OREANDA-NEWS. Fitch Ratings has affirmed the Italian Region of Sicily's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB' with Stable Outlooks, and its Short-term foreign currency IDR at 'F3'. The affirmation affects the region's senior unsecured debt, including a bullet bond issue of EUR568m maturing in December 2015 (XS0121633126).

The rating affirmation reflects Fitch's expectation that Sicily will progress towards a stronger operating balance in 2015-2017 with debt burden remaining at around 50% of revenues.

KEY RATING DRIVERS

Fiscal Performance: Sicily posted a balanced operating budget in 2014 according to preliminary figures, in line with Fitch's expectations. The region continues to curtail its cost base of nearly EUR14bn, by lowering spending for personnel and transfers to local authorities amid dwindling tax revenue. Negotiations with the state for returning to the region's budget tax revenue pertaining to Sicily but collected elsewhere in Italy could lift the operating margin to around EUR400m, or 3%-5% of revenue in 2015-2017, from nearly zero in 2014.

Debt: with nearly EUR6.8bn of loans and bonds outstanding and despite EUR1bn net borrowing in 2015 Sicily has moderate levels of indebtedness. Fitch expects debt to remain around EUR7.5bn, or 50% of current revenue over the medium term, comparing favourably with 'BBB' category peers. Debt servicing is set to remain at around EUR0.5bn, or 4% of operating revenue as most of the new loans are taken out at subsidised rates from the national government.

Institutional Framework: Fitch assesses Italian inter-governmental relations as neutral for Sicily's ratings. The region remains subject to Italy's efforts to balance the national accounts, for example, with the proceeds from VAT increases in 2012 being reclaimed by the national government for its budget. On the other hand, spending limitations agreed with the national government underpin regional efforts to cut spending while state loans will represent three-quarters of Sicily's debt stock over the next two years, highlighting the financial support from the national government.

Economy: Sicily's economy remains weak, with an unemployment rate of around 20%, an employment rate of 39% and GDP contracting by 1% in 2014 (Italy: -0.4%), according to Fitch's estimates. Under the stimulus of EUR5bn of capital spending planned between 2015 and 2016 as well as private investments in chemicals (Eni, Lukoil), manufacturing (hybrid cars), and growing tourism, the local economy has the potential to return to growth in 2015, albeit by just 0.5% in Fitch's estimates. Economic recovery would be conducive to a modest pick-up in tax revenues, which we project to rebound to EUR11bn by 2016-2017 from EUR10.5bn in 2014.

Management: Due to rigid revenue the restatement of the free fund balance to overcome the near EUR1bn deficit posted in 2012 (about EUR0.5bn in 2014) is being postponed to 2016-2017. Management is committed to reducing past spending commitments while preparing to phase in a new accounting system, which may eventually help cut its long-standing EUR8bn of difficult-to-collect receivables. Sicily's operating payables continue to decline from the peak of EUR5.2bn in 2012 and Fitch expects them to halve by 2015. As commercial suppliers are paid within the law-mandated 60 days from invoice Sicily's reliance on preferential payment for timely debt servicing could gradually diminish.

RATING SENSITIVITIES

Positive rating action is unlikely in the near term unless Sicily strengthens the operating margin towards 10%, and achieves both a balanced overall budget and current surplus to match principal repayment over the medium term, making it more compatible with 'BBB+' ratings.

Failure to bolster the operating balance towards 3%-5% to largely cover debt-servicing requirements, and/or unexpected growth of debt towards 75% of revenue, compounded by prolonged economic sluggishness, could lead to negative rating action.