OREANDA-NEWS. Fitch Ratings has revised the Italian City of Naples' Outlook to Negative from Stable and affirmed its Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) at 'BBB-' and Short-Term Foreign Currency IDR at 'F3'. The issue ratings on Naples' senior unsecured bond have also been affirmed at 'BBB-'.

The revision of the Outlook reflects the city's failure to improve tax and fees collection rates, leading to a diverging trend between operating performance on an accrual basis and cash flows. Fitch assumes that the existing preferential payment mechanism will continue to ensure timely debt servicing repayment, although stressing commercial liabilities.

KEY RATING DRIVERS

The rating action reflects the following rating drivers and their relative weights:

HIGH

Weak Collection Rate

Naples' average tax and fees collection rates remain weak, at around 80% in 2015, in line with the past trend, despite management's efforts to limit the accumulation of difficult to collect receivables, provisioned at EUR1.5bn and included in the fund balance deficit. Fitch believes that collection rates will remain challenging in the medium term as they are also burdened by a still slow economy recovery. Subsidised loans in 2013-2014 have partially eased structural liquidly tensions, as have measures fighting tax evasion (leading to EUR40m recovered in 2015). However, matching future revenue-spending remains an issue, potentially leading to pressure on the cash basis budget in light of an accounting revision introduced from 2015. The subsequent one-off revision of payables and receivables and the required provision for difficult to collect revenue led to a EUR690m fund balance deficit.

MEDIUM

Weak Economic Fundamentals

Naples is the most dynamic and industrialised among southern Italian cities, but its socio-economic profile remains weak in 2015 compared with national levels, with the unemployment rate around 20% (12.9% nationally) and the employment rate at 38% (56.3% nationally). After almost stagnant GDP growth in 2015, Fitch expects a slight improvement in 2016, mainly driven by tourism, exports and partly from manufacturing, while projects to revitalise the city's port would be a key support for local long-term economic activity. A large shadow economy helps moderate the impact of the economic weakness.

Moderate Market Debt

Naples' direct risk was EUR2.6bn at end-2015, or about 220% of the budget when EUR1.1bn subsidised loans from Cassa Depositi e Prestiti (CDP, BBB+/Stable) to pay down city's commercial liabilities are included. Without the latter, loans (mainly with CDP) and bonds would represent 120% of revenues (bond accounts for a mere 25%).

More than 95% of loans carry fixed interest rates, reflecting a prudent debt management approach, while debt service requirements, absorbing 10% of current revenue, are expected to be almost fully covered by the operating margin over the medium term.

Stable Fiscal Performance on Accrual Basis

According to 2015 figures, Naples' operating margin as adjusted by Fitch for difficult to collect revenue, is about 9% (10% in 2014), in line with our projections of medium-term budgetary stability. Fitch believes that declining transfers and slow tax revenue trends will continue to be partly offset by strict current spending control as envisaged by the recovery plan Naples has been complying with from 2014.

The ratings also reflect the following rating drivers:

Supporting Institutional Framework

Fitch considers inter-governmental relations as neutral. While Naples is a contributor to Italy's consolidation efforts to balance the national accounts, the city benefits from different kind of support, such as equalisation transfers (EUR320m in 2015, or about 25% of operating revenue) from the central government to offset its weaker than national average fiscal capacity. It also benefits from a recovery plan, to be further revised by 2016 to include 2015 changes in accounting rules, under the monitoring of the national audit body, Corte dei Conti, aiming to replenish the statutory fund balance deficit in 30 years (as allowed by law).

RATING SENSITIVITIES

The ratings could be downgraded if debt and equivalents rise above 2.5x of operating revenue. A downgrade could also stem from a failure to improve tax and fees collection rates, eventually leading to a negative operating margin on cash basis. Adverse changes to the preferential payment mechanism protecting financial lenders could lead to a downgrade, possibly by multiple notches.