OREANDA-NEWS. 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.

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 to 2019 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 offset the expected debt increase.

KEY RATING DRIVERS
According to Fitch's baseline scenario, RM should maintain an operating margin averaging 28% until 2019. This will be achieved through steady tax base growth and supported by the tax hike applied in 2015, contributing to a 1.4% yoy increase in operating revenue in 2014-2018, despite large cuts in state transfers (of 3.1% a year). With growing interest charges (linked to the expected debt increase), we expect the current margin to weaken to below 25% by 2019, from 34.4% in 2015, although it will remain sound.

Taking into account the financing by RM of a second metro line's construction, we expect capital expenditure to average EUR404m per year until 2019, up from EUR165m in 2010-2014. The metropolis' self-financing of capital expenditure, after debt repayment, weakened to 52% in 2015, from 100% in 2010-2014, and we expect it to remain close to that level until 2018. 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, to EUR846m at end-2019, or 180% of current revenue, from 54% in 2015 (22% in 2011-2014), due to the significant capital expenditure programme. The debt payback ratio (direct debt-to-current balance) is therefore likely to increase to above eight years by 2019, from 1.6 years in 2015, which could put pressure on the ratings.

However, Fitch considers RM's track record for the construction of its first metro line in 1997-2002 as credit-positive given the metropole's demonstrated tight control of debt and subsequent de-leveraging. Fitch will pay close attention to RM's capacity to limit the deterioration in debt ratios over the medium term. At end-2015, RM was transferred ancillary budgets from its constituent municipalities along with a EUR61m debt stock, resulting in EUR300m direct risk (68% of current revenue).

Liquidity is underpinned by predictable cash flows. Since 2015, to cover any liquidity shortfall RM has recourse to committed bank lines totalling EUR70m, or 3.6x annual debt service for 2016. Liquidity management is likely to be enhanced with the expected launch of a French CP programme totalling EUR100m later in 2016.

Net overall risk at end-2015 was high at an estimated 247% of current revenue, mainly due to a large guaranteed debt stock (EUR816m). However, Fitch considers these guarantees as low-risk as they relate almost entirely to long-term loans 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 healthy and well-diversified, and enjoys a structurally below-average unemployment rate (8.2% at end-3Q15, against 10.2% for Metropolitan France). Positive economic 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.