Fitch Affirms Ratings of the State of Sao Paulo; Outlook Stable

SAO PAOLO & BOGOTA, Colombia--()--Fitch Ratings has affirmed the ratings assigned to the state of Sao Paulo (Sao Paulo), Brazil. See the full list of rating actions at the end of this release.

KEY RATING DRIVERS

The affirmation of the ratings reflects Sao Paulo's solid economy, which represents one-third of Brazilian GDP. The state benefits from a sound budgetary performance, with 9.2% operating margin and a high level of fiscal autonomy, in which proprietary revenues accounted for 74.2% of operating revenues in 2012.

Also supporting the rating is the financial flexibility stemming from the fact that Sao Paulo's most important creditor is the federal government, which accounted for 95.6% of total debt in 2012. Despite presenting an upward trend in debt servicing until 2015, Fitch believes that Sao Paulo should continue its sound budgetary performance capable of absorbing this increased debt servicing. Any material deviation from that assumption would lead to a review of the ratings.

Sao Paulo's fiscal performance is very dependent on the Imposto Sobre Circulacao de Mercadorias e Servicos (ICMS) tax, which is highly correlated with the Brazilian economy. The state estimates tax revenues will expand 8% in 2013 and on average by 10% per year until 2016, which is quite challenging considering the sluggish economic prospects.

As a result of growing personal expenditures mainly from enlarged pension payments, operating margins diminished in 2012 and could be as low as 6% by 2016, according to Fitch's projections. As mitigating factors, the state is intensifying tax collection efforts, investing roughly BRL39.1 billion (USD18.3 billion) in the coming years mainly in infrastructure and implementing adjustments on the expenditure side. Fitch believes the state's cost structure is quite rigid, thus preventing further reductions.

According to the state's projections, financial debt should represent 19% of total debt by 2018. This level is still compatible with 'BBB' rated entities. The state's exposure to foreign debt corresponds to 73.9% of direct debt or BRL6.3 billion (USD2.9 billion), much lower when compared to other subnationals in Brazil, and is fully guaranteed by the federal government. There are no plans to drastically increase the external debt portion.

Pension-related expenditures correspond to some 90% of personal expenditures and could increase to 300% by 2033. This negative trend already considers that the state implemented a complementary pension system (Prevcom) in 2011. Whereas the current pension system operates under a definite benefit system, Prevcom offers a definite contribution scheme, which prevents the financial deficit from growing.

Sao Paulo plans to intensify cash advancements to private operators in light of the large amount involved in each Public Private Partnership (PPP) project. There are 29 PPP projects under way, amounting to BRL 39.1 billion (USD18.3 billion) that should be completed by 2016. Contrary to other states, the pace of investments has been relatively faster and some projects are already concluded or in advanced stages (Line 4 of the Metro, Taiacupeba water and sewage facility, and fleet modernization of Companhia Paulista de Trens Metropolitanos [CPTM] trains).

RATING SENSITIVITIES

Large expenditures that reduce Sao Paulo's operating margins to levels lower than 5% can have a negative effect on its ratings.

Located in the Southwest region of Brazil, Sao Paulo remains the most economically important state in Brazil. Despite accounting for only 2.9% of the Brazilian area and 22% of the population, Sao Paulo generated 33.1% of the national economic output in 2010, with a powerful manufacturing sector and above-average infrastructure level in relation to other states in Brazil.

Fitch has affirmed the following ratings:

--Foreign Currency Long-term rating at 'BBB'; Stable Outlook;

--Foreign Currency Short-term rating at 'F2';

--Local Currency Long-term rating at 'BBB'; Stable Outlook;

--Local Currency Short-term rating at 'F2';

--National Long-term rating at 'AA+(bra)'; Stable Outlook;

--National Short-term Rating at 'F1+(bra)'.

Additional information is available at 'www.fitchratings.com'

Applicable Criteria and Related Research:

--Tax-Supported Rating Criteria (Aug. 14, 2012);

-- International Local and Regional Governments Rating Criteria (April 9, 2013).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

International Local and Regional Governments Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=704438

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=796277

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Contacts

Fitch Ratings
Primary Analyst:
Paulo Fugulin, +55 11 4504-2206
Associate Director
Fitch Rating Brasil Ltda.
Alameda Santos 700
Sao Paulo, Brazil
or
Secondary Analyst:
Carlos Vicente Ramirez, +57-1-326-9999 ext. 1240
Senior Director
or
Committee Chairperson:
Humberto Panti, +52-81-8399-9152
Senior Director
or
Media Relations:
Jaqueline Carvalho, Rio de Janeiro, +55 21 4503 2623
jaqueline.carvalho@fitchratings.com
or
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst:
Paulo Fugulin, +55 11 4504-2206
Associate Director
Fitch Rating Brasil Ltda.
Alameda Santos 700
Sao Paulo, Brazil
or
Secondary Analyst:
Carlos Vicente Ramirez, +57-1-326-9999 ext. 1240
Senior Director
or
Committee Chairperson:
Humberto Panti, +52-81-8399-9152
Senior Director
or
Media Relations:
Jaqueline Carvalho, Rio de Janeiro, +55 21 4503 2623
jaqueline.carvalho@fitchratings.com
or
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com