OREANDA-NEWS. Fitch Ratings says in a new report that a sovereign ratings cap or floor can result in the Issuer Default Rating (IDR) of a local and regional government (LRG) being different to its intrinsic credit profile.

In some countries, LRGs' ratings are capped by the sovereign rating or lifted by a ratings floor. For example, in Italy, given the present sovereign IDR (BBB+/Stable), over 65% of LRGs are capped by the sovereign. Conversely, the rating floor in Germany means that some German Laender have a higher IDR than their intrinsic credit profile would suggest. In Spain, there are both caps and floors: caps where the regions have a higher intrinsiccredit profile than their IDR as it is capped by the sovereign rating, and a rating floor which lifts the IDRs of some autonomous communities above their intrinsic credit profile.

Fitch's International Local and Regional Government Rating Criteria sets out the five factors for the rating of an LRG. This includes an assessment of the institutional framework, which can have a significant impact on the rating. Fitch also assesses the LRG's intrinsic credit profile. This is an indication of the entity's credit fundamentals before a rating cap or rating floor is introduced. It is internationally comparable but normally with entities within the same institutional framework.

The rationale for a rating cap is that sovereign governments can strongly influence the revenue or tax base, expenditure pressure and debt availability of LRGs. Given these limits, LRGs cannot usually be rated higher than the sovereign IDR, although their intrinsic credit profile may indicate a higher rating. Unless accompanied by a severed economic deterioration, when the sovereign rating is facing downward pressure, an increasing number of LRGs would usually have ratings at the same level as the sovereign.

Fitch may also introduce a rating floor in exceptional circumstances. For example, if there is strong vertical/fiscal equalisation system in place, strong liquidity back-up and access to guaranteed last resort finance from the central government or government established financial entity. A rating floor is constantly reviewed and Fitch may decide to remove it if the factors that led to its introduction are weakened or no longer in existence. Under a rating floor, an LRG's IDR may be higher than its intrinsic credit profile.