Global Credit Research Credit Opinion
1 JUL 2008
Credit Opinion:Trento, Autonomous Province of
Trento, Autonomous Province of
Italy
SUMMARY RATING RATIONALE
Moody's Aaa issuer rating of the Autonomous Province of Trento reflects a Baseline Credit Assessment (BCA) of 1 on a scale of 1-21 (where 1 represents the lowest credit risk), and a moderate probability that the central
government (Aa2, stable) would act to prevent a default by the province.
The BCA of 1 incorporates Trento's well-established special legal status, wealthy economy and sound financial fundamentals, reflected in a consistently strong budgetary performance and no financial debt. It also factors in the province's limited revenue flexibility and rising indirect exposure, which, nonetheless, remains negligible.
Credit Strengths
Credit strengths of the Autonomous Province of Trento are:
Long-established special status, which ensures greater legislative and financial autonomy and offers protection from interference by the Italian government
Strong financial management, with excellent planning capacity
Recently reinforced political stability, which has boosted the pace of government efforts and driven the implementation of new strategies
Well above-average wealth levels
Ratings
Category Moody's Rating
Outlook Stable
Issuer Rating Aaa
Contacts
Analyst Phone
Massimo Visconti/Milan 39.02.9148.1100
Mauro Crisafulli/Milan
Yves Lemay/New York 1.212.553.1653
Key Indicators
Trento, Autonomous Province of
2003 2004 2005 2006 2007
Net direct and indirect debt as % of operating revenues - - 4.2 4.1 8.7
Cash financing surplus (requirement) as % of total revenues
-2.8 -3.3 0.6 0.9 -0.9
Gross operating balance as % of operating revenues 32.8 34.7 32.3 33.9 36.5
Interest payments as % of operating revenues 0.0 0.0 0.0 0.0 0.0
Intergovernmental transfers as a % of operating revenues 4.3 5.4 5.9 4.9 5.1
Capital spending as a % of total expenditures 41.8 40.2 37.7 37.6 37.4
GDP per capita as a % of national average 120.1 118.7 118.5 118.2
Sound operating performance
Absence of direct financial debt and low, although rising, indirect risk Good liquidity position, recently strengthened
Credit Challenges
Credit challenges of the Autonomous Province of Trento are:
Limited revenue flexibility, although mitigated by the province's ability to levy new local taxes Rising indirect exposure, which, however, remains negligible
Rating Outlook
Trento's stable rating outlook reflects its high degree of financial autonomy, strong financial position and good liquidity.
What Could Change the Rating - Up
-What Could Change the Rating - Down
Trento's special status and strong credit fundamentals are key factors supporting its rating. Although highly unlikely given the support of the constitutional framework, any alterations in the fundamental structure of the province's special status could prompt a negative rating change. Significantly growing exposure to indirect debt could also exert downward pressure on the rating.
DETAILED RATING CONSIDERATIONS
The rating assigned to the Autonomous Province of Trento reflects the application of Moody's Joint Default Analysis (JDA) rating methodology for regional and local governments (RLGs). In accordance with this methodology, Moody's first establishes the baseline credit assessment (BCA) for the jurisdiction and then
considers the likelihood of support that the national government would provide to prevent a default by the province, should this extreme situation ever occur.
Baseline Credit Assessment
Trento's BCA of 1 reflect the following factors:
Financial Position and Performance - Over the past few years, the Autonomous Province of Trento has displayed very good budgetary performance, in a context of solid operating margins and an excellent self-financing capacity, as reflected in the absence of direct debt on its books. Operating performance is sound on both an accrual and cash basis; gross operating margins averaged 34% of operating revenues in the 2000-2007 period. The minimal cash financing deficits recorded over the years (-0.2%) have allowed the administration to self-fund its capital investment programme without any recourse to the capital market. Unlike ordinary regions, the province benefits from a strong institutional framework - granted by its special statute - which allows it to enjoy greater financial autonomy and wider spending flexibility. Trento records a much lower weight of healthcare expenditures in its budget, compared to normal status regions in Italy, and has historically run its hospitals efficiently without incurring healthcare deficits. The province's good budgetary flexibility, high level of predictability of its revenue streams, and strict cost controls should ensure that budgetary performance remains sound in the medium term.
In an effort to improve coordination and gain efficiency in the enlarged public sector, the administration has recently revised its governance structure - developing new managerial roles with respect to key provincial functions, which were previously held in-house. Those primarily affected by the reform were the array of entities strictly correlated to the province's interventions or its funds: in particular, Cassa del Trentino SpA, for the allocation management of provincial funds; Patrimonio SpA and Itea SpA, for provincial real estate; Riscossioni SpA, for tax collection; and Centrale Acquisti, for procurement.
