OREANDA-NEWS. Fitch Ratings has assigned the following ratings to the Province of Chubut, Argentina (Chubut):

--Long-Term Foreign Currency Issuer Default Rating (IDR) of 'B';

--Long-Term Local Currency IDR of 'B'.

The Rating Outlook is Stable.

KEY RATING DRIVERS

Chubut's rating mainly takes into consideration its strong sustainability and leverage ratios, positive and adequate operating margins in the period 2011-2015 that have allowed high levels of capex. In addition, it factors in its higher fiscal autonomy in comparison to other provinces in Argentina due partly to its collection of hydrocarbon royalties.

In contrast, the rating is limited by the constrained fiscal and budgetary flexibility of the province as well as its weak liquidity position. Moreover, a highly concentrated economy depending on oil sector is another limitation.

Considering the features of Argentina's institutional framework, Fitch does not believe any subnational entity to be rated higher than the sovereign, as regional governments' access to foreign currency is not deemed stronger than the central government's. Therefore, Chubut is capped by the sovereign rating.

Chubut recorded stable and solid operating margins in the period 2011-2014, but in 2015 this ratio decreased to 3.9%. This deterioration is due to a deceleration of hydrocarbon royalties affected by international oil prices in tandem with a substantial growth in personnel costs (37.6%) given its importance in the expenses' structure. High inflation and currency devaluation have also negatively impacted fiscal performance and in year-end 2015 led to a nominal increase in direct long-term debt.

Chubut's fiscal autonomy has been above average among Argentina's provinces. Historically, its proportion of own revenues to total operating revenue has been significant (58% in 2015). This fact is a positive rating factor. This is explained by a higher share of provincial tax on gross income and receipts from hydrocarbon royalties that are imposed on oil and gas production. However, the province is also limited due to its great economic concentration and because the oil and gas sectors are highly regulated by the national government in Argentina.

During 1Q 2016, total revenues increased 26.4% to ARS5.3 billion. This increase was principally attributable to a rise of 28.2% in receipts from hydrocarbon royalties, as well as a 33.4% increase in federal tax transfers on a year-over-year (y-o-y) basis.

On the other hand, the province's total expenditures (excluding debt interest expense) grew 20.6% y-o-y and reached ARS4.9 billion. This increase is principally attributable to 32.8% rise in personnel expenditures as a result of salary adjustments.

Capex-to-total expenditure has also been relatively significant, averaging 22% in the period 2011-2015 financed with operating balances and debt. At year-end 2015 floating debt reached 33 days of primary expenditure and 11.1% of operating revenue. However, cash deposits are lower than payables and represented 4.4% of total revenues in the same year.

The province can cover temporary deficits of the provincial treasury through the use of the fund balances of all jurisdictions and entities of the province's non-financial public sector without financial cost (Unified Fund of Official Accounts or FUCO, ARS829 million in 2015). As another liquidity buffer, Chubut is authorized to issue short-term treasury notes for up to ARS2,385.9 million or its equivalent in other currencies.

In 2015 Chubut's direct debt totalled ARS7.5 billion, representing 43% of current revenues and 13.7x operating balance. Even though 63% of Chubut's direct debt is denominated in foreign currency the exchange risk is mitigated because the province has part of its own revenues (royalties) linked to the USD.

Direct long-term debt increased by 147.7% in 2015 respect to previous year, mainly explained by the devaluation of the argentine peso and new issuances of debt (USD88.9 million of BODIC II and ARS1,882.2 million under Treasury Bills Program). Debt service absorbed 1.6% of current revenues and represented 43.9% of operating balance.

In early 2016, Chubut issued a bond for USD50 million and considers issuing a new bond by USD650 million. The issuance would alleviate liquidity pressure but increase currency risk exposure. Of the proceeds, 50% of the bond will be to partialy refinance current debt stock. Fitch estimates that debt sustainability ratios will remain pressured debt if operating margins continue to decrease as in 2015.

Chubut did not transfer the pension and retirement fund to the national government, which is obliged to cover the underfunding of those pension funds that were not transferred to its coverage. The retirement and pension system acts only as a pay-as-you-go system, i. e. the province pays if there is a difference between the required payments and the contributions transferred by the employers for future retirement and pension obligations of the beneficiaries. Currently, the province has not transferred extraordinary funds to the Social Security and Insurance Institute.

Chubut is located in the southern region of Argentina. The Province is in a strategic geographic position, with natural and touristic attractions, including excellent access to the Atlantic Ocean. The contribution of the Province's economic activity to national Gross Domestic Product (GDP) was 1.1% in 2014. According to the 2010 census, Chubut's population was 0.5 million and represented 1.3% of the country's population.

Chubut was the largest oil-producing province between 2008 and 2015, and as of Dec. 31, 2015, ranked as the third highest gas producing province in the country accounting for approximately 30% and 8.3% of Argentine oil and gas production during 2015, respectively. Given the importance of the oil and gas sector in Chubut, national policy changes for the sector nationwide could improve economic performance and have a positive impact in its public finances gradually.

RATING SENSITIVITIES

Chubut's IDR should move in tandem with Argentina's sovereign ratings. An upgrade of the sovereign IDR, accompanied by a recovery in fiscal and budgetary flexibility observed in operating margins of around 10 to 12 percent, as well as an improvement of liquidity could lead to an upgrade in Chubut's rating. A downgrade of Argentina's IDR, coupled with a sudden increase in the public debt burden and weak operating margins that significantly affect debt sustainability ratios, could lead to a negative rating action.