Fitch Affirms Queensland and QTC at 'AA'; Outlook Stable

(The following statement was released by the rating agency) Fitch Ratings-Sydney/Hong Kong-26 August 2020: Fitch Ratings has affirmed the Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) of the State of Queensland and Queensland Treasury Corporation (QTC) at 'AA'. The Outlook is Stable. At the same time, Fitch has affirmed the Short-Term Foreign- and Local-Currency IDRs of the two entities at 'F1+'. Fitch has also affirmed the ratings on all of QTC's outstanding senior unsecured, Queensland-guaranteed term debt at 'AA' and the Commonwealth of Australia-guaranteed outstanding debt at 'AAA'. Fitch has affirmed short-term ratings of 'F1+' to all of QTC's outstanding senior unsecured and Queensland-guaranteed short-term debt, including existing issuance under its treasury note and commercial paper programmes. The rating affirmations are based on Fitch's Rating Criteria for International Local and Regional Governments, published on 13 September 2019. The key rating drivers for local and regional government (LRG) issuers under these criteria are their risk profiles and debt sustainability ratios. Fitch classifies Queensland as a Type A LRG on the basis of its provision of key public services, such as healthcare, education and social services, and the presence of high vertical fiscal imbalances and a tax-sharing arrangement with the federal government. Fitch assesses Queensland's Standalone Credit Profile (SCP) at 'aa' based on a 'High Midrange' risk profile assessment, debt-sustainability score of 'aa' and relevant peer analysis. The affirmation of the ratings on QTC's debt guaranteed by the Commonwealth of Australia reflects the affirmation of Australia's Long-Term IDR at 'AAA' on 21 May 2020. QTC has AUD726 million in debt outstanding that benefits from a guarantee from the Australian government. Key Rating Drivers Risk Profile: 'High Midrange' Fitch has assessed Queensland's risk profile at 'High Midrange', reflecting a mix of 'Stronger' or 'Midrange' attributes on the six key risk factors. No factors were assessed as 'Weaker'. Revenue Robustness: 'Stronger' Queensland continues to have a broadly stable revenue base due to its primary income sources of grant revenue and GST distributions, which accounted for 47.3% of revenue in the fiscal year ending June 2019 (FY19). State taxation revenue made up 23.7% of FY19 revenue. Both revenue sources are linked to the macroeconomic performance of the nation and state. State taxation is diversified among payroll tax (29.4% of total state tax revenue), property transfer duty (22.6%), motor-vehicle registration (13.1%), other duties (10.9%), land tax (9.4%), gambling taxes and levies (9.4%), and other taxes (5.3%). Aside from these operating revenue sources, Queensland also benefits from significant contributions from the state's sales of goods and services (9.7% of FY19 revenue), interest income (3.7% of FY19 revenue), dividends and tax equivalents (4.7% of FY19 revenue) and other income (11.0% of FY19 revenue). The latter item is dominated by land rents and royalties that the state earns from the extraction of coal, base and precious metals, bauxite, petroleum and gas, mineral sands and other minerals. Revenue Adjustability: 'Midrange' Queensland continues to benefit from an established system of horizontal fiscal equalisation, but has a modest ability to significantly increase its state taxes. The latter is due in part to the state's focus on moderating the tax burden on its citizens and maintaining the competitiveness of Queensland's tax system, which is an advantage for business, inward investment and interstate migration. The state government continues to benefit from a diverse tax base and an unrestricted ability to set its own tax rates. Queensland forecasts that the federal government's payments to the state will decrease in FY20 due to a fall in GST revenue and other Commonwealth grants. This follows the Australian government's reduced estimates in the national GST revenue pool (versus previous budget estimates). A softening in coal and natural gas prices and impacts of the coronavirus pandemic are reflected in lower mining royalties in FY20 and FY21. Expenditure Sustainability: 'Stronger' Like other Australian states, Queensland is responsible for both non-cyclical expenditure, such as education, and moderately counter-cyclical expenditure, including healthcare. Furthermore, the current state government decided to invest in the provision of front-line services in recent years, which has led to an increase in the numbers of teachers, doctors, nurses, police officers and others that are employed by the state. Fitch expects that health and education will continue to be the main areas of the state's operating expenditure. Queensland has a moderate record of controlling operating expenditure growth, which has generally increased in line with operating revenue in recent years. This has generated stable operating and current balances over the same period. Queensland has effective budget rules in place and a sound record of adherence to these. The state government recently announced the establishment of a Service Priority Review Office to generate cost-saving targets across the state government. These targets include AUD3 billion over the period to FY23. Expenditure Adjustability: 'Midrange' Fitch believes the state's ability to reduce spending in response to shrinking revenue is moderate, notwithstanding its ongoing adherence to several established fiscal principles. This is because employee and superannuation expenses are significant in Queensland's overall operating expenditure, and have increased in line with the state's expansion of frontline hospital and health services and school enrolment growth. Overall, employee and superannuation expenses accounted for 56.7% of Fitch-calculated FY19 operating expenses. The state can delay or reduce some capex, but its ability to do so quickly may be limited by other factors, such as the cost of delivering key public services across the most decentralised state in the nation and Queensland's exposure to natural disasters and extreme weather. The latter factor was evident during the heavy rainfall and major flooding in northern Queensland in early 2019, which led to additional expenditure for recovery and rebuilding projects above the state's previous forecasts. Furthermore, Queensland's latest Mid-Year Fiscal and Economic Review outlined an AUD51.8 billion capex programme for the state with a focus on transport, health and education infrastructure over the next four years. Fitch believes a portion of this programme will be brought forward to promote economic stimulus in the wake of the coronavirus pandemic. Liabilities and Liquidity Robustness: 'Stronger' Queensland exhibits prudent debt management based on established market discipline and the governance framework of its sophisticated financing vehicle, QTC. This entity has provided debt funding, liability and cash management since inception in 1988, as well as financial risk management services to the state government and Queensland's local-government sector. QTC's strong debt profile is reinforced by a well-diversified investor base, even distribution of maturities across its Australian-dollar benchmark bonds and approximately AUD116 billion turnover of QTC bonds in the secondary market. QTC sources funds in the domestic and international financial markets by issuing a range of debt instruments for institutional investors. The debt securities are underpinned by guarantees from the Queensland government, and are issued in various markets, currencies and maturities, and at fixed and floating interest rates. QTC is the largest semi-government issuer of Australian-dollar denominated bonds in both the domestic and offshore markets. It recently completed its programme to borrow AUD9.9 billion over 2019-2020. The state has a strong record of daily liquidity risk management, as QTC employs several funding strategies to ensure sufficient cash is held for unexpected outflows and meeting other scenarios, such as maintaining a minimum forecast liquidity balance over any 12-month period. Liabilities and Liquidity Flexibility: 'Midrange' QTC has well-established access to the capital markets and its frequent debt issuances consistently enjoy substantial over-subscription from its diverse investor base. Approximately 25% of Australian semi-issuance is held offshore. QTC's funding profile continues to be dominated by its Australian-dollar benchmark bond facility (78.6% of debt outstanding as of 30 June 2020), although it has also successfully issued green bonds, floating-rate notes, capital-indexed bonds, other non-benchmark bonds and bonds denominated in other currencies. Queensland's liquidity is also supported by QTC's maintenance of at least around AUD5.0 billion of shorter-term debt outstanding. Debt Sustainability: 'aa' category Under the rating case for 2020-2024, Fitch projects the state's economic liability burden