OREANDA-NEWS. June 10, 2015. Fitch Ratings has affirmed the Metropolitan Municipality of Izmir's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'BBB-'. The National Rating has been affirmed at 'AA+(tur)'. The Outlook is Stable.

The affirmation reflects Izmir's continued strong operating performance of above 50% in 2014, despite its high capex needs. The ratings also reflect ongoing expenditure discipline with a realisation rate just below the 100% of the budgeted amount and accumulation of sound liquidity reserves.
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KEY RATING DRIVERS
Fitch expects Izmir to continue to post strong operating margins of 55%-60% in 2015-2017 driven by its buoyant, well-diversified local economy and a one-off increase in its tax revenue base under Law 6360, which should be realised from 2015 onwards. In 2014, the city accumulated sound liquidity reserves, accounting for 16% of its operating revenue, which will be further supported by the increased tax revenue base.

The new responsibilities attached to the enlargement of Izmir's area to the province border are unlikely to generate significant additional tax revenues, due to the small population in the expanded area, but are likely to result in an increase in capital expenditure. The increase in its capital transfers to its municipalities in 2014 already reflects the increase in its capex budget. However, Fitch does not expect a deterioration in the city's strong self-financing capacity of capex due to Izmir's good track record of financial planning.

Izmir faces some foreign currency risk, as 53% of its debt is unhedged. Debt grew by 14.9.% in 2014 to TRY954.9m. The increase was mainly driven by a depreciation of the Turkish lira against euro in 2014 and new euro-denominated borrowings from the French Development Agency(AA+'/Stable/F1+) and EBRD for the extension of Izmir's public transportation network, as envisaged in its strategic planning for 2014-2019.

However, Fitch expects direct debt to remain in the range of 40%-45% of current revenue by 2017 (assuming that there is no further sharp depreciation of the lira). Furthermore, Izmir demonstrates a cautious debt management approach by accumulating provisions against foreign exchange risk on the large share of its FX liabilities. The agency forecasts the direct risk-to-current balance will remain strong at below one in 2015-2017 as direct risk is amortising, coupled with an expected increase in the current balance.

Izmir's contingent liabilities are growing moderately due to the increase in public services provided by public sector entities (PSEs). Izmir majority owns two PSEs, Eshot (the bus transport entity) and Izsu (water distribution and sewerage), and eight municipal companies. Apart from Izsu, they have mostly demonstrated unbalanced budgets, requiring considerable capital injections and transfers from the municipality. The city also provides a guarantee for its urban rail network operator Izban, which amounted to TRY190m in 2014 (2013: TRY153.5m). Izmir's net overall risk is forecast to decrease to about 50% of current revenue by 2017.

Izmir has Turkey's third-largest population (4.06 million in 2013) with wealth indicators above the national average. According to the latest available statistics, Izmir's per capita GVA in 2011 was well above the national average at TRY19,187. The city is located on the Aegean Sea Coast and is an important transport and industrial hub. Its dynamic socio economic profile and high standard of living exposes it to migrant flows.

RATING SENSITIVITIES
A sovereign downgrade of Turkey (BBB-/F3) would prompt a downgrade of Izmir's foreign currency IDR. Further, a sharp increase in its direct debt above 55% to current revenue, driven by capex and local currency devaluation and could lead to a downgrade.

Stabilisation of its direct debt, a decline in its FX liabilities and continuation of financial strength would be positive for the ratings.

KEY ASSUMPTIONS
Fitch forecasts shared tax revenues to increase by 16% on average, and a continuation of the expenditure discipline leading to strong operating margins to be at high 50% in 2015-2017. Fitch also assumes Izmir's debt payback ratio to remain below one year on average in 2015-2017, supported by a prudent financial and liquidity planning.