OREANDA-NEWS. Fitch Ratings has affirmed the Region of Provence-Alpes-Cote-d'Azur's (PACA) Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AA-'. The Outlooks are Stable. The Short-term foreign currency IDR has been affirmed at 'F1+'. A full list of rating actions is available at the end of this commentary.

KEY RATING DRIVERS

The ratings reflect PACA's sound operating performance, strong economic profile and sound management, as well as its high and growing debt and the risk of a slightly weaker budgetary performance over the medium term, due to cuts in state transfers.

According to Fitch's base case scenario, the operating margin should remain sound over the medium term, although it will erode to 16% in 2018, from 19.6% in 2014. This is reflected in the Stable Outlook. The drop in state transfers will be mostly compensated by a growing tax base, leading to a contained reduction in operating revenue over the medium term (-0.4% a year until 2018). We expect the current margin to weaken to 11.6% in 2018, from 16.1% in 2014, as financial charges rise in line with growing debt.

PACA aims to mitigate the declining state transfers through greater control over spending and a trade-off between different budget spending items. PACA's ability to control operating expenditure is supported by flexibility on discretionary spending, which Fitch estimates at 20%-25% of total operating spending. This could at least partially offset the growth of spending in non-flexible items (train services, training). Flexibility over operating revenue is limited to 13% of total as of end-2014 (car registration duties).

PACA's capital expenditure will remain significant in 2015, expected to be close to EUR600m, as the region finances several large infrastructure projects, mainly acquisition of trains for the regional railway services and co-funding of large road works. These major investments would be near completion after 2015; we therefore expect capital spending to slow down progressively to an annual average of EUR420m in 2016-2018. However, this scaling-back may not be rapid enough to match the region's declining self-financing capacity, which we forecast would average 43% (after debt repayment) over the medium term, down from 62% in 2011-2014.

The lower self-financing capacity should keep PACA's direct risk (including finance leases) on an upward trend until 2018, to 183% of current revenue, from 147% in 2014. The direct risk payback ratio is expected to increase to 16.7 years in 2017, from 9.1 years in 2014. With a weakening budgetary performance, debt service coverage by operating balance may deteriorate to an average of 86% in 2015-2018, from 52% in 2011-2014. The debt structure is low-risk and bullet repayments are provisioned for.

PACA is the third-largest French region by population and GDP. Its economy is well-diversified and mainly relies on the region's services sector, vibrant tourism and high value-added industries. The regional economy is expected to progressively recover over the medium term. However, unemployment is high (11.6% in 1Q15 versus France's average of 10%) and the region's social indicators are slightly weaker than the national average.

The region's liquidity is underpinned by predictable cash flows and regular use of the EUR300m commercial paper (billets de tresorerie; BT) programme. Additionally, the BT programme has a back-up facility of committed revolving credit lines capped at EUR259m, which provides a financial safeguard.

RATING SENSITIVITIES
A weakening of the budgetary performance leading to debt servicing (annual principal plus interest payment) exceeding operating balance (2014: 54%) and a direct risk payback ratio above 15 years could lead to downgrade

A stronger budgetary performance with an operating margin consistently above 20%, and lower debt metrics with the direct risk payback ratio below eight years for more than two consecutive years, could lead to an upgrade.

The rating actions are as follows:
- Long-term foreign and local currency IDRs: affirmed at 'AA-'; Outlook Stable
- Short-term foreign currency IDR: affirmed at 'F1+'
- EUR1bn EMTN programme: affirmed at 'AA-'/'F1+'
- EUR300m BT programme: affirmed at 'F1+'