OREANDA-NEWS. April 21, 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+'.

KEY RATING DRIVERS
The ratings reflect the city's sound although 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.

According to Fitch's base case scenario, the operating balance will decline steadily in the medium term, to 6.7% of operating revenue in 2017, from 8.6% in 2014. The drop in state transfers (4.6% per year until 2017) will be barely compensated by a forecasted rise in tax revenue of 4.3% per year, driven by higher tax rates from 2015 and a growing tax base, leading to flat revenue growth. In the meantime, operating spending is expected to grow moderately, as Strasbourg is implementing a series of structural spending cuts, notably over staff cost. However, this would not be sufficient to offset flat revenue.

Nevertheless, the administration still retains revenue flexibility, as the city's tax leeway remains significant due to fairly low tax pressure. Hence, 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.

We expect capital expenditure to decline progressively, to EUR72m on average in 2015-2017, from EUR118m in 2012-2014, 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 46% on average in 2015-2017, after debt repayment, from 82% in 2010-2014.

The lower self-financing capacity would keep debt on an upward trend until 2017. After a sharp 41% increase in 2014, direct debt will continue to grow, reaching 76% of current revenue in 2017, up from 62% in 2014. The debt payback ratio would weaken to 15.3 years, from 7.6 years in 2014, which would be incompatible with current ratings.

The City of 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.

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 would 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.