Fitch Downgrades City of Rio's National L-T Rating to 'AA(bra)'; Affirms IDR at 'BB'

SAO PAULO--()--Fitch Ratings has downgraded the Brazilian city of Rio de Janeiro's National long-term rating to 'AA(bra)' from 'AA+(bra)' with a Stable Outlook as a result of ratings recalibration following successive downgrades of the sovereign over the last 18 months.

In addition, Fitch has affirmed the Long-Term Issuer Default Rating (IDR) at 'BB'. The Rating Outlook remains Negative. The Outlook reflects the Negative Outlook assigned to Brazil. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The affirmation of the IDRs assigned to the City of Rio de Janeiro (CRio) reflect the generation of operating margins that reached 4.9% in 2015 in a declining trend. This is higher than 'BB' rated peers (3.9%). The declining trend observed since 2015 is attributable to the prolonged economic downturn. The ratings are strongly related to those assigned to the Federative Republic of Brazil. For this reason, CRio's ratings have a Negative Outlook.

Despite the fact that the Federal Government remains directly and indirectly the city's main creditor, debt service related to financial institutions has been increasing at a fast pace, consuming the equivalent of 74% of the city's operating balance in 2015. Unless operating balances increase, direct debt service will continue to consume a relevant portion of it, thus exerting pressure over investments and cash positions, in Fitch's opinion.

CRio has engaged in several credit operations to improve transportation and logistics in Rio. Whereas 'BB' rated entities' capex represented 10.1% of total expenditures, it reached 19.9% for CRio. As a result, debt service until 2018 should consume a large portion of the city's operating balance. This is counterbalanced by the fact that federal creditors are responsible for 96% of new credit operations until 2018.

The prolonged economic recession has not yet translated into a poor fiscal performance for CRio, partially explained by the fact that the city traditionally host large events, such as the Olympics. Nevertheless, there should be some increase in operating expenditures in 2017 given that in early 2016 the city assumed the operating expenditures of two hospitals owned by the State of Rio de Janeiro (IDR of C). Additional pressures in healthcare and law enforcement may negatively impact the city's operating margins. Federal and state transfers are important components of the city's operating revenues, corresponding to 24.7% of the total in 2015.

Despite consuming some 37.5% of total annual personnel expenditures in 2015, the pension system has some assets and its actuarial deficit of BRL3.2 billion corresponded to a low 14.5% of the city's operating revenues. This is much better when compared to large Brazilian states, partially explained by the fact that contrary to states, Brazilian cities do not have to support law enforcement.

Fitch considers CRio's liquidity as adequate, with no short-term concerns. Total debt service of BRL818 million in 2016 is fully covered by the city's outstanding cash position of BRL3.6 billion. This liquidity amount corresponds to 16.2% of the city's operating revenues in 2015. The short-term obligations are mainly composed of debt service and payments to suppliers (42%) and general labor liabilities (22%).

RATING SENSITIVITIES

Rating Actions Linked to the Sovereign: Any rating action affecting the Federative Republic of Brazil, currently rated 'BB'/Negative, will exert a direct influence on CRio's ratings.

Fiscal Performance and Debt: An operating margin lower than 2% coupled with a higher level of financial debt, and expressed by a direct debt/current balance higher than 20 years will exert negative pressure on CRio's ratings.

KEY ASSUMPTIONS

The ratings and Outlooks are sensitive to these assumptions:

--Fitch assumes a high level of sovereign support for the Rio de Janeiro given the national relevance of the city and the high exposure to Federal Government decisions;

--We also assume that the new government will resume the government's legislative agenda, especially those items affecting subnationals, such as pension reform and federal debt renegotiation.

Fitch has taken the following rating actions:

City of Rio de Janeiro

--Foreign Currency Long-Term IDR affirmed at 'BB'; Negative Outlook;

--Foreign Currency Short-Term IDR affirmed at 'B';

--Local Currency Long-Term IDR affirmed at 'BB'; Negative Outlook;

--Local Currency Short-Term IDR affirmed at 'B';

--National Long-term rating downgraded to 'AA(bra)' from 'AA+(bra)'; Stable Outlook;

--National Short-term rating affirmed at 'F1+(bra)'.

Additional information is available at www.fitchratings.com

Applicable Criteria

International Local and Regional Governments Rating Criteria - Outside the United States (pub. 18 Apr 2016)

https://www.fitchratings.com/site/re/878660

National Scale Ratings Criteria (pub. 30 Oct 2013)

https://www.fitchratings.com/site/re/720082

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1012634

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012634

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Paulo Fugulin
Director
+55 11 4504-2206
Fitch Rating Brasil Ltda.
Alameda Santos 700
Sao Paulo, Brazil
or
Secondary Analyst
Carlos Vicente Ramirez
Senior Director
+571 326-9999 ext 1240
or
Committee Chairperson
Humberto Panti Garza
Senior Director
+52 (81) 8399-9152
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Paulo Fugulin
Director
+55 11 4504-2206
Fitch Rating Brasil Ltda.
Alameda Santos 700
Sao Paulo, Brazil
or
Secondary Analyst
Carlos Vicente Ramirez
Senior Director
+571 326-9999 ext 1240
or
Committee Chairperson
Humberto Panti Garza
Senior Director
+52 (81) 8399-9152
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com