OREANDA-NEWS. Fitch Ratings has affirmed French Metropolis of Rennes' (also known as Rennes Metropole, RM) Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AA' and its Short-term foreign currency IDR at 'F1+'. The Outlooks on the Long-term IDRs are Stable.

KEY RATING DRIVERS
The affirmation is based on RM's continued solid and stable performance, robust socio-economic profile and skilled management. The ratings also reflect Fitch's expectations of a significant, but manageable, increase in debt from 2015 due to the construction of a new metro line. The Stable Outlook reflects RM's capacity to maintain its sound budgetary performance over the medium term.

According to Fitch's baseline scenario, RM will maintain sound operating performance in the medium term, with an operating margin averaging 29.6% until 2018. This will be achieved through steady growth of the tax base and tax hikes in 2015 and 2016, contributing to a 2% yoy increase in operating revenue in 2014-2018, despite large cuts in state transfers (of 4% a year).

Capital expenditure will average EUR436m per year in the medium term, compared with EUR165m per year in 2010-2014. This sharp increase is mostly due to the financing by RM of a second metro line's construction, which started in 2014 and is scheduled for completion in 2018-2019. Thus, RM's self-financing capacity of capital expenditure, after debt repayment, could decline to 53% in 2015-2018, from 100% in 2010-2014. The administration aims to self-finance the metro line construction costs at a minimum of about 60% (including co-funding), with recourse to its large reserves while maintaining large current margins over the medium term.

Fitch expects RM's debt to rise sharply to up to EUR795m at end-2018, or 172% of current revenue, from a low 22% at end-2014. This would be due to the significant capital expenditure programme contemplated until then, even while operating performance is assumed to remain sound. Thus, debt coverage (direct debt to current balance) could weaken to 7.5 years, from a strong 0.8 year in 2014. However, Fitch points to RM's positive track record for its first metro line in 1997-2002, when it demonstrated tight control of indebtedness and subsequent rapid de-leveraging.

Liquidity is underpinned by predictable cash flows and accumulated cash surplus. The latter peaked at EUR157m in 2013 and has since started to be deployed for financing part of RM's capital expenditure programme. Thus, the cash surplus declined to EUR71m at end-2014, which was still sufficient to cover debt servicing by 6.5x (or 77% of total debt stock). As the cash surplus will be depleted over the medium term, the administration is adapting its liquidity management, and is considering setting up a CP programme with back-up liquidity lines by end-2015.

Net overall risk at end-2014 was high at an expected 196% of current revenue, mainly due to a large guaranteed debt stock. Fitch considers it as low-risk as it comprises long-term regulated loans extended to state-monitored social housing entities. Debt of public sector entities is low.

As with other French large inter-municipal groupings RM's status has changed to that of a "metropolis" on 1 January 2015, which entails a larger scope of competencies and additional resources. The transferred competencies will represent additional operating spending, which are to be counterbalanced by transferred revenue and lower transfers to constituent municipalities. Therefore, Fitch considers the new competencies to only marginally affect RM's budgetary profile and performance in the medium term.

RM benefits from a stable political framework and sound governance, with strong, and improving, integration with the inner city of Rennes (AA/Stable/F1+). RM's ability to implement its medium-term financial strategy is underpinned by its skilled administration and prudent financial management.

Despite a challenging overhaul of the industrial sector, RM's economy remains dynamic, well diversified, and enjoys a structurally below-average unemployment rate. Economic growth prospects are underpinned by a young, highly qualified population, low real-estate prices and strong public infrastructure.

RATING SENSITIVITIES
A deterioration of RM's budgetary performance and its self-financing capacity, leading to a worsening of debt ratios (e.g., debt coverage of over eight years for more than two consecutive years), could lead to a downgrade.

An upgrade is unlikely even if the sovereign rating (France, AA/Stable/F1+) is upgraded. However, an upgrade is possible if RM strengthens its debt metrics well above Fitch's expectations.