OREANDA-NEWS. December 08, 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 Outlooks are Stable.

The affirmation reflects that in accordance with our baseline scenario, Izmir continued its strong operating performance of above 50% according to the 3Q15 realised budgetary figures. This is reflects its high capex needs coupled with ongoing expenditure discipline with a realisation rate just below the 100% of the budgeted amount and accumulation of sound liquidity reserves.

The Stable Outlooks reflects Fitch's expectations that operating performance will remain strong and debt metrics should remain consistent with the ratings.

KEY RATING DRIVERS
Fitch expects Izmir to continue to post strong operating margins of 55%-65% in 2016-2018 driven by its buoyant, well-diversified local economy and a one-off increase in its tax revenue base under Law 6360, which is largely expected to be realised from 2015 onwards. In 3Q15, the city accumulated sound liquidity reserves, accounting for 20% of its operating revenue, which will be further supported by the boosted tax revenue base.

The new responsibilities attached to the enlargement of the metropolitan municipality's area to the province border are unlikely to generate significant additional own tax revenues, due to a smaller 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 of the strong self-financing capacity of capex due to Izmir's track record of financial planning.

Izmir faces some foreign currency risk, as 53% of its debt is unhedged. At Q315 direct debt was TRY1bn. Debt is expected to grow to TRY1.3bn as of 2018. The increase in debt will be mainly driven by the acquisition of further tranches of the already signed euro-denominated debt for the extension of the public transportation network envisaged in Izmir's strategic planning for 2014-2019. Fitch has already taken into account EUR/TRY depreciation of about 3% annually for the city's foreign debt.

Fitch expects direct debt to remain below 50% of current revenue until 2018 (without taking into account the depreciation). Furthermore, Izmir demonstrates cautious debt management approach by accumulating provisions against foreign exchange risk on the large share of its FX liabilities. The agency forecasts direct risk to current balance will remain strong at below 1 in 2015-2018 as Izmir's direct risk is amortising, and the current balance is expected to increase.

Izmir's contingent liabilities are growing moderately due to increasing services provided by public sector entities (PSEs). Eshot (the bus transport entity) and Izsu (water distribution and sewerage) are two PSEs, which together with eight municipal companies are majority-owned by the city. Apart from Izsu, they have mostly demonstrated unbalanced budgets, requiring considerable capital injections and transfers from the municipality. The city also provides 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 below 40% of current revenue by 2018.

Izmir has Turkey's third-largest population (4.11 million in 2014) with wealth indicators above the national average. Annual inflation rate in 2014 was 9.55% against the Turkish average of 8.85%. According to the latest available statistics, Izmir's per capita GVA at TRY19,187 in 2011 was well above the national average. 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, resulting in the unemployment rate (2013: 13.9%) being persistently above the national average (9.7%).

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.

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