OREANDA-NEWS. March 30, 2015. Fitch Ratings has upgraded the Polish City of Gdansk's Long-term foreign and local currency Issuer Default Ratings (IDR) to 'A-' from 'BBB+' and its National Long-term rating to 'AA(pol)' from 'AA-(pol)'. All ratings have Stable Outlooks.

KEY RATING DRIVERS
The upgrade reflects Gdansk's continued sound operating performance and prudent financial management, which together with high capital revenue, supports a strong self-financing capacity for its investment plans. The upgrade factors in also the stabilisation of direct risk below 50% of current revenue, despite projected high capital spending.

The Stable Outlook reflects Fitch's expectations that the strong operating performance will be maintained in the medium term, despite pressure on operating spending.

The rating action reflects the following rating drivers and their relative weights:

HIGH
Fitch base case expects Gdansk's operating balance to be at 13%-14% of operating revenue in the medium term, which would be above the 2011-2013 average. This will be driven by the city's financial flexibility, the city authorities' policy to limit operating expenditure growth, and growth of tax revenue, supported by projected growth of the national economy in the medium term.

For 2014, Gdansk's posted an exceptionally high operating margin of 16.6% (2013: 12.1%), as the city continued to keep operating expenditure growth substantially below operating revenue growth. The 2014 operating results were also supported by a one-off revenue item related to a resolution by the city of a disputed property tax receivable (PLN48m). However, even after excluding this revenue the city's operating balance would constitute 14.5% of operating revenue, which was still above our expectations.

Fitch forecasts Gdansk's direct risk to stabilise at PLN1.1bn in 2015-2017, after declining from PLN1.4bn at end-2012. In relative terms direct risk will account for less than 50% of current revenue during the same period (2012: 73%). Most of Gdansk's debt is from international financial institutions, providing the city with low funding costs, long debt maturity and a smooth debt repayment profile. In 2014 Gdansk used its cash reserves to repay before maturity PLN50m high-interest-bearing bonds. The city plans to prepay a further PLN83m of expensive debt in 2015.

Fitch projects the city's debt servicing and debt payback ratios will remain healthy in 2015-2017. Debt servicing is expected to be about 35% of the operating balance (excluding premature redemptions) and the debt-to-current balance ratio below five years, well below the city's average weighted debt maturity of 15 years.

MEDIUM
The city's authorities follow a prudent budgetary and financial policy, which guarantees solid operating performance despite persistently high pressure on operating expenditure. Much of the operating expenditure pressure arises from underfunded responsibilities that were transferred to local governments by the State in the past and from the dominance of rigid spending items such as education and social care. Additional, pressure on the budget comes from growing maintenance costs as investments are being completed.

Fitch projects Gdansk's investment spending in 2015-2017 could total PLN2bn (on average 25% of annual total expenditure), as the city prepares to roll out investments under the 2014-2020 EU budget. Despite the projected level of capex, Fitch expects the city's recourse to debt to be limited, as Gdansk demonstrates above-average self-financing capacity among the Polish cities rated by Fitch. Over 80% of investment financing may come from capital revenue (EU and state budget grants), and the city's current balance.

RATING SENSITIVITIES

The rating could be upgraded if the city maintains its operating margin above 15%, accompanied by direct risk at below 50% of current revenue, on a sustained basis.

A negative rating action could result from sustained deterioration in the operating margin far below Fitch's expectations, or a significant rise in direct debt leading to the city's debt payback ratio (debt to current balance) exceeding 10 years.