OREANDA-NEWS. Fitch Ratings has affirmed the Autonomous Community of Canary Islands' Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB-' with Stable Outlooks. Fitch has affirmed the Short-term foreign currency IDR at 'F3'. The 'BBB-' ratings on Canaries' outstanding senior unsecured bond issues have also been affirmed.

KEY RATING DRIVERS

The ratings are supported by the 'BBB-' rating floor for Spanish autonomous communities. The rating floor is based on a number of supporting factors that contribute to a region's improving liquidity and reducing the likelihood of default. These include the budgetary stability law and the recent law controlling commercial debt; the absolute priority of debt servicing by law as per article 135 of the Spanish Constitution; and the access to state support mechanisms such as the Regional Liquidity Fund (FLA) and the Financial Facility Fund (FFF).

In Fitch's view, access to the state support mechanisms will continue to ensure timely debt servicing for Canary Islands. At end-2014, the region had received a total of EUR2.5bn from state support funds, an illustration of strong support from the central government. On 26 December 2014 the Ministry of Finance and Public Administration introduced the Royal Decree Law 17/2014 to enhance the financial state support to the Spanish regions in place since 2012, by introducing a new instrument - the FFF - for regions compliant with the stability goals, and another to fund the regional governments' provision of social services (see "Fitch: State Support for Spanish Regions Reinforced and Extended", dated 13 April 2015, on www.fitchratings.com).

The ratings reflect Canary Islands' recovering fiscal performance, although still insufficient to generate a positive current balance, its increasing debt along the last five years, and a weaker economic profile than Spain with a GDP per capita equivalent to 86% of the national average.

The ratings take into account the region's strong commitment to comply with fiscal targets and its reliable forecasts. Canary Islands posted a 0.91% deficit in 2014, the only region under the common regime to have met the 1% deficit goal for the year. In the 2015 budget the region expects to meet the 0.7% deficit goal, with an operating balance close to zero for the first time in six years. In Fitch's view, if the positive economic trend and cost restraint continue, Canary Islands may see an operating performance break even over 2015-2016.

Canary Islands is eligible for FFF funds as it met the fiscal deficit goal in 2013, and will receive a total of EUR958m in 2015 from this fund carrying zero interest over 2015-2017, to cover its borrowing needs for the year. The region started a funding strategy in 2014, including refinancing several outstanding loans at lower interest rates, such as the EUR224m loan from the Suppliers Fund, and as a result realising a saving of EUR40m, and a EUR50m private placement to an international institutional investor given lower rates compared with the domestic market. The region is keen to continue gaining autonomy in its funding strategy, which is credit-positive in Fitch's view.

Direct debt was EUR6bn at end-2014, a rise of over EUR2.7bn since end-2010. Fitch's base case scenario forecasts a decelerating increase in debt over the next two years, with debt totalling EUR6.8bn by end-2016, close to 125% of the projected current revenue.

GDP growth in 2014 was 2.2%, well above the national average at 1.4%, one of the best regional performers in Spain. Growth above 2% is expected for 2015-2016, outperforming the national economy. The main driver is the tourism sector, which accounts for roughly 30% of GDP. However, the regional economy is burdened by structural high unemployment (32.4% for 2014, above 24.4% for Spain). The Spanish oil company Repsol (BBB/Positive/F3) abandoned an oil extraction project in the territorial waters of the Canary Islands (60km offshore), which may pose a risk to the regional economy.

RATING SENSITIVITIES
Fitch will review the rating floor if state support measures are cancelled or if there is a reduction in the central government's ability and willingness to continue providing extraordinary support to regions. If the floor is removed, Canary Islands' ratings are likely to be downgraded unless it is able to report a structural positive current balance.

An affirmation of the ratings on a standalone basis may result from a structural improvement of the operating balance associated with a debt-to-current revenue below 130%.

RATING ASSUMPTIONS
A new financial system for the Spanish regions is under debate. Although it is too early to determine its impact on Canary Islands, Fitch considers the region only faces positive scenarios as it is currently underfunded compared with the rest of Spanish regions under the common regime.