Province of British Columbia (Canada)

Transcription

1 CREDIT OPINION 8 January 208 Province of British Columbia (Canada) Update to credit analysis Update Summary RATINGS British Columbia, Province of Domicile British Columbia, Canada Long Term Rating Type LT Issuer Rating Outlook Stable Please see the ratings section at the end of this report for more information. The ratings and outlook shown reflect information as of the publication date. The credit profile of the Province of British Columbia ( stable) reflects a diverse and strong provincial economy, prudent fiscal management and a high degree of flexibility to accommodate revenue and expenditure pressures. These positive elements enable the recently elected provincial government to forecast continued, although thin, balanced budgets across its three year budget horizon to 209/20. While sizeable capital expenditures continue to keep British Columbia's debt burden elevated, the extended low interest rate environment ensures that interest expense, and therefore debt affordability, remains manageable. The province s credit profile assumes that the debt burden will remain near current levels over the medium-term. British Columbia also has a Prime- (P-) rating assigned to its commercial paper program. Exhibit Rising revenue from a strong economy will help mitigate the rise in the province's debt burden Net Direct and Indirect Debt as a % of Revenue Adjusted Interest Payments as a % of Revvenue 00% 6% 90% % 80% Contacts 70% 4% 60% Adam Hardi CFA AVP-Analyst adam.hardi@moodys.com Michael Yake VP-Senior Analyst michael.yake@moodys.com 0% 3% 40% 2% 20% % 0% 0% 0% F Credit strengths CLIENT SERVICES» Budgeted surpluses despite pressures in the natural resources sector Asia Pacific Japan EMEA F Source: Moody's Investors Service, British Columbia budget and financial statements David Rubinoff MD-Sub Sovereigns david.rubinoff@moodys.com Americas 209F» Continued economic growth underpinned by a strong and diversified economy» Prudent fiscal management and planning» Considerable fiscal policy flexibility to adjust revenues and expenses to meet fiscal challenges Credit challenges» High debt burden with continued financing pressures from capital expenditures» Growing contingent liability of BC Hydro given its constrained financial strength

2 Rating outlook The outlook is stable reflecting our assumption of continued surpluses across the medium-term and continued affordable debt burden. Factors that could lead to a downgrade The province's credit rating could be downgraded if net direct or indirect debt were to be sustained above 9% of revenue across multiple years, impairing the fiscal flexibility of the province. In addition, a loss in fiscal discipline and a return to consecutive deficits or a deterioration of debt affordability due to a faster than expected rise in interest rates would also exert downward pressure on the rating. Key indicators Exhibit 2 Province of British Columbia (Year Ending 3/ 3) F Net Direct and Indirect Debt as a % of Revenue Net Direct and Indirect Debt as a % of GDP Cash Financing Surplus (Requirement) as a % of Revenue Consolidated Surplus (Deficit) as a % of Revenue Adjusted Interest Expense as a % of Revenues Intergovernmental Transfers as a % of Revenue Real GDP Growth (%) [] [] Corresponds to calendar year Source: Moody's Investors Service, British Columbia financial statements and 207/8 Budget and Quarterly Updates Detailed credit considerations Baseline credit assessment The credit profile of the Province of British Columbia, as expressed in its stable rating, combines a baseline credit assessment (BCA) for the province of aaa, and a high likelihood of extraordinary support coming from the Government of Canada ( stable) in the event that the province faced acute liquidity stress. Continued economic growth underpinned by a strong and diversified economy British Columbia is the third largest Canadian province by population and fourth largest provincial economy. Located on Canada's western coast, British Columbia is an important hub for goods shipped to and from Asia, and as a result the export markets of British Columbia are more diversified than Canada and other provinces. While Canada typically sees over three-quarters of exports flow to the US, this market accounts for slightly over half of British Columbia exports. Other key markets for the province include China (%), Japan (0%) and other Asian countries (0%). This wide diversification of sectors and markets reduces the vulnerability of the provincial economy from sector-specific or trading partner-specific shocks, including uncertainty with US trade policies including NAFTA negotiations. The average real GDP growth rate for outpaced the growth rates of all provinces and Canada. The province expects real GDP growth of 2.9% for 207 and 2.% for 208. In 206 there were eight different industries that each accounted for a minimum of % of provincial GDP, with finance, insurance and real estate representing the highest concentration at a combined 24%. British Columbia s economic strength including strong GDP growth and low unemployment, along with a level of taxation that is at the lower end of Canadian provinces, represent important credit positive elements of the rating. The large and diverse economy provides the province with a large base on which to apply a productive tax base, ensuring that provincial revenues are not strongly impacted by a decline in one particular sector. Furthermore, the current low tax environment offers British Columbia the flexibility to raise taxes if revenues were to fall below expected levels while still remaining competitive with other jurisdictions. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history. 2 8 January 208

