OREANDA-NEWS.  Fitch Ratings has affirmed the Brazilian state of Sao Paulo's National long-term rating at 'AA+(bra)' with Stable Outlook. The agency has also affirmed the long-term Issuer Default Rating (IDR) at 'BBB'. The Outlook remains Negative, and reflects the Negative Outlook assigned to Brazil on April 9, 2015.

KEY RATING DRIVERS

The Sao Paulo's rating affirmation considers its strong economy, which is about one-third of the Brazilian GDP. The state presents an adequate budgetary performance, which based on Fitch's adjustments, accounts for an 8.4% operating margin. The state also has a high level of fiscal autonomy in which tax revenues accounted for 70.5% of operating revenues in 2014.

The ratings are also supported by the fact that Sao Paulo's most important creditor is the federal government. Sao Paulo's fiscal performance is dependent on the Imposto Sobre Circulacao de Mercadorias e Servicos (ICMS) tax, which is highly correlated with the performance of the national economy, which is expected to contract by 1.5% in 2015. Tax revenues will be negatively affected, with some recovery expected in 2016.

As a result of lower growth in personnel expenditures, operating margins should stabilize close to 7% by 2017, according to Fitch's calculations based on the state's projections. Fitch believes the state has had to use nonrecurring revenues, such as tax refinance agreements that are unsustainable over the medium term. These revenues sources are not relevant to the state.

Sao Paulo's financial debt has been increasing. In 2014, direct debt over current balance reached 1.9 years. According to the state's debt projections, this ratio should be close to four years, still compatible with 'BBB' rated entities. Sao Paulo's exposure to foreign debt is relatively low (5.3% of direct risk or BRL10.6 billion in 2014), thus limiting the impacts of the recent USD appreciation.

Despite the implementation of the complementary pension system (Prevcom) in 2011, pension-related expenditures made up a significant portion of personnel expenditures, reaching 34% in 2014 in an upward trend. Sao Paulo has been covering the pension shortfalls. Whereas the current pension system operates under a definite benefit system, Prevcom has a definite contribution program, which prevents the actuarial deficit from growing.

Sao Paulo plans to strengthen cash advances to private operators in light of the large amount of investments in each public-private partnership (PPP) project. In 2015, there are plans to launch six additional PPPs related to urban mobility and infrastructure. As a result, PPP counter-payments related to nine projects should reach BRL1.3 billion, corresponding to around 1% of net revenues of the state, well below the 5% limit stablished by the Senate.

RATING SENSITIVITIES
Sovereign: Any rating action affecting the Federative Republic of Brazil, currently at 'BBB'/Negative Outlook, will exert a direct influence over the ratings assigned to Sao Paulo. Moreover, a significant deterioration in Sao Paulo's fiscal management as measured by an operating margin lower than 5% coupled with a higher level of financial debt, expressed by a direct debt/current balance significantly higher than four years, could result in a review of the ratings.

Located in the southeastern region of Brazil, Sao Paulo is largest state in Brazil in terms of economic stature, with an above-average infrastructure level in relation to other states in Brazil.

KEY ASSUMPTIONS

The ratings and Outlooks are sensitive to these assumptions:

--Fitch assumes a strong level of sovereign support for Sao Paulo given that the state's most relevant creditor is the Federal Government. Fitch's base case does not assume a severe change in Sao Paulo's key structural features.

--Global assumptions are consistent with Fitch's published 'Global Economic Outlook', including the subdued outlook for commodity prices.

Fitch affirms the following ratings:
:
--Foreign Currency Long-Term IDR at 'BBB'; Negative Outlook
--Foreign Currency Short-Term IDR at 'F2';
--Local Currency Long-Term IDR at 'BBB'; Negative Outlook;
--Local Currency Short- Term IDR Rating at 'F2';
--National Long-term at 'AA+(bra)'; Stable Outlook;
--National Short-term rating at 'F1+(bra)'.