Moody's views positively such innovative developments as the strategic role played by these new entities support our opinion that, going forward, the province will benefit from streamlined procedure, better liquidity and debt management of the enlarged public sector. In addition, the province holds stakes in a variety of companies operating in sectors that are deemed strategic for the administration. Amongst those in which the province is the majority shareholder, none of them reported any loss in 2007.
Debt profile - Trento's consistent track record of self-financing and conservative financial management underpins the lack of direct indebtedness, which is almost unique by national and international standards. Nonetheless, Moody's observes that the province has been recently experiencing growing indirect exposure through its controlled companies, a portion of which benefit from the delegation of payment mechanism. At year-end 2007, Trento's net direct and indirect debt including the indirect exposure of the provincial public sector entities -reached roughly EUR 333 million or 9% of its operating revenues.
Governance and Management Factors - The province's financial management is highly sophisticated and is focused on maintaining high efficiency of the budgetary machine. Within a predictable operating environment, the province planning ability is excellent. Financial statements are punctual and well documented; budgetary
performance has always been accurate and better than previously budgeted thereby reflecting prudent management.
Economic Fundamentals - Trento enjoys good wealth levels with GDP per capita exceeding significantly national and EU15 averages. The province's economy accounts for around 1% of Italy's GDP and is largely focused on services, with tourism-related activities representing roughly 18% of provincial GDP. The province's economic healthiness is also mirrored in a low unemployment rate, which is in the range of 3%.
Operating Environment - The operating environment for Italian regional and local governments (RLGs) is typical of advanced industrial economies and is reflected in the country's high wealth levels, low GDP volatility and sound nation's government institutions. These characteristics suggest very low systemic risk, entailing a remote probability of RLGs defaulting because of a national crisis. The sovereign rating is currently Aa2 with a stable outlook.
Institutional Framework - The institutional framework, which encompasses the arrangements determining
intergovernmental relations and jurisdictional powers and responsibilities, is mature and developed. The province's constitutionally recognised special status enables it to benefit from a more diversified revenue structure than ordinary regions, retaining nearly all tax revenues generated and collected in its territory. Trento is constrained by limited revenue flexibility, as tax rates can only be adjusted by the central government, which also collects the taxes. This is partially mitigated by the province's ability to levy new taxes, albeit within the limits/principles set up by the State, and to set prices for services provided. Moreover, the central government cannot interfere with provincial powers without the province's consent. Trento is characterised by a well-diversified expenditure profile with limited exposure to the healthcare sector.
Extraordinary Support Considerations
Moody's rating of Aaa for the Autonomous Province of Trento reflects the BCA of 1 and a moderate probability of extraordinary support from the central government. The moderate likelihood of extraordinary support from the central government reflects the province's long-established special status of autonomy.
Moody's rating committee also assesses high default dependence for Trento, reflecting the province's low reliance on central government's transfers, its own sources of revenue similar to that of the central government, and a local economic base integrated with the national economy.
Output of the Baseline Credit Assessment Scorecard
The BCA scorecard for the Autonomous Province of Trento (presented below) generates an estimated BCA of 3, compared to the rating committee's assigned BCA of 1. The two-notch differential between the assigned BCA and the reference point generated by the scorecard is largely explained by the province's unique features, primarily the long-established special legal status that ensures wide legislative and financial autonomy and offers protection from interference by the Italian government.
The BCA scorecard, which generates estimated baseline credit assessments from a set of qualitative and
quantitative credit metrics, is a tool used by the rating committee in assessing regional and local government credit quality. The credit metrics captured by the scorecard provide a good statistical gauge of stand-alone credit strength; however, the estimated BCAs generated by the scorecard do not substitute for rating committee judgments regarding individual baseline credit assessments, nor is the scorecard a matrix for automatically assigning or changing these assessments. Concomitantly, scorecard results have limitations in that they are backward-looking, using historical data, while the assessments are forward-looking opinions of credit strength. Moreover, the limited number of variables included in the scorecard cannot fully capture the breadth and depth of our analysis. Nevertheless, the performance statistics captured in the scorecard are important and, in general, higher ratings can be expected among issuers with the highest rankings from the scorecard.
ABOUT MOODY'S SUB-SOVEREIGN RATINGS
National and Global Scale Ratings
Moody's assigns national scale ratings in certain local capital markets in which investors have found the global rating scale provides inadequate differentiation among credits or is inconsistent with a rating scale already in
common use in the country. Moody's National Scale Ratings are opinions of the relative creditworthiness of issuers and issues within a particular country. While loss expectation will be an important differentiating factor in the ultimate rating assignment, it should be noted that loss expectation associated with National Scale Ratings can be expected to be significantly higher than apparently similar rating levels on Moody's global scale. Moody's National Scale Ratings rank issuers and issues in order of relative creditworthiness: higher ratings are associated with lower expected credit loss.