3 Budgeted surpluses despite pressures in the natural resources sector In September 207, the newly elected provincial government presented an update to the previous government's February 207 budget plan which highlights the new government s social priorities for revenue generation and spending initiatives. In the updated budget, the province anticipates continued consolidated surpluses over the next three years, although surpluses are forecasted to be thin and averaging 0.% of revenues (after forecast allowances). The province forecasts that revenue growth will average.4% annually over the next three years building on a combination of previously announced and new measures. Fiscal results will be driven by a combination of higher corporate, sales and property tax revenues - supported by the introduction of a new tax bracket for high income earners, raising the corporate income tax rate by percentage point, and increasing carbon tax rates - against weaker personal income and property transfer tax and natural resource revenues. Over the previous two years, the province contributed CAD00 million into the BC Prosperity Fund, a fund that was initially planned to receive revenues from liquified natural gas related activities. While no further transfers to the fund are currently budgeted for by the new government, transfers may still be authorized by the Treasury Board depending on the final surplus results in future years. The long-term goals of the BC Prosperity Fund are to reduce the province's debt over time, establish a long-term legacy fund and to help fund investments in key areas of public policy. Given existing restrictions on wage growth negotiated under the previous government, total expenditure growth has been reduced from an average annual increase of 4.8% during the period to 2.9% over the period Over the next three years, the province forecasts that expenditures will grow by an average 2.9% annually, although much of the increase is front-end loaded to 207/8, reflecting the new government's social spending priorities in the education, healthcare and housing sectors and in poverty reduction, which are areas of government s heightened focus. Expenditure growth also reflects unanticipated expenditures incurred to fight forest fires this year. Although diversified, the economy of British Columbia has an important natural resource sector, primarily natural gas and forestry products. Over the past decade, natural resources revenues as a share of total revenue fell significantly, from above 0% to only.3% in 206/7. Despite increasing natural gas royalties, the province expects that total natural resource revenues will fall by an average 6.6% over the next three years. The latest Softwood Lumber Agreement (SLA) with the US, which was signed in 2006, expired in October 20, and a further one year moratorium on duties expired in October 206. In November 207 the US government imposed duties on Canadian softwood lumber exports ranging from 0% to 24%. The new duties and the lack of a renewed SLA agreement has created pressure and uncertainty in the provincial forestry industry, and any additional economic challenges related to this will persist until a new agreement is reached. Prudent fiscal management and planning British Columbia incorporates several measures of prudence into its annual budget to minimize the impacts of potential downward pressures. The province has adopted economic growth forecasts in its budget, including real GDP growth and natural gas prices, that are below private sector consensus forecasts. This is partly explained by the province's ongoing practice of not including potential growth factors until they are firmly in place, which allows it greater flexibility to accommodate potential negative economic shocks. The province incorporates additional safeguards into its budget forecasts, including forecast allowances and contingencies. Forecast allowances reflect potential volatility to fiscal projections, including revenue volatility. Currently these levels are CAD300 million for each of 207/8 and 208/9, increasing to CAD30 million in 209/20. In addition, contingencies allow the province to build into its budget amounts for unexpected pressures on both the revenue and expense side. Contingencies are budgeted at CAD600 million for 207/8, CAD300 million for 208/9 and CAD30 million for 209/20. Combined, the forecast allowances and contingencies significantly exceed the projected surpluses, and provide the province with a financial cushion while still allowing the targeted outcomes to be achieved. 3 8 January 208

