OREANDA-NEWS. Fitch Ratings has affirmed the Department of Bouches-du-Rhone's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AA' with Negative Outlook, and Short-term foreign currency IDR at 'F1+'. The Department's EUR500m medium-term programme has been affirmed at 'AA'.

The affirmation reflects the Department of Bouches-du-Rhone track record of sound, albeit declining, operating performance and low indebtedness. The Negative Outlook reflects our expectations that the Department's budgetary and debt ratios could deteriorate in the medium term to levels that may not be compatible with the ratings.

KEY RATING DRIVERS
According to Fitch's base case scenario, Department of Bouches-du-Rhone's operating margin could decline to 7.1% in 2018, from an average 14% in 2012-2015. The expected deterioration is mainly due to sharp cuts in state transfers, while operating spending, particularly social spending for social benefits, disability and old age dependence, is expected to continue to grow, albeit at a slower pace (by 1.6% per year on average in 2015-2018, from 2.3% in 2012-2015) thanks to the implementation of cost-cutting measures in 2015.

Bouches-du-Rhone's administration that was elected in March 2015 plans to implement a package of operating savings in 2016 that would offset the cuts in state transfers (EUR35m) and aims to continue to do so in 2017. This is likely to limit the deterioration of the Department's fiscal performance and debt ratios in the medium term. However, we did not factor the potential upside factored into our base case as the measures have not yet been voted on.

Fitch estimates that there is some budgetary flexibility from Bouches-du-Rhone's direct tax leeway. However, the Department has committed not to use it. Some tax items, especially the property transfer duties (14% of estimated operating revenue in 2015) have evolved erratically in recent years and consequently remain a source of budget volatility.

Fitch expects capital expenditure to decrease to EUR450m a year on average in 2016-2018, from an estimated EUR491m in 2015 as the management adjusted its pluriannual programme. Nonetheless, due to the expected decline in the operating performance, Fitch estimates that the Department's self-financing rate of capital expenditure (after debt repayment) will halve to about 34% on average in 2016-2018, from 62% in 2013-2015, eventually doubling debt to close to EUR1.3bn by 2018.

According to our base case scenario, the Department's direct debt payback ratio may reach 10 years in 2018, from an estimated two years in 2015. We also estimate that the Department's direct debt service coverage by the operating balance could deteriorate but still remain sound around 70% in 2018, from an estimated 24% in 2015. The Department's debt structure is sound and does not include any high-risk products. Bouches-du-Rhone's high level of debt guarantees (EUR1.1bn at end-2015, 49% of operating revenue) is mostly related to social housing entities, which Fitch views as a highly regulated and low-risk sector.

Bouches-du-Rhone's unemployment rate is above the national average (12.2% in 3Q15 vs. 10.2% for metropolitan France), which translates into higher social expenditure than other Departments, in light of the responsibility for social benefits. However, Fitch estimates the Department's socio-economic profile is sound compared with its international peers, characterised by a GDP per capita at 116% of EU average, supporting its tax revenue.

RATING SENSITIVITIES
A deterioration of Bouches-du-Rhone's fiscal performance leading to an operating margin weakening towards 8% with a debt payback ratio weakening towards 10 years could result in a downgrade. A downgrade of the sovereign would also be reflected by Bouches-du-Rhone's ratings.

The Outlook could be revised to Stable if improvements in budgetary performance results in operating margin at the current level (above 12%) 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.