December 20, 2017 / 10:15 PM / 3 months ago

Fitch Affirms Province of British Columbia, Canada's Rating at 'AAA'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, December 20 (Fitch) Fitch Ratings has affirmed the Province of British Columbia's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'AAA' and Short-Term IDR at 'F1+'. Fitch has also affirmed the province's senior unsecured long- and short-term debt at 'AAA' and 'F1+', respectively. The Rating Outlook is Stable. SECURITY --Senior unsecured obligations of the province. KEY RATING DRIVERS BROAD ECONOMY, STEADY GROWTH: British Columbia's diverse economy continues its steady pace of economic growth, ahead of most other provinces. Labor market conditions remain solid, and the recently elected provincial government is forecasting modest GDP growth, albeit at below pre-recession rates. Prudently, the government's updated fiscal plan (Budget 2017 Update) includes expense contingencies and forecast allowances around cautious economic forecasts to ensure the provincial budget remains balanced. COMMITMENT TO FISCAL BALANCE: British Columbia's new government released an updated three-year fiscal plan in September that maintains balanced budgets with modest surpluses for fiscals 2018 to 2020. Budget 2017 Update includes various tax and fee policy measures, including both increases and decreases. MANAGEABLE DEBT BURDEN: The province's debt burden remains elevated but manageable with operating debt projected to be fully retired by fiscal 2020. The government projects taxpayer-supported debt-to-GDP will increase modestly through the updated three-year fiscal plan. Risks around the expected growth of self-supporting debt could pose potential rating pressure, in the event that funded projects require general government support. RATING SENSITIVITIES CONTINUED FISCAL BALANCE: British Columbia's ratings are sensitive to shifts in the province's commitment to maintaining balanced fiscal operations over the fiscal plan outlook period as economic growth continues. CONTINUED CAREFUL DEBT MANAGEMENT: The province has demonstrated prudent debt oversight. Rapid growth in debt, for example related to the currently self-supporting BC Hydro projects, could challenge credit stability if not adequately mitigated. CREDIT PROFILE A broad and steadily growing economy and conservative and prudent fiscal management offset elevated debt levels. Provincial economic performance has been generally positive since the recession, and is likely to exceed performance of most other provinces in the near to medium term. Fitch views currently forecast debt ratios, and the likely higher total provincial debt ratios to account for recent increases in BC Hydro's self-supporting Site C project, as consistent with the province's 'AAA' rating given other notable credit strengths. To maintain the rating, British Columbia will need to continue its practice of carefully managing the risk of more rapid growth in debt levels. Material project cost overruns for Site C, or other project issues, that lead to general government support could erode the province's credit standing. FISCAL DISCIPLINE YIELDS MODEST SURPLUSES Fitch considers British Columbia's financial planning and controls to be strong and institutionally embedded. These practices are key reasons for the province's track record of timely returns to fiscal balance following recessions and consistent operating surpluses during economic expansions. In Budget 2017 Update, the province estimates a fifth consecutive balanced budget in fiscal 2018 (year ending March 31). During the downturn, British Columbia ended fiscal 2010 with a deficit of approximately C$1.8 billion (approximately 5% of revenues) following five years of surplus operations. The province embarked on a successful multi-year fiscal consolidation plan and generated the first of four consecutive operating surpluses in fiscal 2014. Following May 2017 provincial elections, a new government took office this past summer (formed through an agreement between the NDP and Green parties) and presented Budget 2017 Update, a revised three-year fiscal plan, in September. For fiscal 2017, the province reported a sizable surplus of approximately C$2.7 billion (or 5% of revenues). As in prior years, this government intends to use the surplus to help pay down direct operating debt more quickly, which Fitch views positively. In Budget 2017 Update the government projects continued surpluses, but at more modest levels than last year's. Spending measures in the new plan such as elimination of tolls on the Port Mann and Golden Ears bridges, and increased education funding are offset by revenue measures such as increases to personal and corporate income taxes, and carbon taxes. The plan also eliminates the requirement that the carbon tax be revenue neutral. Fitch anticipates the government's first full budget plan to be presented next year will