4 Considerable fiscal policy flexibility to adjust revenues and expenses to meet fiscal challenges The Province of British Columbia, like all Canadian provinces, enjoys significant flexibility in its financial management. Compared to their counterparts in other countries, such as the German Länder and the Australian states, Canadian provinces enjoy far greater autonomy in terms of both the spending and revenue sides of their budgets. Unfettered access to a broad range of tax bases and the ability to alter expenditure programs provide Canadian provinces such as British Columbia with substantial flexibility to meet fiscal challenges. High debt burden with continued financing pressures from capital expenditures The province's net direct and indirect debt relative to revenues measured 78.6% as of March 3, 207. Although British Columbia s debt burden has been modestly declining since 204 since the province no longer requires debt to finance operations, debt accumulation will continue across the budget horizon to finance sizeable capital expenditures. Over the three year budget horizon, we expect that debt burden will gradually increase to 88.9% by 209/20, a level we consider elevated but below the recent high of 9.% in 203/4. The higher debt burden also reflects the reclassification of CAD3. billion debt from self-supporting to taxpayer-supported debt following the elimination of bridge tolls in August 207. Total capital spending under the newly elected government will equal CAD23. billion over the budget forecast period 207/8 209/20. Taxpayer supported capital spending is expected to consume just under two thirds of capital expenses, while slightly over one third is expected to be spent on power and infrastructure projects amongst the province's self-supporting entities. Of the total capital spending, approximately half, or CAD.7 billion, will be financed by new borrowing, although we anticipate that the province s net direct and indirect debt will increase by only CAD7.3 billion over the next three years once adjustments are made for self-supporting debt and debt retirement. Concern of the continued elevated debt burden is mitigated by the manageable level of interest expense. Despite recent rate increases, the level of interest rates remains low and the province continues to be able to lock in debt at low rates. Overall, we view British Columbia's debt burden as affordable over the rating horizon. Furthermore, adjusted interest payments, which are forecasted to consume 3.4% of revenues in 207/8, are expected to remain relatively stable over the planning horizon - a level that remains lower than most Canadian provinces and preserves a high degree of fiscal flexibility. Growing contingent liability of BC Hydro given its constrained financial strength The province issues debt on behalf of BC Hydro, the wholly-owned electric utility company of British Columbia. Given its steady revenue stream that generates sufficient cash flow to support operations including interest payments, we view BC Hydro as a selfsupporting entity and therefore exclude the related debt from our net debt metrics of the province. We note, however, that BC Hydro's total reported debt has risen considerably since 2008, increasing from CAD8. billion as of March 3, 2008 to about CAD22 billion as of September 30, 207. Further, BC Hydro s debt is expected to continue to rise over the next several years as the utility moves forward with the construction of the Site C hydroelectric dam with a recently revised cost estimate in excess of CAD0 billion (revised from the previous CAD8.3 billion). With the provincial government s recent decision to move ahead with the construction of the project, the anticipated increase in debt continues to pressure the province s rating since it increases the Province s contingent liability.. BC Hydro has low rates relative to its peers, giving it the flexibility to increase revenues through rate increases (if approved by the regulator) to continue to support its operations and debt obligations. However, some of the utility s financial metrics are among the weakest of Canadian provincial utilities and the use of largely debt financed regulatory asset accounts puts pressure on the balance sheet. In addition, a proposed rate freeze, if implemented, would negatively impact BC Hydro s financial health. However, with the province gradually phasing out the level of dividends it will require BC Hydro to pay (reducing by CAD00 million each year starting in 207/8 until a floor of zero is reached), the utility will be in a better position to reinvest its net income into its own operations. Furthermore, the current 0-year rates plan allows for the full or partial recovery of almost all of the regulatory accounts, with the exception of the accounts for Site C which will be recovered only once the projects come into service. Should BC Hydro's financial position deteriorate, the possibility that it would require some support from the province will increase, which could alter our assessment of the self-supporting status of the utility. We will continue to monitor BC Hydro's financial strength over the coming years through the construction and initial operations of Site C. 4 8 January 208

5 Extraordinary Support Considerations While British Columbia's baseline credit assessment of aaa already places the province in the rating bracket, Moody's also considers the likelihood of extraordinary support coming from the federal government (Canada, stable) to prevent a default by the province, should this extreme situation ever occur. The high likelihood of support reflects Moody's assessment of the federal government's incentive to minimize the risk of potential disruptions to capital markets if British Columbia or any province were to default. It also indicates a moderately positive federal government policy stance as illustrated by the flexibility inherent in the system of federalprovincial transfers. Rating Methodology and Scorecard Factors The assigned BCA of aaa is close to the scorecard-indicated BCA of aa. The scorecard-indicated BCA of aa reflects (i) an idiosyncratic risk score of 2 (presented below) on a to 9 scale, where represents the strongest relative credit quality and 9 the weakest; and (ii) a systemic risk score of, as reflected in the sovereign bond rating for Canada. For details about our rating approach, please refer to Rating Methodology: Regional and Local Governments, 6 January 208. Exhibit 3 Province of British Columbia Baseline Credit Assessment Score Value Sub-factor Weighting Sub-factor Total Factor Weighting Total Economic strength % % 0.76 Economic volatility Legislative background 0% 20% 0.20 Financial flexibility 0% Scorecard Factor : Economic Fundamentals Factor 2: Institutional Framework Factor 3: Financial Performance and Debt Profile Gross operating balance / operating revenues (%) % Interest payments / operating revenues (%) % Liquidity Net direct and indirect debt / operating revenues (%) % 2% Short-term direct debt / total direct debt (%) % Factor 4: Governance and Management - MAX Risk controls and financial management Investment and debt management Transparency and disclosure Idiosyncratic Risk Assessment 2.09(2) Systemic Risk Assessment Suggested BCA aa Source: Moody's Investors Service Ratings Exhibit 4 Category BRITISH COLUMBIA, PROVINCE OF Outlook Issuer Rating Senior Unsecured Commercial Paper Other Short Term Moody's Rating Stable P- (P)P- Source: Moody's Investors Service 8 January 208

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7 CLIENT SERVICES 7 Americas Asia Pacific Japan EMEA January 208