OREANDA-NEWS. Fitch Ratings has affirmed the Metropolitan Municipality of Istanbul's (Istanbul) Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'BBB-' and 'BBB', respectively, with Stable Outlooks. Its Short-term foreign currency IDR has been affirmed at 'F3' and its National Long-term Rating at 'AAA(tur)' with Stable Outlook.

The affirmation is based on Istanbul's continued solid, albeit weakening, operating performance which, together with high capital revenue, supports a strong self-financing capacity for ongoing large capex in 2016-2018. The ratings also take into account our expectations that Istanbul's direct risk-to-current balance will remain under two years, despite significant FX risk exposure and Istanbul's increasing, large capex until 2019 before the next local elections.

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

KEY RATING DRIVERS
Fitch projects Istanbul to post strong, albeit declining, operating margins of 50% in 2016-2018. The expected decline in operating margin is driven by higher operating expenditure related to cleaning, security and consumption services. Overall, Fitch expects local economic growth will support Istanbul's operating performance in the medium term.

Despite Istanbul's accelerated large capex through to 2019 before the next local elections, which will result in an increase of debt financing, Fitch expects the city to continue to contain total expenditure to below 100% of the budgeted amount.

In 2015, the city realised 91% of budgeted operating expenditure, against a 113% realisation of budgeted operating revenue. However, operating expenditure growth in nominal terms outpaced operating revenue growth by 7.3% for the first time since 2010. This caused operating margin to decline to 49.1%, below the five-year average of 58%.

The local economy was resilient against an adverse sentiment change in the international capital markets in 2015, allowing the city's tax revenue to grow 13% yoy at an inflation of 9.5%.

Fitch expects strong operating surpluses and asset sale proceeds will cover the bulk of the city's TRL25bn investment in 2015-2018. Istanbul plans to construct 200km of additional metro lines between 2014 and 2019. Fitch estimates that roughly 25% of capex will be funded by asset sales and proceeds from the IPO of IGDAS (Natural Gas Distributor), with the remainder coming from budget surpluses and borrowings. However, it is still not known what percentage of the company shares will be sold through the IPO.

The city's authorities follow a solid budgetary policy and financial planning is improving, which supports its sound operating performance. Sound financial planning enables the city to cover further large financing needs of capex in a timely and forward-looking manner. However, the push for large capex by the city before the next local elections may increase its debt burden and worsen its budget deficit before debt variation and, consequently, its budgetary performance.

Direct debt was TRY4.96bn at end-2015, up 8% yoy and equal to 52% of current revenue. The debt-to-current balance increased to slightly over one year, according to our estimates. Fitch expects the debt-to-current balance to remain slightly over one year in 2016-2018, but well below the weighted average maturity of its debt stock of 4.6 years. Istanbul's lender portfolio consists mainly of multilateral banks and also international and domestic commercial banks

Istanbul increased intercompany borrowing from its water management affiliate ISKI to a total of TRY2.26bn at end-2015 from TRY1.47bn at end-2014. This improves the city's debt profile, as intercompany borrowing is at zero cost and repayment is postponed. Fitch expects this debt will be netted against the sale of ISKI assets that belong to Istanbul and classifies this debt as direct risk. The agency forecasts the city's direct risk-to-current balance to remain below two years in 2016-2018.

Istanbul faces significant foreign exchange risk in times of elevated financial volatility as 97% of its debt at end-2015 was foreign currency-denominated and unhedged, up from 95% in 2014. Istanbul has been increasing its FX borrowing due to high domestic interest rates and the short-term maturity profile of the domestic loans. However, Fitch projects the city's debt servicing and debt-to-current balance will remain sound in 2016-2018. Direct debt servicing will remain below 30% of the operating balance.

Istanbul is Turkey's main economic hub, contributing on average 27.4% of the country's gross value added in 2004-2011 (last available statistics). Rapid urbanisation and continued immigration flows challenge the province with a continued need for infrastructure investments. In 2015, the population grew 2% yoy to 14.7 million.

RATING SENSITIVITIES
A downgrade of Turkey's sovereign ratings (BBB-/BBB/Stable/F3) will prompt a downgrade of Istanbul's ratings. Material deterioration of the debt servicing capacity of the city as a result of persistent financial instability and further depreciation of the Turkish lira or a deterioration of the budget deficit before debt to more than 10% of total revenues (2015: 6.9%) could also prompt a downgrade, although this is not Fitch's base case scenario.

An upgrade of the sovereign ratings could result in a similar action on Istanbul's ratings subject to a reduction of the city's foreign currency exposure to below 35% of its outstanding debt, continued strong budgetary performance and consistent management policies.