Fitch Affirms Canton of Zurich at 'AAA'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed the Canton of Zurich's (Zurich) Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AAA' with Stable Outlooks and Short-term foreign currency IDR at 'F1+'.
The affirmation reflects Zurich's high degree of fiscal autonomy and corresponding leeway on tax rate adjustments, its wealthy and dynamic economy and its track record of sound financial performance and flexibility. It also considers the weaker budgetary performance expected in 2016-2019 and increasing debt burden. The Stable Outlooks reflect our expectations that the canton's core debt and financial ratios will remain well in line with its 'AAA' rating.
KEY RATING DRIVERS
The canton's ratings are driven by its strong tax autonomy and cautious financial management, as well as its solid and diversified economy and still strong debt and debt servicing ratios supported by a prudent history of financial performance. They also take into account the canton's vulnerability through the economic cycle and its high level of contingency liabilities, albeit with limited real risk exposure.
Based on interim results, the canton's 2015 financial performance is slightly below budget. Driven by tax revenues that were CHF91m below budget and not achieving the central savings of CHF100m envisaged in the financial department, the canton may need to report a negative current balance of CHF96m. However, Zurich may comply with the envisaged reduction of capital expenditure of CHF210m so that the overall results may be at least balanced.
The canton's current medium-term financial plan for 2015-2019 incorporates a further decline in budgetary performance. The canton assumes a weakening of Switzerland's economy after the fixed CHF-EUR exchange rate was removed. This may correspond to lower growth in tax revenues, which may not be compensated for by adjustments in spending. The canton's government has already started implementing cost consolidation measures in order to comply with a legally required cumulated medium-term balance of its budget in 2013-2020, with some leeway in capital spending supporting these.
In its baseline scenario, Fitch assumes a negative operating margin in 2016 driven by financial revenue above interest cost a surplus of the current margin. 2017-2018 is expected to be slightly weaker before the operating margin may turn positive in 2019. The weaker budgetary performance will push the canton's self-financing rate of its investments below 100% with a likely increase in debt.
Zurich's direct risk was CHF5,524m at end-2015 (including CHF400m of short-term debt), down from CHF6,284m in 2014. At the same time, Zurich's cash and cash equivalents reduced to CHF561m from CHF1,537m. In 2014, the canton made use of the favourable interest rate environment until mid-2015 and took on short-term debt and increased its cash position. A large part of the cash was used in 2015 for funding purposes so that the direct risk increased to CHF4,963m on a net basis from CHF4,747m in 2014. The remaining cash outstanding will be sufficient to fund maturing debt in 2016 and committed credit lines ensure short-term liquidity in case of need, thus mitigating the canton's refinancing risk.
According to the canton, its medium to long-term debt is likely to consistently increase to CHF5,517m in 2019 from CHF5,124m in 2015, reflecting the decline in budgetary performance and its reduced self-financing of capex. The envisaged increase in debt will not result in a deterioration of the canton's debt and debt servicing ratios. Interest paid/operating revenue should remain below 1.0% and its direct debt servicing/current revenue is expected to peak at 8.8% in 2017 but fall back to below 3.0% in 2018-2019.
Zurich has material contingent liabilities, and net overall risk was CHF22bn at end-2014 (we assume no material changes to have taken place in 2015). Most of this relates to guaranteed obligations of the 100%-owned Zuercher Kantonalbank (AAA/Stable/F1+) and the unfunded portion of the pension fund. Recapitalisation measures should protect the canton from a future higher burden, and Fitch views these steps as prudent management. Fitch's calculations do not include the debt of the canton's public-sector entities, as we assume such debt to be entirely self-supporting.
Fitch expects Switzerland to achieve real GDP growth of 0.9% in 2015 and 1.6% (1.8%) in 2016 (2017). Due to the canton's well-diversified and dynamic economy, Zurich should mirror or even outperform national growth. However, the abolition of the EUR-CHF peg in January 2015 affected the canton's industry, trade and tourism, resulting in slower economic growth, which we expect to be sustained.
Given the canton's large tax potential and envisaged cost-cutting measures, a downgrade is currently unlikely. However, the ratings may come under pressure from a sustained period of increasing debt and corresponding weakening of debt servicing ability with a debt payback of above 20 years. A deterioration of the current balance constraining the canton's financial flexibility or contingent risk above Fitch's expectations would also result in negative rating action.
Significant changes in the cantons' financial leeway or additional financial obligations, in either the intra- or inter-cantonal context, could also be rating negative. Any negative rating action on Switzerland would trigger rating action on Zurich.