OREANDA-NEWS. Fitch Ratings has affirmed the French City of Rennes' Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AA' and its Short-term foreign currency IDR at 'F1+'. The Outlook is Stable. Fitch has also affirmed Rennes' EUR200m EMTN programme at 'AA'/'F1+'.

The affirmation reflects Rennes' sound operating performance, moderate indebtedness, strong governance and robust economy. The Stable Outlook reflects Fitch's view that despite expected weakening of performance over the medium term, the city will be able and willing to keep financial metrics compatible with the ratings.

KEY RATING DRIVERS
In application of the French "Metropolis" law, as part of a wider set of territorial reforms, Rennes transferred a number of its responsibilities (such as road maintenance) to its inter-municipal grouping, the Metropolis of Rennes (RM, AA/Stable/F1+), as of 1 January 2015. Fitch understands from the administration that Rennes is managing a part of RM's transferred competencies through specific agreements for a two-year transition period. These agreements inflated the city's operating and capital revenue and expenditure in 2015 and will continue to do so in 2016, but their budgetary impact is neutral.

The territorial reform led to a change in Rennes' financial profile as most of the transfers concerned the city's investment responsibilities. Fitch estimates that investments will represent on average 15.5% of the city's expenditure in 2015-2018 (excluding the above-mentioned agreements with RM in 2015 and 2016), compared with 22% in 2011-2014. The reform also negatively impacted Rennes' operating balance through a downward recalculation of the operating transfers made by RM to Rennes. Overall, notwithstanding the sharp state transfer cuts until 2017, Fitch considers that the territorial reform does not affect Rennes's debt repayment capacity.

Despite pressure on operating revenue due to sharp cuts in state transfers until 2017, Fitch considers that Rennes will continue to report sound fiscal performance. Fitch estimates that operating revenue will slightly decline in the coming years (-0.3% a year on average from 2015 to 2018) while operating expenditure will continue to grow at a moderate pace (1.6% a year on average from 2015 to 2018), considering the relative rigidity of operating spending (such as staff costs). Fitch forecasts that this, along with the above-mentioned change in the scope of responsibilities, may result in a decline in the operating balance to an annual average of 10% of operating revenue in 2016-2018, compared with a 16.4% in 2012-2014. Our forecasts do not factor in any tax hikes considering the city's political commitment to tax stability.

Capital expenditure declined to an estimated EUR51.4m in 2015 (excluding the above-mentioned agreements with RM) from EUR92m in 2014, due to the transfers of competencies of January 2015, and should stabilise at around EUR50m in the coming years. Consequently, despite the weaker operating balance, the self-financing capacity of capital expenditure will remain adequate at around 55% on average in 2016-2018.

Direct risk (direct debt plus Fitch-classified debt) declined to an estimated EUR161.9m at end- 2015, or a sound 56.5% of current revenue, from EUR226.7m (72.8%) in 2014 due to the reduction of the scope of competencies and the transfer of debt commitments to RM. In the medium term, we expect direct risk to remain moderate in absolute terms and relative to current revenue.

However, through the expected decline in the current balance, the payback ratio (direct risk to current balance) may weaken to seven years on average in 2016-2018, from 4.7 years in 2012-2014. We expect the city's debt service capacity to remain sound, at 61% of operating balance in 2018, compared with 46% in 2014. Debt guarantees are estimated to have continued to fall to EUR134m at end-2015, compared with EUR152m in 2014 and EUR226m in 2010. They are mostly for the benefit of social housing entities, which Fitch views as a highly regulated and low-risk sector.

Rennes benefits from a stable political framework and sound governance, with a high level of integration with RM. Rennes' ability to implement its medium-term financial strategy is underpinned by its skilled administration and prudent financial management.

Rennes' economy remains dynamic, well-diversified, and has a below-average unemployment rate (8.2% at end-3Q15 vs. 10.2% for metropolitan France), despite a challenging industrial restructuring. Economic growth prospects are underpinned by a young, highly qualified population, moderate real-estate prices and outstanding public infrastructure.

RATING SENSITIVITIES
An upgrade could be triggered by a sustained improvement of the debt payback ratio to below four years, provided the sovereign's rating is also upgraded.

A consistently weak operating margin, together with a debt payback ratio increasing to over eight years, could result in negative rating action. A downgrade of the sovereign would also be reflected in Rennes' ratings.