include additional spending and revenue policy measures. By fiscal 2020, the government projects a C$257 million surplus, equal to approximately 0.5% of revenues, and in line with the estimate included in the prior government's Budget 2017 tabled in February. Similar to Budget 2017, Budget 2017 Update includes a phase-out of the provincial sales tax on taxable electricity, at a cost of C$267 million over three years. The updated plan expands on Budget 2017's proposed reduction in medical services plan (MSP) premiums increasing the cost to C$2.8 billion over three years versus C$1.9 billion. Additional revenue measures, including those noted earlier, offset this higher cost. The government also established a taskforce with the goal of eliminating MSP premiums entirely within four years. Fitch continues to view overall healthcare spending as a key point of potential expenditure pressure for the province. Health accounts for approximately 40% of total provincial spending. Budget 2017 Update forecasts a higher average annual growth rate between fiscal 2018 and 2020 of 3.3% versus the 2.6% in Budget 2017. Fitch attributes part of the increase to increased spending to address the ongoing fentanyl (opioid) emergency. Another key factor in expense management is development of a new mandate to govern labor contracts. Most contracts settled under the prior government's Economic Stability Mandate (ESM) expire by March 2019. ESM included a 5.5% general wage increase spread over five years, with the potential for additional raises tied to the province's economic performance. Two such economic stability dividends have been paid out and a third will be paid beginning in the current fiscal year. Implementation of a new fiscally prudent mandate for expiring labor contracts will be an important factor in the province's ability to maintain fiscal balance over the medium term. Also key are prudent institutional practices. The province's practice of issuing multi-year budgets allows for long-term fiscal planning, while quarterly intra-year published updates provide management with the opportunity to address changing fiscal and economic circumstances. BUDGET INCLUDES CUSHION Importantly, the budget continues British Columbia's practice of including built-in cushions in the form of expense contingencies and forecast allowances. The total value of the contingencies, at C$1.25 billion over the three-year fiscal plan, is minor relative to the total budgets, covering approximately 1% each year, but still a meaningful cushion. Forecast allowances are a similar C$905 million over the three-year plan. Keeping with past practice, the government built its budget on economic growth slightly more conservative than the views from its panel of independent economists, the Economic Forecast Council. Budgeted real GDP growth is 0.1 percentage points (pp) lower than the council's outlook for calendar 2017 and 0.2pp lower than the outlook for 2018 through 2021, as presented in Budget 2017 Update. Contingencies, forecast allowances, and conservative economic growth assumptions are all long-standing aspects of the government's budgetary planning supporting Fitch's assessment of British Columbia's strong fiscal management. Together they provide fiscal leeway in the event of rising expenses or economic volatility. BROAD ECONOMIC BASE CONTINUES GROWTH British Columbia's overall economic profile provides a solid and diverse revenue base. The province's growth rate exceeds most peers', although it remains below the pre-recession pace. The province is a key component of Canada's overall economic profile with provincial real GDP in 2016 comprising approximately 13% of national GDP. Distribution across sectors is similar to the national distribution, indicating a well-diversified economic base. Natural resources are critical for portions of the province's vast interior, but other sectors including financial activities and education and health services, based mainly in Vancouver and other urban areas, are significantly larger components of the province's GDP. Leading up to the recession, British Columbia's growth rate outpaced national trends and the downturn was somewhat less severe in the province than for the nation as a whole. While the province's recessionary recovery was somewhat less robust than the nation's, recent performance has been stronger. In 2016, 3.5% real GDP growth exceeded the national gain of 1.4% and led all provinces. The government's forecast for 2017 and 2018 of 2.9% and 2% growth, respectively, is ahead of its national forecasts of 2.7% in 2017 and 1.8% in 2018. Fitch's September 2017 Global Economic Outlook projects more robust 3.2% national growth in 2017 and 2% in 2018. British Columbia's employment growth (measured by the Labour Force Survey) accelerated in 2016, increasing 3.2% versus 0.7% national growth. Population growth should continue, though likely at lower