OREANDA-NEWS. September 21, 2015. Fitch Ratings has revised the Department of Bouches-du-Rhone's Outlook to Negative from Stable and affirmed its Long-term foreign and local currency Issuer Default Ratings (IDR) at 'AA' and Short-term foreign currency IDR at 'F1+'.

Fitch has also affirmed Department of Bouches-du-Rhone's EUR500m euro medium-term programme at 'AA'.

The Negative Outlook reflects our expectations that the Department's budgetary and debt ratios will deteriorate over the next three years to levels that may not be compatible with the ratings. This is due to continuous cuts in state transfers, which combined with steadily growing social spending and sustained investment, is likely to contribute to a deterioration in the Department's financial profile, despite spending control that is underpinned by its strong governance.

KEY RATING DRIVERS
The Outlook revision reflects the following key rating drivers and their respective weights:

HIGH
Fiscal Performance
According to Fitch's base case scenario (excluding future political decisions), the Department's operating balance will decline steadily to 8.2% of operating revenue in 2018, from an average of 15.0% in 2010-2014. The expected deterioration in performance is mainly due to sharp cuts in state transfers, while operating spending - particularly in social spending - is expected to continue to grow, albeit more slowly (1.5% in 2014-2018, from 3.3% over 2010-2014) thanks to the implementation of some cost-cutting measures.

However, Fitch considers there is some budgetary flexibility stemming from Bouches-du-Rhone's direct tax leeway, although the administration is not contemplating this option. Some tax items, especially the property transfer duties (13% of operating revenue), have evolved erratically and are not easily predictable. Operating expenditure is driven by rigid items such as staff costs, mandatory transfers and state-defined social spending

Fitch expects investments to slightly increase on average to EUR519m per year over 2015-2018 (EUR491.5m at end-2014). Combined with the expected weaker operating performance, Fitch forecasts that the Department's self-financing rate of capital expenditure (current balance and capital revenue, net of debt repayment, on capital expenditure) is likely to weaken to an average 50.3% per year over 2015-2018 (61.0% expected at end-2015).

Debt
According to Fitch's base case scenario, outstanding debt could reach to about 71% of current revenue in 2018, compared with 32.0% expected at end-2015. In addition, due to a deterioration in the self-financing rate of capital expenditure, the debt payback ratio will weaken to about 11 years in 2018 (2.9 years expected at-end 2015), a level that is incompatible with the ratings. The debt structure is sound and does not include high-risk products. The department's high level of debt guarantees (EUR1bn at end-2015) is 92% related to social housing institutions, which are strictly monitored and regulated by the state. Fitch considers the main dependent public sector entities as low-risk (fire services and social housing institutions).

MEDIUM
Institutional Framework
Like most French departments, Bouches-du-Rhone suffers from a structural gap between slow-growing revenue, mostly based on non-modifiable taxes and state transfers, and dynamic expenditure, mainly social transfers linked to unemployment, disability and old age dependence. Operating revenue is under increasing pressure owing to the sluggish tax base and to state transfer cuts as part of the fiscal consolidation pressurising the budgetary performance.

Bouches-du-Rhone's ratings also reflect the following rating drivers:

Economy
The Department has a weaker-than-average socio-economic profile. In 1Q15, the unemployment rate (12.0%) was fairly stable but higher than the national average (10.1%), which implies higher social expenditure than other departments.

Management
Following the conclusions of a financial audit commissioned by the new political majority, Fitch will be attentive to the measures that could be voted in during the next budget (February 2016).

RATING SENSITIVITIES
A downgrade could result from Bouches-du-Rhone's deterioration of operating balance due to an unbalanced evolution of operating revenue and expenditure (with an operating margin towards 8%) associated with a debt payback ratio weakening towards 10 years from about two years at end-2014.

Conversely, the Outlook could be revised to Stable if improvements in budgetary performance results in operating margin at the current level (about 13%) in the medium term associated with a direct debt payback ratio around two years. Further improvement of the local economy giving additional boost to internally generated revenue would also be positive for the ratings.