OREANDA-NEWS. Fitch Ratings has revised the Autonomous Community of the Canary Islands' Outlook to Positive from Stable while affirming the region's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB-'. The Short-term foreign currency IDR has been affirmed at 'F3'. The 'BBB-' ratings on Canary Islands' outstanding senior unsecured bond issues have also been affirmed.

KEY RATING DRIVERS
The change in the Outlook of Canary Islands' IDRs reflects the following key rating drivers and their relative weights:

HIGH
Canary Islands' budgetary performance improved over 2012-15, driven by higher tax revenues. The region's outermost status within the EU allows Canary Islands to collect some of its indirect taxes, notably the General Indirect Canarian Tax (IGIC), in contrast to the rest of autonomous communities of the common regime. Sound economic performance in 2014-2015, particularly consumption, contributed to a 15% growth in operating revenue over 2012-15. We expect the growth in operating revenue to continue in 2016-2017, driven by economic momentum, and forecast a small positive current margin from 2016 onwards, at below 1%.

Canary Islands have met its progressively tight financial goals since the Budgetary Stability Law came into force in 2012. The region posted an overall fiscal deficit of 0.54% in 2015, the lowest among Spanish regions, and is on track to meet the target of 0.3% for 2016. This improvement has allowed the Canary Islands to report small positive operating margins of below 0.5% in 2014 and in 2015, a substantial improvement from the negative operating margin of 10.2% in 2012.

Moreover, as Canary Islands receive less funding than other autonomous communities under the common regime, Fitch believes an eventual review of the regional funding system should benefit the region more than the rest.

MEDIUM
Direct debt was EUR6.6bn at end-2015, a rise of over EU0.6bn since 2014. More than half of their direct debt is contracted through the state mechanisms, notably the Financial Facility Fund (FFF) and the Regional Liquidity Fund (FLA). The Canary Islands contracted EUR1,107m of debt in 2015, comprising EUR970m from the FFF at zero interest, and the rest in bank debt hence reducing their overall interest burden.

The region is entitled to receive close to EUR1bn from the FFF in 2016, sufficient to cover its funding needs. Debt is proactively managed to reduce the interest burden, and the region has recourse to alternative funding sources. Total debt-to-current revenue was 114.5% in 2015. Fitch expects the figure to stabilise at around this level on the back of expected operating revenue growth over 2016-2017, even if direct debt grows nominally to EUR7bn.

With a population of 2.1 million, the Canary Islands have a weaker economic profile than Spain with a GDP per capita equivalent to 85% of the national figure, which is average by international standards. Its economy is concentrated in the services sector, mainly tourism, accounting for a third of regional GDP at EUR42.3bn. Tourism fuelled economic growth in 2008-2015, making Canary Islands the third best performer in nominal GDP growth over 2008-2015. It posted a nominal GDP growth of 3.8% in 2015, in line with Spain, and is expected by Fitch to grow at least at 2.5% over 2016-2017.

The regional management has shown an ability to control operating expenditure proportionate to revenue collection, avoiding budget slippages and paying its commercial liabilities on time. Revenue forecasts are conservative.

RATING SENSITIVITIES
A consistent improvement of the operating balance associated with a direct debt-to-current revenue ratio of below 130% may lead to an upgrade.basis.