rates than recent years. British Columbia's current population of approximately 4.8 million is up 12% since 2007. Economic weakness in neighboring Alberta had driven inter-provincial migration into British Columbia higher but that trend has slowed as Alberta's economy has strengthened. International migration will likely support continued population gains in British Columbia. Fitch views slowdowns in the U.S. and Canadian economies as key economic risks for British Columbia. The province appears well- positioned to withstand natural resource-driven challenges at the national level given its economic diversity. Given the close linkage with the neighboring U.S. economy, unanticipated weakness there or disruptions to longstanding trade agreements could have quick and significant implications for the province's economy. Despite a more diversified export base, notably in Asia, the U.S. remains the destination for the majority of British Columbia's exports. The forecast allowances and use of a more conservative economic forecast provide a small, but important, cushion in the event economic growth stalls. Fitch also anticipates the province would take quick budgetary action to respond to significant revenue weakness beyond the allowances. Continued reductions in direct operating debt enhance the province's budgetary flexibility. WELL-MANAGED DEBT PROFILE While debt ratios are elevated, Fitch believes British Columbia's debt position is well-managed and compares favorably to that of provincial peers. The province also benefits from ample access to a well-regulated, liquid domestic capital market, as well as to multiple foreign markets including in the U.S., Eurozone, China and Australia. Taxpayer-supported debt stood at approximately 16% of GDP and 82% of revenue at the end of fiscal 2017. Total provincial debt ratios are higher at approximately 25.1% of GDP and 99.3% of revenue, and include self-supporting debt paid from non-tax revenues including utility revenues of the provincial-owned BC Hydro. Borrowing and debt levels increased during the recession and initial recovery for deficit financing and economic stimulus purposes, consistent with how Canadian provinces manage economic and revenue cyclicality. Positively, the province began reducing outstanding direct operating debt in fiscal 2015 and in Budget 2017 Update the government anticipates eliminating it entirely by fiscal 2020. Taxpayer-supported debt levels as a percent of GDP also declined in fiscal 2015 through fiscal 2017. British Columbia projects a modest increase in the ratio for the current 2018 fiscal year to 16.2% from 15.8% in 2017, mainly driven by the government's cancellation of tolls on the Port Mann Bridge. The toll elimination led to the shift of C$3.5 billion from self-supporting to taxpayer-supported debt. Taxpayer-supported debt ratios increase slowly through fiscal 2020 under the three-year fiscal plan, reaching 16.3% of GDP and 93% of revenue. While elevated, Fitch considers these levels within the province's ability to prudently manage at the 'AAA' rating level. RISKS ASSOCIATED WITH SELF-SUPPORTING DEBT Budget 2017 Update includes projections for total provincial debt remaining relatively steady at approximately 24% of GDP but increasing to 103.6% of revenues by 2020 from the current 99.3%. Fitch anticipates these levels will increase more rapidly following recent developments around BC Hydro's Site C project. This fall, the BC Utilities Commission issued reports indicating the Site C hydroelectric dam project was behind schedule and at risk of going over its nearly C$9 billion budget. Last week, the premier announced that BC Hydro will complete the Site C project with a new budget of C$10.7 billion (with C$2 billion spent to date). The project will remain a BC Hydro self-supporting project paid from utility revenues. The timing for additional debt for Site C will extend beyond the Budget 2017 Update fiscal plan, as the scheduled completion date is in 2024. The government has established additional oversight for the Site C project to contain further cost overruns; however, the project remains complex and several years from completion, leaving risk for BC Hydro and the province. Also, Fitch anticipates the government will pursue an alternative to the C$2.3 billion George Massey Tunnel replacement project it canceled earlier this year which could add to provincial debt levels. Contact: Primary Analyst Eric Kim Director +1-212-908-0241 Fitch Ratings, Inc. 33 Whitehall St. New York, NY 10004 Secondary Analyst Douglas Offerman Senior Director +1-212-908-0889 Committee Chairperson Laura Porter Managing Director +1-212-908-0575 In addition to the sources of information identified in the Tax-Supported Rating Criteria, this action was additionally informed by information from Statistics Canada and the Canada Department of Finance. 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