OREANDA-NEWS. September 15, 2015.  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, which should compensate for the expected debt increase.

According to Fitch's baseline scenario, RM should maintain an operating margin averaging 28% until 2018. This will be achieved through steady growth of the tax base and tax hikes in 2015, contributing to a 2% yoy increase in operating revenue in 2014-2018, despite large cuts in state transfers (of 3.5% a year).

Taking into account the financing by RM of a second metro line's construction until 2019, we expect capital expenditure to average EUR444m per year over the medium term, up from EUR165m in 2010-2014. The metropolis' self-financing of capital expenditure, after debt repayment, would weaken to 52% through to 2018, from 100% in 2010-2014. The overall cost of the new metro line's construction is estimated at EUR1.4bn over 2015-2022. The administration aims to self-finance at least 60% of this project (including co-funding received from other tiers of governments), while maintaining large current margins over the medium term.

Fitch expects RM's debt to rise sharply, up to EUR840m at end-2018, or 183% of current revenue, from a low 22% at end-2014. This would be due to the significant capital expenditure programme, while operating performance should remain sound. Thus, the debt payback ratio (direct debt-to-current balance) could increase to eight years by 2018, from a strong 0.8 year in 2014. However, Fitch points to RM's positive track record for the construction of its first metro line in 1997-2002, when it demonstrated tight control of indebtedness and subsequent de-leveraging. Considering the planned schedule of the construction works, the debt payback ratio should recover after 2019. Fitch will pay close attention to RM's capacity to limit the deterioration in debt ratios over the medium term.

Liquidity is underpinned by predictable cash flows. RM has been using its large cash surplus to finance part of its capital expenditure programme, causing cash reserves to decline to EUR71m at end-2014 from EUR157m in 2013, but which are still sufficient to cover debt servicing by 6.5x. As the cash surplus will be depleted over the medium term, the administration has adapted its liquidity management with the signing of EUR70m of committed bank lines in 2015 and the expected implementation of a CP programme by end-2015, totalling EUR100m.

Net overall risk at end-2014 was high at an estimated 200% of current revenue, mainly due to a large guaranteed debt stock (EUR813m). However, Fitch considers the guaranteed debt as low-risk as it comprises almost entirely long-term regulated loans extended to state-monitored social housing entities. Debt of public sector entities is low.

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.

RM's economy remains dynamic and well diversified, and enjoys a structurally below-average unemployment rate (8.1% at end-1Q15, against 10% for Metropolitan France). 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 payback of about eight years on a permanent basis), could lead to a downgrade.

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