OREANDA-NEWS. September 07, 2015. Fitch Ratings has affirmed Department of Puy-de-Dome's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AA' with Negative Outlook, and the Short-term foreign currency IDR at 'F1+'.

The department's EUR500m euro medium-term programme and its EUR100m commercial paper programme have been affirmed at 'AA' and 'F1+'.

The affirmation reflects mostly unchanged assumptions in Fitch's central scenario over the last six months. The Negative Outlook reflects our expectation that the department's budgetary performance and debt metrics will weaken over the medium term, as a result of continuous cuts in state transfers and growing social spending.

KEY RATING DRIVERS
The ratings reflect the department's track record of sound operating performance, moderate debt, strong governance and balanced socio-economic profile.

According to our baseline scenario, we expect the operating margin to weaken over the medium term, to 7.7% by 2018, from a sound average of 13.3% in 2010-2014. This is due to the impact of state transfers cuts, which will lead to flat revenue. We expect social spending will continue to grow dynamically. Puy-de-Dome's revenue mix offers limited flexibility as 75% of operating revenue is based on non-modifiable taxes and state transfers. However, some budgetary flexibility stems from Puy-de-Dome's direct tax leeway, although the administration is not contemplating this option. Some tax items, especially property transfer duties (9% of operating revenue), tend to evolve erratically and are less than predictable.

Operating expenditure is driven by rigid items such as staff costs, mandatory transfers and social spending. However, Puy-de-Dome is committed to scaling back non-mandatory spending and cutting costs. The department's cost-cutting plan is underpinned by strong governance based on a skilled administration, a stable local political environment, and a track record of prudent financial management. Our central scenario factors in a moderation in operating spending, to 1.3% yoy on average until 2018, from 2.5% in 2010-2014.

The administration's aim is to keep the department's operating margin close to 10% and the debt payback ratio below nine years over the medium term. Since our last rating action six months ago, Puy-de-Dome's administration has defined an additional package of savings and control measures for 2016 and 2017 (cap on discretionary social spending items, control over staff costs and general spending, freeze on grants, and further cuts in discretionary expenditure). According to administration's forecasts, this would lead to a stabilisation in operating spending until 2017, which would be sufficient to keep the operating margin at about 10%. However, these measures are still to be adopted (mostly for the 2016 budget) and are not fully factored in our projections at this stage.

Over the medium term, Puy-de-Dome aims at scaling down its capital expenditure to slightly below EUR100m, from an average EUR128m in 2010-2014. According to Fitch's base case scenario, this would not be sufficient to fully offset an expected decline in its current balance. Therefore the department's self-financing rate of capital expenditure (current balance and capital revenue, net of debt repayment, on capital expenditure) is likely to weaken to 34% in 2015-2018 from 58% in 2010-2014.

Direct debt reached EUR372.2m or 60% of current revenue at end-2014 (including short term debt at end-2014), a moderate level compared with peers. The debt payback ratio remains comfortable at 5.4 years. However, with an expected lower current balance, the ratio may exceed 10 years from 2017. The debt structure is sound and does not include high-risk products.

Liquidity is underpinned by strong predictable cash flows and by easy access to short-term funding. The latter is based on regular issuance of Billets de Tresorerie (BT) under a EUR100m programme, backed by adequate revolving and committed bank credit lines. Liquidity forecasts are detailed and updated regularly.

Despite a high level of contingent liabilities, Fitch considers contingent risk as low due to borrowers' solid credit profiles (mostly social housing institutions) and their sound debt structure. A sophisticated monitoring framework and strict eligibility guidelines implemented by the administration should limit the growth of guaranteed debt over the medium term.

RATING SENSITIVITIES
A deterioration of operating performance leading to an operating margin consistently below 10% or a debt payback ratio consistently of 10 years or above could result in negative rating action.