National Scale Ratings can be understood as a relative ranking of creditworthiness (including relevant external support) within a particular country. National Scale Ratings are not designed to be compared among countries; rather, they address relative credit risk within a given country. Use of National Scale Ratings by investors is only appropriate within that portion of a portfolio that is exposed to a given country's local market, taking into
consideration the various risks implied by that country's foreign and local currency ratings. The Moody's Global Scale rating for issuers and issues in local currency allows investors to compare the issuer's/issue's
creditworthiness to all others in the world, rather than merely in one country. It incorporates all risks relating to that country, including the potential volatility of the national economy.
Country Ceilings for Foreign Currency Obligations
Moody's assigns a ceiling for foreign-currency bonds and notes to every country (or separate monetary area) in which there are rated obligors. The ceiling generally indicates the highest rating that can be assigned to a foreign-currency denominated security issued by an entity subject to the monetary sovereignty of that country or area. In most cases, the ceiling will be equivalent to the rating that is (or would be) assigned to foreign-currency
denominated bonds of the government. Ratings that pierce the country ceiling may be permitted, however, for foreign-currency denominated securities benefiting from special characteristics that are judged to give them a lower risk of default than is indicated by the ceiling. Such characteristics may be intrinsic to the issuer and/or related to Moody's view regarding the government's likely policy actions during a foreign currency crisis. Baseline Credit Assessment
Moody's baseline credit assessment incorporates the government's intrinsic credit strength and accounts for ongoing operating subsidies and transfers from the supporting government. In effect, the baseline credit assessment reflects the likelihood that a local government would require extraordinary support.
Extraordinary Support
Extraordinary support is defined as action taken by a supporting government to prevent a default by a regional or local government (RLG) and could take different forms, ranging from a formal guarantee to direct cash infusions to facilitating negotiations with lenders to enhance access to needed financing. Extraordinary support is described as either low (0% 30%), moderate (31% 50%), high (51% 70%), very high (71% 95%) or fully supported (96% -100%).
Default Dependence
Default dependence reflects the likelihood that the credit profiles of two obligors may be imperfectly correlated. Such imperfect correlation, if present, has important diversifying effects which can change the joint-default outcome. Intuitively, if two obligors' default risks are imperfectly correlated, the risk that they would simultaneously default is smaller than the risk of either defaulting on its own.
In the application of joint-default analysis to RLGs, default dependence reflects the tendency of the RLG and the supporting government to be jointly susceptible to adverse circumstances leading to defaults. Since the capacity of the higher-tier government to provide extraordinary support and prevent a default by an RLG is conditional on the solvency of both entities, the more highly dependent -- or correlated -- the two obligors' baseline default risks, the lower the benefits achieved from joint support. In most cases, the close economic links and/or overlapping tax bases and/or close intergovernmental fiscal arrangements between different levels of government result in a moderate to very high degree of default dependence.
Default dependence is described as either low (0% - 30%), moderate (31% - 50%), high (51% - 70%) or very high (71% - 100%).
Rating Factors
Trento, Autonomous Province of
Baseline Credit Assessment Sub-Factor Sub-Factor Factor Total
Scorecard - 2006 Value Score Weighting Total Weighting
National GDP per capita (PPP basis, $US) 29,944 1 50.0%
National GDP Volatility (%) 3.1 3 25.0% 3.50 50.0% 1.75
National Govt Effectiveness Index (World Bank) 0.38 9 25.0%
Factor 2: Institutional Framework
Predictability, Stability, Responsiveness 1 1 50.0%
Fiscal Flexibility (A): Own-Source Revenues 7.5 7.5 16.7% 2.09 10.0% 0.21
Fiscal Flexibility (B): Spending 1 1 16.7%
Fiscal Flexibility (C): Extent of Borrowing 1 1 16.6%
Factor 3: Financial Position & Performance
Interest Payments/Operating Revenue (%) 0.0 1 25.0%
Cash Financing Surplus(Req)/Total Revenue (%) 0.2 6 25.0% 3.50 10.0% 0.35
Gross Operating Balance/Operating Revenue (%) 33.6 1 25.0%
Net Working Capital/Total Expenditures 8.5 6 25.0%
Factor 4: Debt Profile
Net Direct and Indirect Debt/Operating Revenue (%) 4.1 1 66.7%
Short-Term Direct Debt/Direct Debt (%) 0.0 1 33.3% 5.00 10.0% 0.50
4 Yr Trend in Net Direct & Indirect Debt/Op Rev (%) 4.1 12 33.3%
Factor 5: Governance & Management
Fiscal Management 1 1 40.0%
Investment & Debt Management 1 1 20.0%
Transparency & Disclosure (A) 1 1 15.0% 1.98 10.0% 0.20
Transparency & Disclosure (B) 7.5 7.5 15.0%
Institutional Capacity 1 1 10.0%
Factor 6: Economic Fundamentals
Regional or Local GDP pc PPP - estimated ($US) 35,300 1 100.0% 1.00 10.0% 0.10
Estimated BCA 3
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