OREANDA-NEWS. December 08, 2015. Fitch Ratings has assigned the Region of Piemonte Long-term foreign and local currency Issuer Default Ratings (IDRs) of 'BBB' with Stable Outlook, and a Short-term foreign currency IDR of 'F3'. The rating has also been assigned to the region's EUR1.8bn outstanding bonds (ISIN: XS0276060083).

Piemonte's IDRs reflect the region's weak operating performance and large budgetary deficit amid high debt. The rating is however underpinned by the region's strong economy fundamentals and accelerated economic recovery path. The Stable Outlook reflects Fitch's expectation of stabilised operating margins over the medium term. The Short-term 'F3' rating reflects the region's fickle liquidity position and persisting cash tensions.

KEY RATING DRIVERS
The rating reflects the following rating drivers and their relative weights:

HIGH
Fiscal Performance (Weakness/Stable)
Piemonte's weak fiscal performance is reflected by a track record of operating margins below 3% in the past five fiscal years. Performance is structurally constrained by the heavy burden from the healthcare sector. Fitch believes revenue enhancements such as a personal income tax surcharge increase may stabilise operating margins in the 3%-4% range for 2015-2017, roughly covering its debt obligations. However, statutory calls for fund balance replenishment will put pressure on debt growth.

The Constitutional Court endorsed a qualified opinion from the state audit board, Corte dei Conti, which contended that Piemonte had missed about EUR2.3bn of administrative commitments and funded them with additional EUR1.5bn debt, ultimately underreporting the region's fund balance deficit from the actual EUR5.9bn, or EUR6.2bn when difficult to collect taxes for 2015 are prudently taken into account. Fitch calculates that the fund balance deficit would shrink to EUR3.2bn in 2015 net of the cash advances from the Ministry of Finance as this debt is repayable in 30 years vs. seven years applied to adjusted fund balance deficit. This mitigates pressure on debt coverage ratios. Fitch also understands that some of the contingent liabilities are represented by commercial obligations.

MEDIUM
Debt and Liquidity (Neutral/Stable)
Piemonte's debt has increased materially to nearly EUR10bn in 2015 from EUR6.5bn at the end of 2009. This is because the region accelerated the draw-down of subsidised loans, lowering the market debt share to about 50% of total direct debt. Fitch expects the region's direct debt to further grow up to EUR11bn by 2017 as a result of funding requirements from capital imbalances and fund balance replenishment. The debt to revenue ratio will hover at around 100%, a level compatible with Piemonte's rating category. Preferential treatment allowed by legislation on the repayment of financial debt vs. commercial liabilities represents a remedy of last resort when the region faces liquidity stress, although Fitch understands that the region may arrange a cash pool for its equity controlled entities.

Economy (Strength/Stable)
Piemonte is one of the strongest manufacturing Italian hubs. It has a large economy with high socio-economic wealth indicators as reflected by GDP per head that is 7% higher than the national average. In addition, unemployment is structurally below the national level (8.0% in 2014 versus Italy's 12.7%). After years of slower economic gains following the last recession, Fitch expects continued improvement in the economy, with GDP to grow 0.8% in 2015 sustained by growing exports, improved domestic demand and revived investments. The competitive posture of the region's manufacturing-related concentration and strong export-oriented feature leave the regional economy sensitive to external economic downturns.

Institutional Framework (Neutral/Stable)
A solid legislative background defines regions' responsibilities and revenue predictability including access to subsidised loans with long-term tenures/maturities from the central government. Weak enforcement of the regulation aimed at preserving fiscal balance leads, at times, to off-balance sheet liabilities, such as Piemonte's fund deficit. Tax raising flexibility is moderate and may be further limited by the 2016 national budget law compressing performance and the ability to strengthen regional finances. The provision for co-shared responsibilities, such as healthcare, together with the regions' presence in the capital markets are incentives for the central government to provide financial support to regions in case of need.

Management (Weakness/Stable)
Fitch views positively the region's commitment to fiscal consolidation by addressing its cost structure, especially on healthcare, which will continue to exert some pressure on the region's expenditure given the ageing population. Limited tax leeway and the lack of reserves to keep unexpected financial shocks at bay are limiting factors for the management policy. While Fitch understands that litigation triggered by the region's unilateral breach under derivative contracts with swap counterparties (Dexia, Merrill Lynch and Banca Intesa) have been settled, a history of weak management practice means that financial challenges may not always be handled effectively, in Fitch's views.

RATING SENSITIVITIES
Fitch views an upgrade as unlikely. Positive rating action would require evidence of structurally improved operating margins in the 6-8% range as well as improved debt metrics.

Piemonte's rating is sensitive to a deterioration in its operating performance that could consistently weaken its debt servicing ratio well below 1x and to the region's inability to sustainably restore its fund balance.