OREANDA-NEWS. October 13, 2015.  Fitch Ratings has affirmed the City of Strasbourg's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AA' with a Negative Outlook. The Short-term foreign currency IDR has been affirmed at 'F1+'.

The affirmation reflects Fitch's assessment of stable rating factors since the last reviews. The ratings are underpinned by the city's sound albeit declining operating performance, tax flexibility and moderate debt. The Negative Outlook reflects Fitch's expectations of a weaker financial profile, due to the combination of rigid expenditure, negative revenue trends and growing debt levels that would not be compatible with the current ratings.

KEY RATING DRIVERS
According to Fitch's base case scenario, the operating balance will decline in the medium term to below 8% of operating revenue from 2017 onward, from an average10.4% in 2010-2014. The drop in state transfers will be barely compensated by a forecast rise in tax revenue of 4.3% per year, driven by higher tax rates from 2015 and a growing tax base, leading to slow revenue growth. Operating spending is expected to grow moderately, as Strasbourg is implementing a series of structural spending cuts, notably over staff costs. However, this will be insufficient to offset flat revenue.

The administration still retains revenue flexibility, as the city's tax leeway remains significant due to fairly low tax pressure. Consequently, the city may be able to take further actions to limit the deterioration in fiscal performance in the medium term, such as further tax hikes, higher fees or exemptions removal. Should these elements materialise, at least partially, we could factor them into our central scenario. The expected deterioration in the budgetary performance may then be more subdued.

We expect capital expenditure to decline progressively, to EUR70m on average in 2015-2018, from EUR107m in 2011-2014, as Strasbourg is 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 shrinking operating performance. Therefore, the self-financing share of capital expenditure may decline, to 47% on average in 2015-2018, after debt repayment, from 82% in 2010-2014.

The lower self-financing capacity would keep debt on an upward trend until 2018. Debt may reach 73% of current revenue in 2017, up from 62% in 2014. The debt payback ratio would exceed 10 years after 2016, up from 7.6 years in 2014, which would be incompatible with the current ratings. The growing debt, along with constrained budgetary surpluses, is likely to lead to a net deterioration in debt service. Annual debt service/operating balance ratio could weaken to above 120% by 2018, from 72% in 2014. Fitch considers that the risk from contingent liabilities is low.

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 its operational efficiency and contain operating cost growth is underpinned by its skilled administration. Cash flows are predictable, and prudently managed. Short-term funding is adequate and relies on committed credit lines totalling EUR49m as of October 2015.

The city benefits from a well-diversified economy, high-quality infrastructure and outstanding transportation networks. Long-term growth prospects are underpinned by its location within one of Europe's most industrialised areas, and its special status as the seat of several European institutions. After the implementation of the territorial reform by 2016, the City of Strasbourg will become the capital of an enlarged region, merging with the regions of Alsace, Lorraine and Champagne-Ardenne.

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