Frankfurt am Main, August 16, 2022 -- Moody's Investors Service ("Moody's") has today downgraded to B3 from B2 long-term issuer and senior unsecured debt ratings of the Metropolitan Municipality of Istanbul and the global long-term issuer ratings of the Metropolitan Municipality of Izmir. The National Scale Issuer Rating on Izmir has been downgraded to A3.tr from A1.tr. The outlooks for both municipalities have been changed to stable from negative. Concomitantly, Moody's assessment of both cities' baseline credit assessments (BCAs) has been downgraded to b3 from b2.
Today's rating action follows the Moody's decision to downgrade Turkiye's sovereign ratings to B3 from B2 with a stable outlook on 12 August 2022. For full details, please refer to the sovereign press release at: https://www.moodys.com/research/--PR_468377.
RATIONALE FOR THE RATING DOWNGRADES
Today's rating action reflects the strong correlation between Turkiye's sovereign and sub-sovereign credit risk, reflected in their strong institutional, operational and financial linkages.
Moody's decision also takes into account the fact that the metropolitan municipalities of Istanbul and Izmir:
1) Lack any special status to insulate their credit fundamentals from any unilateral adverse decisions taken by the sovereign.
2) Do not have sufficient financial flexibility to permit their credit quality to be stronger than that of the sovereign, receiving the bulk of their operating revenues from the central government and are subject to potential unpredictable changes in legislation, such as tax redistribution.
3) Are strongly dependent on the sovereign's operating environment, which is marked by high inflation and currency volatility, constraining the predictability of Istanbul and Izmir's revenue generation and debt servicing responsibilities.
4) High debt levels with Net Direct and Indirect Debt at 124% and 114% of operating revenue in 2021 for Istanbul and Izmir, respectively. The main financial risks for the two cities include their very high foreign-currency exposure with a share of about 80% of Istanbul's total debt and 75% for Izmir.
RATIONALE FOR THE STABLE OUTLOOKS
The stable outlook on both cities reflects Istanbul and Izmir's track record of persistently strong operating performance, high tax generation capacity and flexibility to withstand adverse development. Moody's expects operating results to remain extremely strong with gross operating balances (GOBs) for Istanbul and Izmir at around 40% of forecasted operating revenue in 2022 (similar levels in 2021). Strong increases in tax revenues reflect both high nominal GDP growth and high inflation, while the growth of inflation-adjusted operating expenditures (excluding interest costs) will remain under control.
Although the strong operating balances are a good funding source for Istanbul and Izmir's traditionally very high capital expenditures, fast population growth and rapid urbanization are driving up their investment needs even further. As such, we expect financing deficits to persist in 2022 and 2023, albeit at lower levels given the more prudent approach adopted by both cities in reducing capital expenditure in response to the more challenging operating environment.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Istanbul and Izmir's ESG Credit Impact Scores are moderately negative (CIS-3), reflecting their high exposure to a number of environmental risks, moderate exposure to social risks and moderate governance profile.
Istanbul and Izmir have environmental issuer profile scores of E-4 (highly negative) driven by the high level of carbon intensity and greenhouse gas emissions within their economies. Moreover, rapid population growth, industrialisation and urbanization have prompted adaptation and mitigation measures that have led to a scaling up of the cities' capital expenditures, contributing to fiscal deficits and higher debt levels.
The moderately negative social issuer profile scores (S-3) for Istanbul and Izmir reflect moderately negative risks associated with the overall provision of services to the fast-growing population, which falls short of the standards in most OECD countries. In addition, both cities struggle with youth unemployment and their labour force has often not received the kind of education that employers need.
Istanbul and Izmir's moderately negative governance issuer profile scores (G-3) are based on the municipalities' ability to manage complex projects and provide basic services amid continued growth of already large populations of more than 15 million and 4.5 million, respectively. While our assessment of the cities' debt management incorporates their large exposure to foreign currency risk, Istanbul and Izmir have accumulated significant buffers to potential shocks to debt servicing. Although hedging instruments are not allowed under Turkish law, Izmir has created Foreign Debt Payment Risk Account to ensure sufficient funds to cover foreign debt service repayments on euro-denominated loans with European Investment Bank (Aaa stable) and European Bank for Reconstruction and Development (Aaa stable), mitigating the risk of lira depreciation. Istanbul also operates a Reserve Fund to ensure debt service repayment in the face of liquidity pressures stemming from the currency depreciation.
The sovereign action on Turkiye published on Friday 12 August 2022 required the publication of these credit rating actions on a date that deviates from the previously scheduled release date in the sovereign release calendar, published on www.moodys.com.
The specific economic indicators, as required by EU regulation, are not available for these entities. The following national economic indicators are relevant to the sovereign rating, which was used as an input to this credit rating action.
Sovereign Issuer: Turkiye, Government of
GDP per capita (PPP basis, US$): 34,755 (2021) (also known as Per Capita Income)
Real GDP growth (% change): 11% (2021) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 36.1% (2021)
Gen. Gov. Financial Balance/GDP: -3.4% (2021) (also known as Fiscal Balance)
Current Account Balance/GDP: -1.7% (2021) (also known as External Balance)
External debt/GDP: 54.4% (2021)
Economic resiliency: ba1
Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.
SUMMARY OF MINUTES FROM RATING COMMITTEE
On 11 August 2022, a rating committee was called to discuss the rating of the Istanbul, Metropolitan Municipality of; Izmir, Metropolitan Municipality of. The main points raised during the discussion were: The systemic risk in which the issuer operates has materially increased.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Although unlikely given the recent downgrade, an upgrade of Istanbul and Izmir's ratings will require a similar change of the sovereign rating.
A downgrade of Turkiye's sovereign rating would lead to a downgrade of Istanbul and Izmir's ratings given the close institutional, financial and operational linkages with the central government.
Downward ratings pressure may also arise from a sustained growth in debt and debt servicing costs, triggered by further currency depreciation and the knock-on effect from outstanding foreign-currency debt. Any concern in access to funding sources would also trigger a negative rating action.
The principal methodology used in these ratings was Regional and Local Governments published in January 2018 and available at https://ratings.moodys.com/api/rmc-documents/66129. Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.
Moody's National Scale Credit Ratings (NSRs) are intended as relative measures of creditworthiness among debt issues and issuers within a country, enabling market participants to better differentiate relative risks. NSRs differ from Moody's global scale credit ratings in that they are not globally comparable with the full universe of Moody's rated entities, but only with NSRs for other rated debt issues and issuers within the same country. NSRs are designated by a ".nn" country modifier signifying the relevant country, as in ".za" for South Africa. For further information on Moody's approach to national scale credit ratings, please refer to Moody's Credit rating Methodology published in May 2016 entitled "Mapping National Scale Ratings from Global Scale Ratings". While NSRs have no inherent absolute meaning in terms of default risk or expected loss, a historical probability of default consistent with a given NSR can be inferred from the GSR to which it maps back at that particular point in time. For information on the historical default rates associated with different global scale rating categories over different investment horizons, please see https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1280297.
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions.
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Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://ratings.moodys.com/documents/PBC_1288235.
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