OREANDA-NEWS. Fitch Ratings has affirmed the City of Strasbourg's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AA'. The Outlooks are Negative. The Short-term foreign currency IDR has been affirmed at 'F1+'.

The affirmation with Negative Outlooks reflects Fitch's unchanged expectations of a weaker financial profile, due to the combination of rigid expenditure, negative revenue trends and growing debt levels that will not be compatible with the current ratings.

KEY RATING DRIVERS

The ratings reflect the city's sound, albeit gradually deteriorating, operating performance, tax flexibility and moderate debt. The ratings also benefit from the city's sound governance and a well-diversified economy.

Despite expected stronger performance for 2015, driven by tax hikes and the implementation of cost-cutting measures, our base case forecasts the current balance will decline in the medium term to below 8% of current revenue from 2017 onward, from an estimated 10.6% in 2015. Revenue for 2016-2019 will be slightly weaker as lower state transfers will barely be compensated by a forecast rise in tax revenue of 2.3% per year, driven by a further tax rate increase in 2016 and a growing tax base.

We expect operating spending to grow moderately in 2016-2019, following a series of structural spending cuts, notably over staff costs, which stabilised in 2015. The city's administration aims to keep the current margin at above 8% and the debt payback ratio at below 10 years. The administration still retains revenue flexibility, as tax leeway remains significant although the city has expressed a commitment not to use its tax leeway after the 2016 tax increase. Further cost-cutting measures are envisaged over the medium term to adjust spending to falling revenue.

We expect capital expenditure to decline progressively to EUR71m on average in 2016-2019, from EUR105m in 2010-2015, as Strasbourg scales down its multi-year investment programme in view of the expected deterioration in operating performance. However, Fitch believes the city may not be able to scale back its capital outlays rapidly enough to align with its shrinking operating performance. Therefore, the city's self-financing share of capital expenditure may decline, to 45% on average in 2016-2019, after debt repayment, from 78% in 2011-2015.

The lower self-financing capacity will keep debt on an upward trend until 2019. Debt may reach 78% of current revenue in 2019, up from 63% in 2015. The debt payback ratio will rise to 10 years after 2016, from 5.9 years in 2015.

The growing debt, along with constrained budget surpluses, is likely to lead to deterioration in debt service. Fitch forecasts the debt service/operating balance ratio could weaken to around 110% from 2017 from 59% in 2015. Fitch views the risk from contingent liabilities as low as they are from well-capitalised and self-supporting public sector entities, which, along with debt guarantees, represented 91% of the city's current revenue as of end-2014.

Strasbourg benefits from sound governance, as full integration with the Eurometropole of Strasbourg (AA/Negative/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 as of end-March 2016.

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. Also, the City of Strasbourg has been confirmed as a regional capital, after the merger of the regions of Alsace, Lorraine and Champagne-Ardenne into a larger region (the fifth most populated in France with 5.7 million inhabitants).

RATING SENSITIVITIES
An operating margin below 8% and a debt payback ratio consistently above 10 years could lead to a downgrade.