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Fitch Affirms Autonomous Community of Valencia at 'BBB-'; Outlook Stable.

Barcelona: Fitch Ratings has affirmed the Autonomous Community of Valencia's Long-Term Foreign and Local-Currency Issuer Default Ratings (IDR) at 'BBB-' with Stable Outlooks. Fitch has also affirmed the Short-Term Foreign Currency IDR at 'F3'. The ratings on the region's senior unsecured outstanding bonds have been affirmed at 'BBB-'.

The affirmation reflects the unchanged 'BBB-' rating floor applied to Spanish autonomous communities, including Valencia. This supports the region's 'BBB-' IDRs, which are higher than the region's intrinsic credit profile. Fitch will closely monitor liquidity support from the central government to Spanish regions.

KEY RATING DRIVERS

Valencia's IDRs are based on Fitch's expectation of state support, as captured by the 'BBB-' rating floor. The rating floor is based on a number of supporting factors that mitigate a region's liquidity risk, reducing the likelihood of default. These include the absolute priority of debt servicing by law as per article 135 of the Spanish Constitution; access to state liquidity mechanisms such as the Regional Liquidity Fund (FLA) and the Financial Facility Fund, and the budgetary stability law, which enforces fiscal discipline on local and regional governments.

Central Government Support

In Fitch's view, Valencia's access to the FLA will continue to ensure timely debt servicing in 2017. Eighty-three per cent of the regional government's outstanding direct debt at end-2016 was funded through the state support mechanisms, illustrating strong support from the central government. The central government ratified its financial support on 23 December 2014, introducing further measures to ease the debt burden of autonomous communities, including zero interest loans in 2015. As a result, interest costs for Valencia declined EUR878 million between 2014 and 2016.

At end-2016, direct debt increased to EUR41.3 billion (EUR37.8 billion in 2015), although the direct debt-to-current revenue ratio was slightly lower at 354% (359% in 2015). Under Fitch's base case scenario, direct debt is expected to increase to over EUR42 billion-EUR44 billion by end-2017, but as a share of forecast current revenue further decline to 348%-355%.

Valencia's long-term debt redemptions for 2017 are estimated at EUR3.4 billion and the region has requested to borrow at least EUR5.4 billion from the FLA, including EUR360 million for debt redemption in its public sector.

During 1Q17 and 2Q17, support from the FLA was delayed due to the operational application of the mechanism at the beginning of the year. This led Valencia to directly service its debt by requesting advances from the 2015 funding system settlement and through its own recourse to alleviate peak liquidity demands. Fitch will monitor the efficiency of the liquidity mechanisms and the political commitment to provide liquidity to regions as part of the agency's rating floor assessment.

In 2016, Valencia contracted EUR2.1 billion short-term debt and renewed EUR2.2 billion for 2017 for another 12 months. Of the latter, EUR1.1 billion was utilised in August 2017. Without central government support, pressure on debt servicing would have been high. As of end-2016, debt maturities for the next three years totalled EUR15 billion, representing 37% of outstanding direct debt at end-2016. However, this is mitigated by a large part being contracted through the state support mechanism.

Weak Intrinsic Credit Profile Subject to Funding Reform

Valencia's structurally negative current and operating balances since 2010, recurring overall budget deficits before debt repayment, high net overall risk and a weaker economic profile than Spain, mean that the regional government's intrinsic credit profile is weaker than the IDRs indicate.

Under Fitch's base case scenario, the regional government's weak budgetary performance will be difficult to reverse in the near- to medium-term, unless there is a significant change in the current funding system. Valencia is underfunded compared with the average funding per capita of the 15 Spanish regions under the common regime and is reliant on reform to address this gap. Nevertheless, Valencia's 2016 result before net financing improved significantly by EUR2 billion from 2015, largely due to EUR1 billion higher resources from the funding system and lower interest costs. In 2017 and 2018, resources from the funding system will increase by a further EUR993 million and EUR84 million, respectively.

Regional Economic Recovery

Valencia has a weaker-than-average economic profile, with a GDP per capita 11.2% below Spain's average in 2016. However, Valencia's GDP grew 3.7% in 2016 (3.6% in Spain) to an estimated nominal EUR105 billion.

The elderly represent a high share of Valencia's five million population, which may put pressure on health and social services. The labour market has improved as job creations in September 2017 increased by 14% since December 2013, after 21% of jobs were lost during 2007-2013. However, at 20.6% in 2016, the regional unemployment rate remains slightly higher than the national rate (19.6%).

RATING SENSITIVITIES

As Valencia's IDRs are supported by the 'BBB-' rating floor for Spanish autonomous communities, they would be downgraded by at least two notches if the floor is removed.

KEY ASSUMPTIONS

Fitch assumes that the state will continue providing support to Spanish regions over the medium term. Moreover, Fitch will review the rating floor if state support measures are withdrawn or if the central government's ability and willingness to provide extraordinary support to the regions deteriorates.

Discussions on the regional financial system are ongoing in Spain, and changes are in prospect over the medium term. Nevertheless, Fitch believes Valencia's revenue is unlikely to decrease as a result.
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Publication:Daily the Pak Banker (Lahore, Pakistan)
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Date:Dec 30, 2017
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