December 15, 2017 / 9:31 PM / a year ago

Fitch Downgrades Italian City of Naples to 'BB+'; Outlook Negative

(The following statement was released by the rating agency) Link to Fitch Ratings' Report: City of Naples - Rating Action Report here MILAN/BARCELONA, December 15 (Fitch) Fitch Ratings has downgraded the Italian City of Naples' Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) to 'BB+' from 'BBB-' and Short-Term Foreign Currency IDR to 'B' from 'F3'. The Outlook is Negative. The issue ratings on Naples' senior unsecured bond and on the city's programme have also been downgraded to 'BB+' from 'BBB-'. The downgrade reflects higher-than-expected off-balance sheet liabilities, partially fuelled by ongoing weak tax and fee collection rates. The Negative Outlook factors in prolonged prospects of sizeable off-balance sheet liabilities pressuring liquidity amid uncertain extraordinary support from the national government. KEY RATING DRIVERS The rating action reflects the following rating drivers and their relative weights: HIGH Management and Administration (Weak) The administration's commitment within the 2014 recovery plan to overcome (within 10 years) the fund balance deficit has fallen short of Fitch's expectations, eroding confidence that improvements may be achieved over the medium term. Collection rates on own-source revenue have languished at below 85% of accrued/recorded taxes and fees, sale of assets came in about EUR10 million out of planned EUR100 million, while subsidiaries remain mostly loss-making. A proposed rescheduling of the recovery plan has been opposed by Corte dei Conti (national audit body) upon low provisions for litigations. A lengthening of the recovery plan's time horizon to 20 years (currently being considered at the national level) could facilitate Naples' budgeting while exacerbating the recovery time for unpaid creditors. Naples' operating payables to suppliers are 1x the city's budget. Naples' capacity to service debt on time remains reliant on Italy's preferential payment mechanism, a tool used to smooth out temporary cash mismatches but which may come under stress from growing unpaid commitments. Adjusted for about EUR450 million of potential and actual liabilities from unfavourable court rulings, the city's free fund balance deficit totals EUR1.2 billion. MEDIUM Fiscal Performance (Weak) Naples' 2016 operating margin was about 6%, adjusted for difficult-to-collect revenue, which was insufficient to repay interest expenses that represented 9% of revenue. Stagnant state transfers and low fiscal flexibility would lead to 1% revenue CAGR in 2017-2020 under Fitch's scenario, as improved tax collection from the fight against tax evasion barely matches current spending growth. Fitch expects the current balance to remain negative at around 2% over the medium term. Under Fitch's forecasts, the city's EUR1 billion capex in 2017-2020 will focus on transportation, extraordinary road maintenance, public lighting and urban renovation. They will be mostly funded by non-debt resources such as EU funds and transfers. According to Fitch's central scenario, new borrowing of EUR250 million and a new plan to sell real estate assets to institutional counterparties (governmental real estate fund INVIMIT and social insurance agency INAIL) will contribute to funding capex. Although the city is planning asset sales of EUR300 million over the medium term, Fitch factored in its central scenario an average of less than EUR60 million per year. Institutional Framework (Neutral): Fitch views inter-governmental relations as neutral to Naples' ratings. Despite Naples being exposed to the national government's spending cuts, the city benefits from state support, such as equalisation transfers (EUR350 million in 2016, or nearly 30% of operating revenue, and an expected EUR330 million in 2017), to offset its weaker-than-national average fiscal capacity, and funding for large projects. Naples also received subsidised loans to pay down its commercial liabilities. LOW Debt, Liabilities and Liquidity (Weak): Under Fitch's central scenario, Naples' direct risk will stabilise at around EUR2.3 billion in 2017-2020 (EUR2.4 billion in 2015 and 2016) net of pre-financing, or below 200% of the budget when EUR1.1 billion subsidised loans from Cassa Depositi e Prestiti (CDP, BBB/Stable, the national government financial arm) to pay down the city's commercial liabilities are included. CDP and the national government are counterparties to nearly 75% of Naples' direct risk and almost the entire stock of Naples' loans carries fixed interest rates, reflecting a low risk appetite. Fitch expects debt ratios will remain weak, while cash flows remain a risk over the medium term. Economy (Neutral): With nearly 1 million inhabitants, Naples is one of the biggest Italian cities and, although it is the most dynamic and industrialised city in southern Italy, its socio-economic profile remains weak relative to national levels, also affected by a large shadow economy. Naples' official labour market continues to underperform the national economy with an unemployment rate of more than 20% (11.7% nationally). The city's mild GDP recovery, which has been continuing in 2017, mainly driven by tourism, industry and commerce, has had no impact on tax revenue. ] KEY ASSUMPTIONS Fitch assumes that the existing preferential payment mechanism as defined by national law will continue to support timely debt servicing by Naples, despite the city's growing commercial liabilities in the medium term as its cash flows generation capacity continues to be weak. RATING SENSITIVITIES Persistently negative adjusted current balance or failure to shrink the fund balance deficit would lead to a downgrade. The ratings could also be downgraded if debt and equivalents rise above 2.5x operating revenue or if the preferential payment mechanism protecting financial lenders is removed or undermined by regulatory changes. The Outlook could be revised to Stable if the fund balance deficit shrinks as a result of higher- than-expected asset sales or an improvement in operating performance. Contact: Primary Analyst Federica Bardelli Associate Director +39 02 879087 261 Fitch Italia S.p.A. Via Morigi 6 Milan 20123 Secondary Analyst Chiaramaria Mozzi Associate Director +39 02 87 90 87 231 Committee Chairperson Guilhem Costes Senior Director +34 93 323 8410 Summary of Data Adjustments Fitch has made a number of adjustments on the official accounts to make the local and regional governments internationally comparable for analytical purposes. These adjustments include: -Taxes and fees are net of difficult to collect/uncollectible revenue, as calculated by Fitch; -Urbanisation fees reclassified as current revenue from capital revenue as national legislation allows them to be used to finance recurrent spending; -Municipalities' equalisation fund has been reclassified as current transfers from tax revenue; and -Fund balance deficit net of subsidised loans from the national government, which is used to finance past operating spending, is included by Fitch in its direct risk calculation. 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