ALBERTA, PROVINCE OF

Transcription

1 CREDIT OPINION 2 August 207 ALBERTA, PROVINCE OF Update Following Assignment of Short-Term Debt Rating Update Summary Rating Rationale The Aa long-term debt rating assigned to the Province of Alberta reflects () strong debt affordability; (2) important holdings of cash and investments which provide liquidity security; and (3) fiscal flexibility to enact spending and tax measures. These positives are offset by (4) continued deep deficits with a lengthy and uncertain return to balance; () a rapidly rising debt burden to finance deficits and capital infrastructure; and (6) exposure to volatility in oil prices. RATINGS Alberta, Province of Domicile Canada Long Term Rating Aa Type Senior Unsecured - Fgn Curr 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. Alberta continues to face several years of large budgetary deficits along with a rapid accumulation of debt. Despite favourable economic trends, fiscal recovery over the next two years will slow relative to our previous expectations, although the province has not deviated from its target to return to balance by Revenues will remain pressured as oil prices are expected to recover only gradually but will remain below historic highs. High population growth for over a decade has broadened the province s tax base but also makes it difficult for Alberta to cut back on investments in infrastructure. Exhibit Large deficits and capital spending drive the rise of Alberta's debt burden Contacts Adam Hardi CFA AVP-Analyst adam.hardi@moodys.com Michael Yake VP-Senior Analyst michael.yake@moodys.com Alejandro Olivo Associate Managing Director alejandro.olivo@moodys.com David Rubinoff MD-Sub Sovereigns david.rubinoff@moodys.com $80.0 Net debt (CAD billions) [Left] Net debt as a % of total revenue [Right] 60.0% $ % $ % $ % $ % $ % $ % $ % $- 0.0% F 209F Source: Moody's; Alberta budget and financial statements National and International Peer Comparisons Alberta is rated in the upper half of Canadian provinces, whose ratings remain in a narrow range of Aaa to Aa3. Alberta's net direct and indirect debt is expected to rise quicker than

2 peers given the anticipated large deficits and sizable capital spending program. The province continues to demonstrate a high dependence on natural resources, which introduces greater than average volatility into revenue planning than other provinces. Credit Strengths Strong, but declining, liquidity cushion Fiscal capacity to raise revenues Institutional framework providing a high level of policy flexibility Credit Challenges Economic improvement that remains dependent on oil recovery Prolonged large deficits and continued debt accumulation Contingent liability risk Rating The outlook is negative reflecting the risk to economic and fiscal recovery given larger ongoing deficits, increasing debt burden and uncertainty around the recovery in oil prices and production. Factors that Could Lead to an Upgrade Given the negative outlook, an upgrade in the rating in the near term is unlikely. The outlook could be revised back to stable if the province successfully contained deficits and stabilized debt accumulation, leading to stronger than expected outcomes. Factors that Could Lead to a Downgrade Failure by the province to successfully contain its deficits, resulting in greater than expected debt accumulation Weaker than anticipated liquidity levels A material deterioration in the financial health of ATB Financial, increasing the risk that the province would be required to recapitalize the entity Key Indicators Exhibit 2 (Year Ending March 3) F 209F Net Direct and Indirect Debt as a % of Revenues Net Direct and Indirect Debt as a % of GDP Cash Financing Surplus (Requirement) as a % of Revenues (6.) (.) (26.3) (33.) (36.) (30.9) Consolidated Surplus (Deficit) as a % of Revenues (0.6) 2.3 (.) (2.4) (23.0) (20.4) (3.6) (2.8) Total Interest Expense as a % of Revenues Intergovernmental Transfers as a % of Revenues Real GDP Growth (%) [] [] Corresponds to calendar year. 206 and subsequent GDP figures represent forecasts. Source: Moody's Investors Service, Alberta financial statements 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 2 August 207

