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Fitch Upgrades Russian Lipetsk Region to 'BB+'; Outlook Stable

March 13, 2017 | Cbonds

Fitch Ratings has upgraded Russian Lipetsk Region's Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) to 'BB+' from 'BB' and affirmed the Short-Term Foreign Currency IDR at 'B'. The National Long-Term Rating has been upgraded to 'AA(rus)' from 'AA-(rus)' and withdrawn. The Outlook on the Long-Term Ratings is Stable.

The region's senior debt ratings have been upgraded to long-term local currency 'BB+' from 'BB'. The region's senior debt National long-term rating has been upgraded to 'AA(rus)' from 'AA-(rus)' and withdrawn.

The upgrade reflects the region's better-than-expected operating performance, which resulted in a low deficit before debt variation and corresponding decrease in debt.
The National ratings are being withdrawn because Fitch has withdrawn its Russian National-scale ratings in response to a new regulatory framework for credit rating agencies in Russia (see Fitch Ratings Withdraws National Scale Ratings in the Russian Federation dated 23 December 2016).

KEY RATING DRIVERS
The 'BB+' ratings reflect the region's sound budgetary performance with an operating margin close to 15% and sound liquidity. They also take into account the high concentration of the regional economy in ferrous metallurgy, which makes Lipetsk region vulnerable to steel market fluctuations, leading to volatile tax revenue.

The rating action reflects the following rating drivers and their relative weights:

High:

Sound Budgetary Performance
Lipetsk Region continued to demonstrate sound operating results on a sustained basis, despite a drop in the operating margin in 2016. The latter decreased to 13.1% from a peak of 14.7% in 2015, after a stronger rouble negatively affected the revenue of the region's top taxpayer, export-oriented Novolipetsk Steel Plant (BBB-/Stable). Positively, financial sector profits accelerated significantly. Other contributors were excise duties, which rose 38% due to a tariff increase for petrochemicals, while personal income tax proceeds grew 5.5% amid growth of salaries across all sectors. Deficit before debt variation stood at a modest 0.9%.

Fitch forecasts the region will stabilise its operating margin at 13%-15% over the medium-term. Its industrialised economy with a focus on the steel sector will gain from Russia's economic recovery. Fitch projects Russia's GDP will return to a growth of 1.3% in 2017, and that the region will run modest deficits of 1%-2% over the medium term, leading to broadly stable debt.
The volatility of the region's finances is partly mitigated by the administration's prudent approach, which sets aside excess tax proceeds in cash reserves and keeps expenses under control. This led to a cash balance of RUB4.4 billion at end-2016, which constituted about 10% of the region's full-year operating revenue.

Medium:

Direct Risk Decrease
Direct risk decreased further to 37.5% of current revenue in 2016 from 43.2% in 2015, while the debt payback ratio improved to a sound 3.6 years from 3.9 years. The administration used accumulated cash reserves to pay down the region's most expensive loans and finance the deficit, saving interest expenses. Fitch's baseline scenario forecasts the region's direct risk will stabilise at below 40% in the medium-term.

As with most regions in Russia, Lipetsk Region is exposed to refinancing pressure in 2017-2019 when 91% of direct risk (RUB15.9 billion as of end-2016) matures. Despite a concentrated debt maturity profile, the region has manageable refinancing risks due to moderate debt levels, sound liquidity and access to federal loans. For 2017 refinancing needs are limited to RUB4.5 billion (26% of total outstanding debt), which is fully covered by cash reserves.

The ratings also consider the following rating factors:

Strong but Concentrated Economy
Lipetsk Region has a fairly well-developed industrialised economy with a focus on the ferrous metallurgy sector, supporting wealth metrics above the national median. In 2016, gross regional product grew 2.2%, which is better than the wider Russian economy (a 0.4% fall). The ferrous metallurgy sector contributed 58% of the region's industrial output and around 37% of total tax proceeds in 2016, making the regional economy vulnerable to fluctuations in the domestic and international steel markets.

Weak Institutional Framework
Fitch views the region's credit profile as being constrained by the weak Russian institutional framework for sub-nationals, which has a shorter record of stable development than many of its international peers. The predictability of Russian local and regional governments' budgetary policy is hampered by the frequent reallocation of revenue and expenditure responsibilities within government tiers.

RATING SENSITIVITIES
An operating margin sustainably above 15%, accompanied by sound debt metrics with a direct risk-to-current balance (2016: 3.6 years) being in line with the weighted average debt maturity profile (2016: 2.5 years), would lead to an upgrade.

Growth of direct risk, accompanied by deterioration in the operating margin leading to debt payback to above 10 years on a sustained basis, would lead to a downgrade.

Company: Lipetsk region

Full company nameLipetsk region
Country of riskRussia
Country of registrationRussia

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