TIDENEU senior unsecured step-up notes for an original USD366 million and a current outstanding of USD377.16 million due April 27, 2030. The bonds are rated at the same level as the province's IDRs.

 and TIDENEU senior unsecured step-up notes for an original USD366 million and a current outstanding of USD377.16 million due April 27, 2030. The bonds are rated at the same level as the province's IDRs.

KEY RATING DRIVERS

Risk Profile: 'Vulnerable'

The risk profile for PN, like other Argentine subnationals, is 'Vulnerable' and captures Fitch's view of very high risk relative to international peers that the issuer's ability to cover debt service by the operating balance may weaken unexpectedly because of lower-than-expected revenue or expenditure above expectations, or because of an unanticipated rise in liabilities.

Revenue Robustness: 'Weaker'

The assessment considers the province's local revenue dependency on the hydrocarbon sector (highly cyclical economic activity) and the country's complex and imbalanced fiscal framework for local and regional governments (LRGs). Neuquen has a lower reliance on federal transfers from the co-participation regime, with current transfers at around 27.9% of total revenues in YE2020 being mostly transfers from a 'CCC' sovereign with a weak economic performance.

In 2020, national real GDP decreased around 10%, dragging down co-participation transfers to an estimated real-term drop of 2.5% relative to 2019. For 2021 real term GDP growth along with high inflation dynamics drove growth in transfers of federal origin as of September 2021.

Revenue Adjustability: 'Weaker'

Local revenue adjustability is low, and challenged by the country's large and distortive tax burden. The volatile and weak economic environment also limits LRG's ability to boost revenues.

Hydrocarbon royalties represented 25% of Neuquen's YE2020 revenues. Commodity-based revenues add cyclicality and volatility to the finances of Neuquen, as tax revenues are also highly concentrated in oil and gas sector. These revenues have influence of exogenous determinants, like market conditions and national regulation.

In 2020 hydrocarbon royalties grew a nominal 7.0% and local taxes 2.4%, both with a real-term decrease due to the context of low global oil prices and economic activity. In 2021, commodity price recovery and higher non-conventional oil production led to an increase of 24% in provincial oil production as of September, while gas production has remained on a flatter trajectory due to infrastructure needs to increase production.

Expenditure Sustainability: 'Weaker'

Argentine provinces have high expenditure responsibilities and the country's fiscal regime is structurally imbalanced regarding revenue-expenditure decentralization. Due to the coronavirus pandemic in 2020, operating expenditure (opex) grew above operating revenues resulting in a lower operating balance of 4% of operating revenues (2019: 8.6%). Neuquen is among the provinces that did not transfer their pension scheme to the nation, thus when considering the weight of this additional burden the operating balance results in 0.5%.

For 2021-2023 Fitch estimates the province's operating balance will average around 6.8%. Budgetary risks remain, including the growing pension deficit weight and salary adjustment pressures due to structurally high inflation, weakening expenditure predictability.

Expenditure Adjustability: 'Weaker'

Neuquen's ratio of staff expenses in its opex structure is high at 70.3%; with opex totaling around 86.2% of total expenditure. On average only a low 2016-2020 10.2% of total expenditure corresponds to capex. Due to high infrastructure needs, there is not much leeway to adjust capex as infrastructure works are relevant for hydrocarbon sector development.

Liabilities and Liquidity Robustness: 'Weaker'

During 2020, Neuquen executed a distressed debt exchange (DDE) process and restructured most of its foreign currency debt, including its senior secured TICADE notes, senior unsecured TIDENEU notes, and a loan with Credit Suisse. In YE2020 direct debt totaled ARS105.8 billion, mostly denominated in foreign currency, and total debt grew 40% relative to 2019 mainly due to currency depreciation. In September 2021, debt totaled ARS127.9 billion.

Despite the obtained debt relief for 2021-2022, in the short to medium term liquidity and refinancing risks remain considering the outstanding amount of treasury bill issuances of ARS14.4 billion as of September 2021. Neuquen's fiscal debt burden ratio was of 72.6% in YE 2020, and the province's debt service coverage levels averaged 0.5x the operating balance during 2016-2020 and are projected to hover around 0.7x in 2021-2023.

Neuquen's TICADE notes are secured with hydrocarbon royalties, which are linked to the U.S. dollar and payable monthly in Argentine pesos. TICADE's 2021 coverage levels have been above the transaction's 1.35x required level.

Liabilities and Liquidity Flexibility: 'Weaker'

For liquidity, Argentine provinces rely mainly on their own unrestricted cash. For cash imbalances, Neuquen has issued short to medium term Treasury bills. At YE 2020 Neuquen's unrestricted cash totaled ARS6.3 billion with a 0.5x liquidity coverage ratio reflecting a very tight and volatile liquidity position. According to law No. 3269 that will be effective Jan. 1, 2022, the province intends to create a stabilization and development fund that will include an anticyclical sub-fund.

Debt sustainability: 'bbb' category

In Fitch's rating case (2021-2023) the primary metric of payback will be between 9x-13x with a score of 'a', reflecting the province's weak operating balances. The actual debt service coverage ratio (ADSCR) will continue to be close to or below 1.0x; a 'b' score, resulting in a 'bbb' assessment due to an override of the weaker ADSCR.

DERIVATION SUMMARY

Neuquen's 'cc' SCP is derived from a 'Vulnerable' risk profile and 'bbb' debt sustainability score. The SCP considers comparison with peers, including the Municipality of Cordoba and the Provinces of Chubut and La Rioja. Fitch does not apply any asymmetric risk or extraordinary support from upper-tier government.

Fitch classifies Province of Neuquen as a type B LRG, as it covers debt service from cash flow on an annual basis.