OREANDA-NEWS. Fitch Ratings has affirmed the Autonomous Community of Valencia's (Valencia) Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB-' with Stable Outlooks. Fitch has also affirmed the Short-term foreign currency IDR at 'F3'. The ratings on the senior unsecured outstanding bond issues have been affirmed at 'BBB-'.

The affirmation reflects Fitch's unchanged rating floor of 'BBB-' being applied to Spanish autonomous communities. Fitch will closely monitor the debate regarding liquidity state support to Spanish regions.

KEY RATING DRIVERS
Valencia's IDRs are based on Fitch's expectation of state support captured by the 'BBB-' rating floor for Spanish autonomous communities. The rating floor was introduced in 2013 and is based on a number of supporting factors that contribute to improving a region's liquidity and reducing the likelihood of default. These include the budgetary stability law and the recent law on controlling commercial debt; the absolute priority of debt servicing by law as per article 135 of the Spanish Constitution; and access to state support mechanisms such as the Regional Liquidity Fund (FLA) and the Financial Facility Fund (FFF).

Central Government Support
In Fitch's view, access to the FLA will continue to ensure timely debt servicing for Valencia. The regional government had a total of EUR29bn outstanding direct debt through state support mechanisms (76.9% of direct debt) at end-2015, illustrating strong support from the central government. The central government ratified its financial support on 23 December 2014, introducing further measures to ease the debt burden of autonomous communities, including zero interest loans in 2015. As a result, interest costs for Valencia declined in 2015 to EUR657.8m from EUR1.2bn in 2014.

In 2015, Valencia contracted EUR2.1bn short-term debt and an additional EUR1.9bn in early 2016 for another 12 months, while a further EUR193m are pending negotiations. Liquidity assistance from the central government includes advances from the 2014 funding system settlement to alleviate peak liquidity demands. For 2016 Valencia has received EUR411m, with a remaining EUR834m pending in July.

Valencia's long-term debt redemptions are estimated at EUR3.7bn in 2016 and the region has requested at least EUR4.6bn from the FLA, including EUR444m for debt redemptions in its public sector. Under Fitch's base case scenario, direct debt is expected to increase to over EUR41bn-EUR42bn by 2016 or 356%-360% of expected current revenue (EUR37.7bn or 358.6% in 2015).

Without central government support, the pressure on debt servicing would have been high. As of end-2015, debt maturities for the next three years totalled EUR13.5bn, representing 36% of outstanding direct debt. However, this is mitigated by a large part of the direct debt being contracted through the state support mechanism.

Weak Standalone Credit Profile
Valencia's structurally negative current balances since 2009, recurring overall budget deficits before debt repayment, high net overall risk and a weaker economic profile than Spain, mean that the regional government's intrinsic credit profile (ICP) is weaker than the IDRs indicate.

Under Fitch's base case scenario the regional government's weak budgetary performance will be difficult to reverse in the near- to medium-term, unless there is a significant change in the current funding system. Valencia received 15% less funding per capita in 2013 than the average of the other 14 Spanish regions under the common regime and is reliant on a reform of the funding system to address this gap. Valencia's negative current margin of 27.7% in 2015 was worse than the negative 25.6% reported in 2014, due to a 3.3% yoy growth in current spending as a result of EUR465m capital transfers being reclassified as current transfers.

New Government
A coalition government in Valencia was elected in May 2015 between the socialist party and the left party Compromis with the support of Podemos. This has resulted in a fragmented political composition, with a new political agreement, which prioritises social care and public health.

Regional Economic Recovery
Valencia has a weaker-than-average economic profile, with a GDP per capita 11.6% in 2015 below Spain's average. Valencia's economy grew 4.3% in 2015 to an estimated nominal GDP of EUR101.6bn versus 3.8% in Spain. The elderly represents a high share in Valencia's population of 5 million, which may put some pressure on health and social services. After a strong 15% growth between 2003 and 2012, the number of residents started to decline in 2013 by a cumulative 3% until 2015. The labour market also improved as job creations increased 7.3% over two years to December 2015, after some 14.2% jobs were lost in the preceding five years.

RATING SENSITIVITIES
A removal of the 'BBB-' rating floor, given Valencia's high level of debt, would result in a downgrade of at least two notches, unless the regional government is able to report a structurally positive operating balance.

KEY ASSUMPTIONS
Fitch assumes that the state will continue providing support to the Spanish autonomous communities over the medium term. Moreover, Fitch will review the rating floor if state support measures are cancelled or if there is deterioration in the central government's ability and willingness to continue providing extraordinary support to the regions.