable operating performance in 2015-2017 with an operating margin averaging 7%-8%. This will be supported by the city authorities' continued cost control measures and growth of tax revenue, supported by the projected growth of the national economy.

Fitch projects that Rzeszow's investment spending in 2015-2017 could total PLN1.3bn (on average 30% of annual total expenditure), as the city prepares to roll out investments under the 2014-2020 EU budget. Over 60% of investment financing may come from capital revenue and the city's current balance, provided Rzeszow's administration continues to be successful in obtaining high EU and state grants to fund its investment programme. The remainder will be covered by new debt.

Fitch also expects that high investment spending to drive the city's debt higher in 2015-2017 to 80% of current revenue (2014: 65% or PLN532m). However, despite this projected debt increase, Fitch expects the city's debt-service and -payback ratios to remain healthy. Debt service, projected to average PLN55m, is likely to be covered 1.1x-1.5x by the operating balance. The debt-to-current balance ratio is expected to be around 13 years, which will still be below the city's final debt maturity (up to 24 years).

At end-2014 almost all of the city's direct debt had floating rates, which exposes Rzeszow to interest rate risk. Local and regional governments in Poland are not allowed to use derivatives to hedge their interest rate or FX risk exposure. However, because Rzeszow tends to budget for higher interest payments than the actual amounts paid, the city has an adequate buffer to manage interest rate risk.

Rzeszow continues to increase the efficiency of its public services delivery and has no plans to use any quasi-debt instruments or to transfer risk or debt to its dependent entities. As a result, it has lower contingent liabilities than most of its Polish peers, at only PLN28m at end-2014 (2013: PLN20.5m).

Rzeszow is a medium-sized city by Polish standards, with a diversified economy and is attractive to inhabitants and private investors. GDP per capita has risen rapidly in the Rzeszow sub-region, in which the city is located, to 87% of the national average in 2012 (latest available data) from 74% in 2007. However, Fitch believes that the city's wealth indicators are above the national average, as the city is the strongest area in the sub-region. Despite being situated in one of the five poorest Polish regions, the dynamic local economy continues to support the growth of the city's tax base and should lead to faster growth of tax revenue than its peers.

RATING SENSITIVITIES
The ratings could be upgraded if Rzeszow sustainably strengthens its operating balance above 11% of operating revenue, accompanied by diminishing recourse to debt that leads to an improvement of the debt-to-current balance ratio to below 10 years.

The ratings could be downgraded if Rzeszow's growing debt is not accompanied by improvements to operating performance such that the debt servicing (interest and principal repayment) to operating balance ratio materially exceeds 100% for a sustained period (2014: 75.8%).

KEY ASSUMPTIONS
Fitch expects the city to maintain its control on operating expenditure growth and to manage its budget prudently over the medium term.

Fitch assumes that the city will continue to receive EU funds to co-finance its investment programme.

Fitch also assumes that the city will continue to comply with all the EU regulations and procedures when implementing investments projects co-financed by the EU. Otherwise, Rzeszow could face the penalty of having to return previously received EU grants.