OREANDA-NEWS. June 17, 2015. Fitch Ratings has assigned a long-term local currency Issuer Default Rating (IDR) of 'BBB' to the Municipality of Puebla, Mexico (Puebla). The Rating Outlook is Stable.

Puebla's rating reflects a very low leverage, a strong liquidity position as well as solid and consistent operating balances. The rating also takes into consideration Puebla's robust socioeconomic profile, its importance at the state and regional context and a very low degree of marginality. Finally, the rating takes account of the sound and strong administrative and financial management practices of Puebla.

In contrast, the rating is constrained by the very high dependence of current transfers (Federal contributions and 'Ramo 33' Fund IV), a common feature of the municipalities in Mexico. In addition, Puebla faces contingent liabilities in the long run related to the unfunded pension and retirement obligations.

KEY RATING DRIVERS
As of April 30, 2015, Puebla's direct debt (DD) amounted MXN560.7 million, corresponding to two 15-year bank loans, maturing in 2023 and 2025; both of them have interest rate hedges, renewed on an annual basis. In addition, Other Fitch Classified Debt (OFD) includes a lease of luminaires, maturing in October 2018, with an outstanding balance of MXN538.2 million. The annual cost of this contract is MXN155.6 million (4% of current revenue).

In the period of analysis (2010-2014), direct risk (DD + OFD) remained below 32% of current revenue. In addition, debt service was less than 57% of operating balance (9.1% in 2014). The current administration has no plans to incur additional debt. As a result, Fitch estimates that between 2015 and 2018, DD will remain below 13% of current revenue and debt service will be less than 14% of operating balance. Both ratios compare favourably with 'BBB' median (45.3% and 50.6%, respectively).

Between 2010 and 2014, Puebla's liquidity position improved steadily. Current assets covered 227% of current liabilities in 2014 (82% in 2010). Furthermore, after reaching a maximum of 115 days in 2011, the turnover of accounts payable fell to 12.8 days in 2014. This metric has remained below 15 days in the last two years, thus Puebla has not incurred into short-term debt.

In the period of analysis, operating margin averaged 16% of operating revenue, higher than 'BBB' median (9.5%). However, operating revenue showed a compound annual growth rate (CAGR) of 10.5%, lower than 11.3% of operating expenditure CAGR.

The 'capital expenditure to total expenditure' ratio showed a downward trend, from 28.6% in 2010 to 22.5% in 2014. However, it still compares favourably with 'BBB' median (23.8% vs. 17.5 %, respectively). In addition, during 2010-2014 Puebla financed 60.8% of capital expenditure with its current balance.

On local collection, taxes showed a CAGR of 15.6%, higher than 8.5% of current transfers CAGR. Therefore, 'tax revenue to operating revenue' ratio improved from 16.9% in 2010 to 20.3% in 2014. However, this figure still compares below the 'BBB' median (68.3%). In order to strengthen its local tax revenue, Puebla is upgrading and modernizing its cadastre. However, Fitch estimates that in the medium term, current transfers will continue to represent about 60% of operating revenues.

Puebla funds part of its pension and retirement liabilities with current expenditure, which represents a contingency for municipal finances in the medium and long term. During 2014, MXN76.8 million was disbursed to pay pension and retirement obligations and contributed MXN293.1 million to both social security and retirement plans. As of April 30, 2015, Puebla reported 5,119 active workers and 585 pensioners and retirees.

Puebla congregates 26.6% of the State's population. Due to the size of its population (1.5 million) and its economic dynamism (Puebla contributes around 70% of the State's GDP) it is considered the fourth most important city in Mexico. According to the National Population Council (Consejo Nacional de Poblacion), Puebla has a strong human development index, ranking 49th among the 165 municipalities with more than 100,000 people nationwide. Due to the forthcoming opening of an automotive assembly plant in San Jose Chiapa, economic expectations are favourable. Consequently, an increase in real estate is expected, which could benefit local collection in the medium term.

RATING SENSITIVITIES
An upgrade could occur if Puebla is able to strengthen its local tax revenue collection, and reduce its dependency on current transfers; or if the municipality is able to improve operating balances consistently by controlling operating expenditure growth. A reform to the pension system, which introduces employees' contributions to finance pension liabilities, would also have a positive rating action.

Conversely, a negative rating action could occur if operational expenditure shows a strong increase that hinders its operating balances. Likewise, a downgrade could occur if capital expenditure presents a substantial growth, accompanied by a similar increase in direct debt and / or current liabilities.

RATING OUTLOOK - STABLE
The Stable Outlook reflects Fitch's expectation that Puebla will maintain a strong fiscal performance, resulting in very manageable debt service ratios and solid liquidity position. Moreover, Fitch estimates that Puebla will maintain operating margins above 15% and will be able to finance most of its capital expenditure with current balance.