3 Baseline Credit Assessment The Province of Alberta's Aa rating combines () a baseline credit assessment (BCA) of aa2, and (2) a high likelihood of extraordinary support coming from the Government of Canada (Aaa stable) in the event that the province faced acute liquidity stress. Recent Developments On 7 July 207 Moody s assigned a P- foreign currency, short-term debt rating to the province s new USD6 billion commercial paper notes program. The P- rating reflects the province s sizeable liquidity sources, which comprise approximately 2% cash and equivalents and 7% portfolio investments. Readily available liquidity sources, including more than CAD0 billion in cash and cash equivalent securities, fully cover the province's ongoing short-term liquidity needs and debt servicing costs, supporting the P- rating. Detailed Rating Considerations STRONG, BUT DECLINING, LIQUIDITY CUSHION The province currently maintains nearly CAD4 billion in liquidity, including CAD0.3 billion in cash and cash equivalent securities, the CAD.4 billion (book value) Heritage Savings Trust Fund and the CAD2.2 billion Contingency Account. The Contingency Account, which was expected to be depleted last year, is now expected to be fully drawn down during in order to finance the province's operating deficit, and will not be replenished until the province returns to a surplus position. We do not anticipate that the province will tap into the Heritage Fund, a long-term savings fund created to invest a portion of Alberta's oil revenues for the benefit of future generations. In recent years, however, the fund's net income has been used to support program expenses. Alberta s liquidity buffer provides the province with a cushion against a period of lower oil prices, protracted budgetary deficits and increasing debt. Liquidity metrics relative to debt have declined since 204- and we expect additional declines over the 3 year budget horizon. For 206-7, cash and investments, net of sinking funds, covered 2% of net debt and 76% of expenditures, down from 270% of net debt and 84% of expenditures in Despite our projection that these ratios will weaken over the next 2-3 years, they will continue to compare favourably against provincial peers. FISCAL CAPACITY TO RAISE REVENUES Alberta has leeway to address its fiscal problems through revenue measures. In 20, the government increased the corporate income tax rate to 2% from 0%, and introduced a progressive tax system for personal incomes above CAD2,000 (but maintained a 0% flat personal income tax rate under CAD2,000). To ease the reliance on oil royalty revenues, which historically supported expenditure growth during periods of high oil prices, the province has taken steps to raise tax revenues, including raising the income tax brackets and introducing a carbon levy. The carbon levy is expected to generate a combined CAD3.9 billion over the next three years. Alberta s tax regime remains competitive relative to the majority of its provincial peers which affords it significant fiscal flexibility. However, we note that the province has been reluctant to fully utilize its taxation powers through other tax measures, including implementing a provincial sales tax. INSTITUTIONAL FRAMEWORK PROVIDING A HIGH LEVEL OF POLICY FLEXIBILITY Alberta, like all Canadian provinces, enjoys significant flexibility in its financial management. Compared with 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 with substantial flexibility to meet fiscal challenges. As such, Canadian provinces benefit from a high degree of fiscal policy flexibility that is more akin to that of sovereign governments than to many of their international subsovereign peers. These positive institutional factors increase Canadian provinces' ability to manage through economic downturns and handle relatively high debt burdens. ECONOMIC IMPROVEMENT THAT REMAINS DEPENDENT ON OIL RECOVERY Although Alberta s real GDP is forecasted to grow between 2.2% and 2.6% in the medium term, economic growth remains in large part dependent on the recovery in the natural resources sector, including an expectation of rising oil prices and production. 3 2 August 207

