OREANDA-NEWS. September 21, 2015. Fitch Ratings has affirmed the Italian Region of Sicily's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB' with Stable Outlooks and Short-term foreign currency IDR at 'F3'. The affirmation affects the region's senior unsecured debt, including a bullet bond issue of EUR568m maturing in December 2015 (XS0121633126).

The affirmation reflects Fitch's expectation that Sicily will progress towards a stronger operating balance in 2015-2017 with debt burden remaining at around 50% of revenues.

KEY RATING DRIVERS
Fiscal Performance
Sicily posted a balanced operating budget in 2014 in line with Fitch's expectations when adjusted for nearly EUR0.6bn of transfers delayed in April 2015. Fitch's central scenario remains that Sicily's operating margin will strengthen to around 3% in 2016/2017 from 0 (balance) in 2013-2014. The region has agreed with the state to stabilise current spending at EUR14bn in 2014-2017. Fitch believes that costs are difficult to shrink further as wages, health care and interest absorb three-quarters of the current budget. However, Sicily will deliver on its commitment to stabilise operating spending as a policy reversal could trigger the state cutting shares of national taxes that are devolved to the region.

Debt
Despite nearly EUR8.5bn of loans and bonds currently outstanding, Sicily has moderate levels of indebtedness, comparing favourably with 'BBB' category peers, especially as the majority of borrowing is from Italy's public sector, including the national government. Debt servicing requirements will remain modest at 4% of revenue thanks to amortising structures and long-term maturities of state-subsidised loans. Fitch expects the operating balance to fully cover interest but only two-thirds of debt servicing when principal is added. While resources for the repayment of the EUR568m bullet in December 2015 are provisioned in the sinking fund, timely debt servicing for loans continues to be underpinned by preferential payments amid payables to suppliers ranging around EUR5bn, or one-third of the budget.

Economy
Sicily's economy suffered from national and regional austerity, with the latter implying a 7% cost reduction in 2013. Moreover cash capex declined to EUR1.5bn in 2014 from an average of EUR2.5bn in 2007-2011. As spending limitations on investments are eventually unwound by the national government, Fitch expects the local economy to reverse the downtrend, partly banking on capital spending sustained by EU transfers for EUR4.5bn in 2015-2020. However, even 1% growth in 2016 (Fitch expects no growth in 2015) is unlikely to reduce unemployment from the current 22%, offering limited contribution to growth of tax proceeds.

RATING SENSITIVITIES
Failure to bolster the operating balance towards 3% of revenue to largely cover debt servicing requirements, and/or unexpected growth of debt towards 75% of revenue could lead to a downgrade, especially amid continued economic sluggishness.

Positive rating action is contingent upon the operating margin strengthening towards 10%, and Sicily achieving balanced overall budget and a current surplus matching principal repayment over the medium term.