OREANDA-NEWS. Fitch Ratings has affirmed the Region of Provence-Alpes-Cote-d'Azur's (PACA) Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'AA-'. The Outlooks are Stable. The Short-Term Foreign Currency IDR has been affirmed at 'F1+'. A full list of rating actions is at the end of this commentary.

The affirmation reflects our view that PACA will maintain a sound operating performance and limit any debt increase in the medium term. The ratings also reflect PACA's strong economic profile and sound financial management, as well as its high debt.

KEY RATING DRIVERS

According to Fitch's base case scenario, PACA will continue to post a sound operating margin of 18.7% in 2016-2019, stable from 2015 (18.3%; 2012-2014: 23%). This expectation takes into account slightly falling revenue (-0.5%), due to cuts in state grants until 2017, barely compensated by a growing tax base. However, we expect the sluggish revenue to be compensated by operating spending restraint, through a trade-off between different budget spending items and stricter labour force management.

PACA's government intends to implement further budget control measures in the coming years. The region's ability to contain operating expenditure is supported by flexibility on discretionary spending, which Fitch estimates at 20%-25% of total operating spending. This could at least partially offset the increase in non-flexible expenditure (train services, training). The outcome of the renegotiation of the multi-year convention with the regional train operator could have a significant impact on spending.

We expect PACA's capital expenditure to slow down progressively until 2019, to around EUR460m on average, from EUR570m in 2012-2015. The scaling down will be helped by the completion of large projects in the transport sector, notably the renewing of the trains for regional railway services. However, this will not be enough to match the region's declining self-financing capacity, which we forecast will average 45% (after debt repayment) over the medium term, down from 62% in 2012-2015.

The lower self-financing capacity should keep PACA's direct risk (including finance leases) on an upward trend until 2019, albeit to a lesser extent than we previously anticipated, in light of recent budgetary measures. According to our scenario, direct risk will average 185% of current revenue until 2019, from 160% in 2015. We expect the direct risk payback ratio to deteriorate slightly, to around 13 years in 2016-2019, from 10.9 years in 2015. Following the expected weakening budgetary performance, we expect debt service coverage by operating balance to deteriorate to an average of 78% in 2016-2019, from 54% in 2012-2015, but remain consistent with the ratings. The debt structure is low risk, with bullet repayments covered by budget funds set aside.

PACA ranks seventh and fifth among French regions (after 2016 mergers, as an effect of the Law of 16/01/15 on French regions' boundaries) in population and GDP, respectively. Its economy is well-diversified and mainly relies on the services sector, tourism and high value-added industries. We expect the regional economy to progressively recover over the medium term. However, unemployment is high (11.4% in 1Q16 versus France's average of 9.9%) and the department's social indicators are slightly weaker than the national average.

The region's liquidity is underpinned by predictable cash flows and regular use of the EUR250m commercial paper (titres negociables a court terme; TNCT) programme. Additionally, the TNCT programme is backed up by committed revolving credit lines totalling EUR255m, which provides a sound financial safeguard.

RATING SENSITIVITIES

A weakening of the budgetary performance leading to debt servicing (annual principal repayment plus interest) exceeding operating balance (2015: 62%) and a direct risk payback ratio above 15 years could lead to a downgrade.

An upgrade is unlikely according to our scenario. However, a stronger budgetary performance with an operating margin consistently above 20%, and lower debt metrics with the direct risk payback ratio below eight years for more than two consecutive years, could lead to an upgrade.

The rating actions are as follows:

- Long-Term Foreign and Local Currency IDRs: affirmed at 'AA-'; Outlook Stable

- Short-Term Foreign Currency IDR: affirmed at 'F1+'

- EUR1bn EMTN programme: affirmed at 'AA-'/'F1+'

- EUR250m TNCT programme: affirmed at 'F1+'