4 Alberta had been the growth engine of Canada for a substantial period of time driven by a buoyant oil industry and resulting high population growth which supported household spending, housing markets, employment and residential construction. Over the last two years, a period of declining oil prices that stabilized at below historical levels has significantly slowed Alberta s growth. Consequently, Alberta's oil revenues declined as a share of consolidated revenue since 204. For 206-7, oil revenues made up.2% of consolidated revenue, significantly below its % historical pre-204 average. Alberta maintains one of the largest oil reserves in the world, with proven oil sands reserves in excess of 60 billion barrels. Consistent with the forecast of a gradual recovery in oil prices, oil production and exploration activity is expected to remain an important component of the province's economy across the medium-term. As several large scale investment projects are expected to mature including the Suncor Fort Hills and CNRL Horizon Phase 3 projects, daily oil production is expected to increase by approximately 600,000 barrels over the next two years. PROLONGED LARGE DEFICITS AND CONTINUED DEBT ACCUMULATION The province continues to forecast large deficits over its three-year budget horizon, with deficits averaging CAD0 billion over the next two years, declining to CAD7.2 billion in The reduction in the deficit is largely dependent on the province s expectation of a material recovery in non-renewable resource revenue. The province expects to balance its budget by The projected deficits include an annually increasing risk adjustment buffer to reflect oil price volatility, which provides a cushion against the province s forecasted WTI crude oil prices of USD/barrel in 207-8, rising to USD68/barrel by We continue to see risk that the province could face difficulties in achieving the necessary expenditure controls or that a slower than expected oil price recovery may further pressure budgeted fiscal outcomes over the next few years. The province will borrow CAD20.7 billion during the budget horizon of to in order to finance the projected operating deficits. Additionally, it will borrow CAD7.9 billion during this period to finance its ambitious capital plan. As a result, we expect that Alberta's net direct and indirect debt will grow significantly faster than the majority of its provincial peers, and will exceed 20% of GDP and 40% of revenue by , up from 8% of GDP and 60% of revenue in CONTINGENT LIABILITY RISK Alberta faces some contingent liability risk via its provincially owned entity, ATB Financial. Although the province guarantees ATB s debt of around CAD3.8 billion and customer deposits, we view ATB as a self-supporting entity, and its debt is not included in Alberta's debt metrics. ATB has experienced strong growth in its loan portfolio in recent years. However, over the last two years the loan portfolio showed signs of deterioration resulting in increased loan impairments and loan loss provisions, reflecting Alberta's weakened economic environment and the impact of lower oil prices on ATB's energy portfolio. At December 3, 206, ATB s gross impaired loans increased to.7% of the total loan portfolio, up from.% a year earlier. Despite the weakening, impairments are at a relatively low level. ATB Financial would likely be reliant on the province in a period of financial stress, and as a result the provincial guarantee of ATB s obligations may pose stress on the province s level of cash and investments. Furthermore, ATB s lending activities have led to an increased use of collateralization. As ATB s debt is currently not included in our calculation of the province s net direct and indirect debt, the negative outlook partly reflects the increased risk that ATB may require capital injection from the province. The province also has unfunded pension liabilities of CAD0 billion for (23.6% of revenues). Nevertheless, the pension liability has gradually declined over the past few years as the province implemented various measures to contain future pension liability growth and pension contributions such as increasing the age of retirement post 20 or increasing early retirement penalties. We expect that Alberta will continue to proactively manage its pension liabilities. Extraordinary Support Considerations Moody's assigns a high likelihood that the federal government (Canada, rated Aaa stable) would act to prevent a default by Alberta. The high likelihood of support reflects our assessment of the federal government's incentive to minimize the risk of potential disruptions to capital markets if Alberta 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 federal-provincial transfers. 4 2 August 207

5 Output of the Baseline Credit Assessment Scorecard In the case of Alberta, the BCA matrix generates an estimated BCA of aa2, the same as the rating committee's assigned BCA of aa2. The matrix-generated BCA of aa2 reflects () an idiosyncratic risk score of 3 (presented below) on a to 9 scale, where represents the strongest relative credit quality and 9 the weakest; and (2) a systemic risk score of Aaa, as reflected in the sovereign bond rating for Canada. The idiosyncratic risk scorecard and BCA matrix, which generate estimated baseline credit assessments from a set of qualitative and quantitative credit metrics, are tools used by the rating committee in assessing regional and local government credit quality. The credit metrics captured by these tools provide a good statistical gauge of stand-alone credit strength and, in general, higher ratings can be expected among issuers with the highest scorecard-estimated BCAs. Nevertheless, the scorecard-estimated BCAs 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. Scorecard results have limitations in that they are backward-looking, using historical data, while the assessments are forward-looking opinions of credit strength. Concomitantly, the limited number of variables included in these tools cannot fully capture the breadth and depth of our credit analysis. Rating Methodology and Scorecard Factors The principal methodology used in the rating is Regional and Local Governments published in January 203. Please see the Credit Policy page on for a copy of this methodology. Exhibit 3 Alberta, Province of Baseline Credit Assessment Score Value Sub-factor Weighting Sub-factor Total Factor Weighting Total Economic strength % % 0.44 Economic volatility 30% Legislative background 0% 20% 0.20 Financial flexibility 0% % %.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 (%) 0.0 2% Factor 4: Governance and Management - MAX Risk controls and financial management Investment and debt management Transparency and disclosure Idiosyncratic Risk Assessment 3.2(3) Systemic Risk Assessment Aaa Suggested BCA aa2 Source: Moody's Investors Service 2 August 207

6 Ratings Exhibit 4 Category ALBERTA, PROVINCE OF Senior Unsecured Commercial Paper ST Issuer Rating -Dom Curr Moody's Rating Aa P- P- ATB FINANCIAL Issuer Rating -Dom Curr ST Issuer Rating -Dom Curr Aa P- ALBERTA CAPITAL FINANCE AUTHORITY Bkd Senior Unsecured -Dom Curr Aa Source: Moody's Investors Service 6 2 August 207

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