OREANDA-NEWS. Fitch Ratings has affirmed the French Department of La Manche's Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) at 'AA-' and Short-Term Foreign Currency IDR at 'F1+'. The Outlook is Stable.

The affirmation reflects La Manche's sound budgetary performance, despite a slight expected weakening in 2016, and moderate debt. The Stable Outlook reflects our expectations that the department will contain likely deterioration in its operating margin and limit debt growth in line with its peers, due to its tax leeway and scope for cost-cutting.

KEY RATING DRIVERS
According to Fitch's base-case scenario, the Department of Manche's operating margin is likely to decline to, but remain sound at, 10.5% in 2020, from an average 15.1% in 2011-2015. The expected deterioration is mainly due to sharp cuts in state transfers, while operating spending, particularly social spending, is likely to stabilise after rising 2.4% a year on average in 2011-2015, due to the implementation of cost-cutting measures.

Although La Manche is committed to leaving tax rates unchanged in the medium term, Fitch views the department's tax flexibility as a positive rating factor. Operating expenditure is driven by rigid items such as staff costs, mandatory transfers and state-defined social spending. Nonetheless, La Manche's social spending structure is more favourable than other departments', given the department's lower-than-national average unemployment rate.

In 2020, the department aims to keep the debt payback ratio below eight years and to achieve a minimum current balance of EUR45m. Although we estimate that the debt payback ratio could reach a maximum of 9.5 years on weaker operating performance, putting the ratings under pressure, we believe the department will achieve its medium-term financial objectives, underpinned by its track record of reliable financial forecasting.

Fitch expects capital expenditure to decrease to EUR68m a year on average in 2016-2020, from EUR78.3m in 2015, following adjustments to the department's investment programme. Nonetheless, Fitch estimates that the department's self-financing capacity of capital expenditure (after debt repayment) will slightly decline to about 90% in 2020 (from 108% in 2015), leading an increase of debt to about EUR361m.

Although guaranteed debt is high in absolute terms (EUR293.8m at end-2015), Fitch views risk related to the guaranteed debt as low, since the guarantees are mostly to low-risk regulated social housing entities.

On an international basis, Fitch views La Manche's economy as strong. In 4Q15, its unemployment rate (8.2%) was lower than the national average (10%). This results in lower social spending than other departments. This low level of unemployment is particularly important in our assessment of the department's economic profile as the department's expenditure is weighted towards social aids to the unemployed.

Fitch views the institutional framework as neutral to the ratings. The main responsibilities of the department include social transfers linked to unemployment, disability and old age dependence, for which policies and eligibility criteria are defined by the state. The French departments suffer from a negative structural gap between slow-growing revenue (mostly based on non-modifiable taxes and state transfers), and dynamic expenditure (mainly related to social transfers), which has led some departments to cut costs. Operating revenue is under increasing pressure from a sluggish tax base and from state transfer cuts as part of the national fiscal consolidation.

RATING SENSITIVITIES
A downgrade could result from La Manche's inability to control operating expenditure and to adjust capital expenditure to the department's self-financing capacity, resulting, for instance, in a debt payback ratio above 10 years (2015: 5.4 years).

Although Fitch views it unlikely at this stage, an improvement in the current margin for several consecutive years, combined with capital expenditure restraint, leading, for instance, to a debt payback ratio consistently lower than five years, could result in an upgrade.