Fitch Affirms City of Naples at 'BBB-'; Outlook Stable
The affirmation reflects Naples' consistent strategy to limit debt liabilities at around EUR2.6bn over the medium term, or 2.2x of revenue, while clearing the stock of commercial liabilities (towards EUR0.5bn in 2015, from EUR1.7bn in 2011). The Stable Outlook balances risks of failure to improve tax and fee collection rates with chances of stronger than expected operating margin and lower debt level
KEY RATING DRIVERS
Fiscal performance (Neutral/Stable): Fitch believes Naples' operating balance will hover around EUR120m, or about 10% of operating revenue, in the medium term, almost fully covering debt service requirements. Fitch expects current revenue in 2015 to shrink by about EUR100m due to cuts in national subsidies as well as more accurate municipal budgeting removing part of the uncollectible items. Naples' revenue flexibility remains limited as the property tax rate is already at the higher allowed level, while efforts to fight tax evasion may bring in around EUR20m-EUR25m, which could boost free reserve/fund balance.
The implementation of the 2013-2022 recovery plan will help reduce current expenditure for the purchase of goods and services (EUR50m), partly offsetting the revenue decline. Fitch expects capital expenditure in 2015-2017 to be primarily funded by capital transfers for about EUR800m, as well as sales of city's real estate assets for about EUR100m over the period, conducive to a balanced budget.
Debt (Weakness/Stable): Fitch believes Naples' stock of debt will hover around EUR2.6bn in the medium term, when including EUR1.3bn of subsidised borrowing in 2013-2015 from the state's lending arm, Cassa Depositi and Prestiti (CDP; BBB+/Stable), to pay down commercial liabilities. The latter includes payables towards municipal main subsidiaries whose financial debt will subsequently fall close to zero in 2015 from EUR340m in 2012. Fitch forecasts Naples' debt- payback at 50 years in 2015-2017. However, the ratio would almost halve if only direct market debt for bonds and loans is considered.
Management (Weakness/Stable): Naples aims to overcome the underestimation of operating spending - which often cause off-balance sheet liabilities - as well as the accumulation of difficult to collect receivables. However long-standing challenges persist. The average tax and fee collection rate in 2014 stagnated at close to 80% of accrued revenue. Although liquidity stress has been drastically eased thanks to subsidised loans, matching revenue and spending remains challenging. Net of payments funded from CDP loans, operating payables would have grown to EUR2.2bn in 2014, from EUR1.7bn in 2011, while operating receivables could climb above EUR2bn by 2015, from EUR1.2bn in 2011, highlighting Naples' failure to reverse the trend in their accumulation. Conversely, Naples projects operating payables to fall to EUR0.5bn by 2015, when eliminating proforma components.
Economy (Neutral/Stable): Naples' SMEs have had a reprieve following the payment of arrears. Fitch expects GDP to remain stagnant in 2015, after a contraction in 2014, with the unemployment rate at around 20%. Growing tourism flows, substantial structural funds for economic development (EU) and foreign direct investment, particularly in technology research and manufacturing, may stimulate the economy over the medium term, albeit without any significant impact in tax revenue collection.
Institutional Framework (Neutral/Stable): Fitch considers inter-governmental relations as neutral. The city remains exposed to curtailment of revenue from the national policy to contain deficit and debt, as 30% (EUR370m) of the city's revenue comes from equalisation transfers from the government to offset its weaker than the national average fiscal capacity.
Ex-ante prudential regulation failed to prevent the accumulation of a fund balance deficit. However, the national government has set a recovery plan under the control of the national audit body, Corte dei Conti. Legislation allows for preferential payments to serve financial debt when due.
RATING SENSITIVITIES
The ratings could be downgraded if debt and equivalents (such as subsidised loans or re-scheduled payables), climb towards 2.5x of operating revenues. A downgrade could also stem from failure to increase tax and fees collection rates towards 95% over the medium term, leading to current receivables to trend towards 2x revenue, from 1.5 in 2014. Adverse changes to the preferential payment mechanism protecting financial lenders could lead to a downgrade, possibly by multiple notches.
An upgrade seems unlikely over the medium term. However, factors which may, individually or collectively, result in positive rating action include a fall in financial debt back towards 1x the budget size and a recovering economy that would support a stronger fiscal performance with an operating margin rising towards 20%, and improved operations preventing the accumulation of payables.
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