OREANDA-NEWS. April 29, 2015. Fitch Ratings has affirmed the Region of Provence-Alpes-Cote-d'Azur's (PACA) Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AA-'. The Outlooks are Stable. The Short-term foreign currency IDR has been affirmed at 'F1+'. A full list of rating actions is available at the end of this commentary.

KEY RATING DRIVERS
The ratings reflect PACA's sound operating performance, strong economic profile and sound management, as well as its high and growing debt and the risk of a weaker budgetary performance in the medium term, due to cuts in state transfers. The Stable Outlook reflects Fitch's view that the region has the ability and willingness to maintain a sound operating performance and to limit debt growth.

According to Fitch's base case scenario, the operating margin will decline to 15.9% in 2018, from a sound 19.6% in 2014. This will be due to declining revenue (-1% a year until 2018) as a result of the cut in state transfers (-6.9% a year). This is despite our expectation of steady growth of tax proceeds (up 3.3%), such as from the levy on corporate value added, and from the introduction of new regional taxes (additional share of fuel tax being granted to regions from 2015). We expect the current margin to weaken to 11.2% in 2018, from 16.1% in 2014, as financial charges rise in accordance with growing debt.

Fitch believes declining revenue will lead to further spending re-prioritisation and cost-cutting measures. PACA's ability to control operating expenditure is supported by some flexibility on discretionary spending. This could at least partially offset the growth of spending in non-flexible items (train services, training).

Capital expenditure will remain significant in 2015, close to EUR560m, as the region finances several large infrastructure projects, mainly acquisition of trains for regional railway services and participation in large road works in Marseille. These major investments would be near completion after 2015; we therefore expect capital spending to slow down progressively to an average EUR400m in 2016-2018. However, this scaling-back may not be rapid enough to match the region's declining self-financing capacity, which we forecast would average 44% (after debt repayment) over the medium term, down from 62% in 2011-2014.

The lower self-financing capacity should keep PACA's direct risk (including finance leases) on an upward trend until 2018, to 185% of current revenue, from 147% in 2014. The direct risk payback ratio could weaken to 16.5 years in 2018, from 9.1 years in 2014. The debt structure is low-risk and bullet repayments are provisioned for.

PACA is the third-largest French region in terms of population and GDP. Its economy is well-diversified and mainly relies on the region's services sector, vibrant tourism and high value-added industries. The regional economy is expected to progressively recover in the medium term. However, unemployment is high (11.6% in 4Q14 versus mainland France's average of 10%) and the region's social indicators are slightly weaker than the national average.

The region's liquidity is underpinned by predictable cash flows and regular use of the EUR300m commercial paper (billets de tresorerie; BT) programme. The BT programme has a back-up facility of committed revolving credit lines capped at EUR257m, which provides a financial safeguard.

RATING SENSITIVITIES
A weakening of the budgetary performance leading to an operating margin towards 12% associated with a direct risk payback ratio rising above 15 years could lead to a downgrade.

A stronger budgetary performance with an operating margin consistently above 20%, and lower debt metrics with the direct risk payback ratio below eight years for more than two consecutive years, could lead to an upgrade.

The rating actions are as follows:
- Long-term foreign and local currency IDRs: affirmed at 'AA-'; Outlook Stable
- Short-term foreign currency IDR: affirmed at 'F1+'
- EUR1bn EMTN programme: affirmed at 'AA-'/'F1+'
- EUR300m BT programme: affirmed at 'F1+'