OREANDA-NEWS. March 16, 2015. Fitch Ratings has revised the Department of Puy-de-Dome's Outlook to Negative from Stable and affirmed the department's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'AA' and 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+'.

KEY RATING DRIVERS
The Outlook revision reflects Fitch's expectation that the department's budgetary performance and debt metrics will weaken in the medium term. This is due to continuous cuts in state transfers, which combined with steadily growing social spending, is likely to contribute to a deterioration in the department's financial profile, despite control over spending, strong governance and robust socio-economic profile.

The Outlook revision reflects the following rating drivers and their relative weights:

HIGH
Fitch expects the operating margin to weaken over the medium term to 7.3% by 2017, from an average of 13.3% in 2010-2014. This is due to the impact of state transfers cuts, which will lead to sluggish revenue growth. Social spending will continue to grow dynamically.

Puy-de-Dome's budget has limited flexibility as 75% of operating revenue is based on non-modifiable taxes and state transfers, and operating expenditure is driven by rigid items such as staff costs, mandatory transfers and social spending. However, there is some budgetary flexibility stemming from Puy-de-Dome's direct tax leeway, although the administration is not contemplating this option, and from its commitment to scale back non-mandatory spending and cut costs. The department's cost-cutting plan is underpinned by strong governance based on a skilled administration, a stable local political context, and a track record of prudent financial management.

In the medium term, Puy-de-Dome aims at scaling down its capital expenditure to below EUR100m, from an average EUR128m in 2010-2014. According to Fitch's base case scenario, this would not be sufficient to fully offset the expected decline in current margin yet. Therefore the capital expenditure self-financing rate (current balance, capital revenue and debt repayment on capital expenditure) is likely to weaken to 22% in 2017 from 56% in 2010-2014.

Direct debt reached EUR345.2m or 55.6% of current revenue at end-2014, a moderate level compared with peers. The debt payback ratio remains comfortable at five 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.

MEDIUM
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.

The institutional framework for French departments remains robust. However, departments' scope of responsibilities may change in the medium term, pending the French government's plans for a territorial reform involving a change in local authorities' responsibilities through a law currently still under discussion.

Puy-de-Dome's ratings also reflect the following rating drivers:

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