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Fitch Affirms Italian City of Naples at 'BB+'; Outlook Negative
15 JUN 2018 4:17 PM ET
Fitch Ratings-Milan/London-15 June 2018: Fitch Ratings has affirmed the Italian City of Naples' Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'BB+' and Short-Term Foreign Currency IDR at 'B'. The Outlook is Negative. The issue ratings on Naples' senior unsecured bond and on the city's programme have also been affirmed at 'BB+'.
The ratings factor in Naples' reliance on a supportive institutional framework in the form of a preferential payment mechanism for timely debt servicing, as poor tax and fee collection rates weigh on fiscal performance, limiting the recovery of the city's fund balance deficit. They also reflect the city's GDP growth, high but stable debt and ongoing weak liquidity.
The Negative Outlook reflects challenges in implementing the city's recovery plan, which hinges on asset sales of about EUR400 million in 2018-2020, and on improving revenue collection, which has so far been less than adequate.
KEY RATING DRIVERS
Institutional Framework (Neutral/Stable)
Fitch views inter-governmental relations as neutral to Naples' ratings. Naples benefits from state transfers to offset its weaker-than-national average fiscal capacity, and capital subsidy funding for large projects. State transfers account for one third of current revenue, the most relevant being the equalisation fund (EUR340 million in 2017).
Naples also received subsidised loans to pay down its commercial liabilities and legal coverage to reschedule its recovery plan to 20 years from the original 10 years. The central government is expected this year to take over nearly 80% of the EUR85 million off-balance sheet debt accrued for past liabilities linked to the after-earthquake reconstruction.
The preferential payment mechanism allows Naples to prioritise debt service, together with staff costs and some defined essential services, as long as subordinated bills are paid according to the chronology of invoices. Fitch calculated Naples' prioritised operating expenditure at 85% of total spending and evaluated the city's adjusted senior operating margin in its overall assessment.
Fiscal Performance (Weakness/Stable)
Naples' 2017 operating balance, adjusted for difficult-to-collect revenue, was low at EUR90 million, or about 7.5% of operating revenue, barely covering interest expenses. However, when adjusted for operating expenditure that could be subordinated, the margin improves to EUR230 million or 20%, translating into debt service coverage of 1.25x from 0.5x. The city's plan to strengthen the margin by improving tax and fee collection continues to fall short of expectations. Therefore, Fitch expects the city to collect about 75% of its forecast EUR1 billion own revenue.
Fitch expects total operating expenditure to remain under control, with purchases growing at an average inflationary rate of 1.4% in the medium term. Staff costs will continue to decrease due to early retirements and hiring freeze under the recovery plan, which has led to an employee reduction of roughly 15% of the city's workforce since 2014. Under Fitch's forecasts, the city's EUR0.8 billion capex in 2019-2020 will focus on transportation, extraordinary road maintenance, public lighting and urban renovation. They will mostly be funded by non-debt resources such as EU funds and transfers.
The city's plan to sell real estate assets to institutional counterparties (governmental real estate fund INVIMIT and social insurance agency INAIL) will be devoted to shrinking the fund balance deficit, which remained large at EUR1.3 billion at end-2017. Fitch believes that the planned EUR400 million asset sales may take longer-than-expected to materialise, given the EUR35 million sale of a municipal company's stake in 2018 was the first tangible result since the recovery plan launch in 2014.
Debt, Liabilities and Liquidity (Weakness/Stable)
Under Fitch's rating scenario, Naples' direct risk will stabilise at around EUR2.4 billion in 2018-2020 net of undrawn borrowing, or above 200% of the budget when EUR1.2 billion subsidised loans to pay down the city's commercial liabilities are included. In its rating case, Fitch expects the city's debt payback ratio to average 30 years in the medium term, improving to 10 years when considering the senior operating margin. New borrowing of around EUR250 million, which roughly matches the city's debt repayment over the next two years, will be drawn from Cassa Depositi e Prestiti (CDP, BBB/Stable, the national government financial arm) and the European Investment Bank.
