Fitch Affirms South Australia at 'AA'; Outlook Stable

(The following statement was released by the rating agency) Fitch Ratings-Sydney/Hong Kong-27 August 2020: Fitch Ratings has affirmed the Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) of the State of South Australia at 'AA'. The Outlook is Stable. At the same time, Fitch has affirmed the Short-Term Foreign- and Local-Currency IDRs at 'F1+'. The affirmation is based on Fitch's Rating Criteria for International Local and Regional Governments, which states that the key rating drivers for local and regional governments are their risk profiles and debt sustainability ratios. Fitch classifies South Australia as a 'Type A' local and regional government, as it provides key public services, such as healthcare, education and social services, and due to the presence of high vertical fiscal imbalances and tax-sharing arrangements with the federal government. Fitch assesses South Australia's Standalone Credit Profile (SCP) at 'aa'. This is based on a 'High Midrange' risk profile assessment, debt sustainability score of 'aa' and relevant peer analysis. Key Rating Drivers Risk Profile: 'High Midrange' Fitch assesses South Australia's risk profile at 'High Midrange', reflecting a mix of 'Stronger' and 'Midrange' attributes on the six key risk factors. No factors are assessed as 'Weaker'. Revenue Robustness: 'Stronger' South Australia benefits from stable revenue in its general-government sector, which comes from two principal sources; grants and goods and services tax (GST) distributions (57.9% of total revenue for fiscal year ending June 2019 (FY19)) and state taxation (22.3%) - both of which are linked to the macroeconomic performance of the nation and state. State taxation was split in FY19 between payroll taxes (27.5%), property taxes (38.3%), motor-vehicle taxes (14.6%), insurance taxes (10.6%) and gambling taxes (9.0%). The state also benefits from significant contributions from sales of goods and services (12.9% of FY19 total revenue) and smaller contributions from interest income, dividends and tax equivalents, and other revenue (combined 6.9% of FY19 revenue). The latter includes royalties that the state earns from the production of mineral and petroleum commodities, which delivered AUD299.4 million of royalty income in FY19. Currently, the state has over 550 extractive operations and petroleum production licenses. Capital revenue was AUD1.4 million in FY19 and mostly comprised capital grants. Revenue Adjustability: 'Midrange' South Australia's fiscal position is assisted by an established system of horizontal fiscal equalisation. Federal government transfers address the fiscal imbalance between the state and central government, as South Australia's ability to significantly increase its state taxes is modest. South Australia expects GST grant revenue to decline in FY20 due to a downward revision of the national GST pool. South Australia is a low-tax jurisdiction, driven by its focus on moderating the tax burden on its citizens while maintaining the competitiveness of the state's tax system. This acts as a competitive advantage for business and inward investment and supports job creation. The state government in the most recent budget announced AUD670.8 million of new tax and revenue measures over the next four years, including above-standard indexation of fees and charges and changes to the dividend payout ratio for state-owned businesses. This will help to offset the state's forecast of lower public-land tax and conveyance duty growth due to a softer housing market. Expenditure Sustainability: 'Stronger' South Australia is responsible for non-cyclical expenditure, such as education, and moderately counter-cyclical expenditure, including healthcare. South Australia's 2019-2020 budget included AUD2.2 billion in new operating and investing expenditure over FY20-FY23, which will deliver on the state government's strategic priorities and address budget pressure in health and wellbeing, child protection and the vocational education and training sectors. Health (32.7%) and education (26.2%) were the main recipients of the state's FY19 operating expenditure, while employee and superannuation expenses (51.4%) were the largest component of Fitch-calculated operating expenses. South Australia maintained strong control over operating expenditure growth prior to FY17, keeping it below operating revenue growth. The trend has moderated since, eroding the state's operating balance. The state maintains a commitment to adhering to fiscal targets and has committed to a number of stimulus measures introduced in response to the current coronavirus pandemic to promote an economic recovery. Fiscal targets are also underpinned by the state government's commitment to fully fund the state's defined benefit superannuation liability by 2034 and to provide budgetary or financial assistance to state-owned corporations that generate insufficient revenue to support their operations. Expenditure Adjustability: 'Midrange' South Australia has effective budget balance rules in place, but Fitch assesses the state's ability to adjust expenditure in response to declining revenue as moderate. This is partially due to a significant share of inflexible costs within South Australia's overall operating expenditure, which has progressively risen over recent years as the state government has directed investment to the provision of core public services. Operating and investing expenditure initiatives for the general-government sector, as announced in the 2019-20 Mid-Year Budget Review, include bringing forward AUD327 million in major road infrastructure projects in partnership with the commonwealth government and AUD74.6 million dedicated to hospital and medical centre expenditure. Budget flexibility is also reinforced by the state's ability to adjust the timing of major capital projects within its extensive general-government capex programme over the five years to FY24 as well as holdings of operating and investing contingency provisions. The government has also committed to limiting wage increases to responsible outcomes, with enterprise bargaining agreements required to support efficiency and productivity in the delivery of government services. Liabilities and Liquidity Robustness: 'Stronger' South Australia demonstrates a pragmatic debt-management strategy within the context of Australia's strong institutional framework and the governance structures of the state's central financing vehicle, South Australian Government Financing Authority (SAFA). In the absence of formal prudential regulation, the state demonstrates control over its borrowing levels via consistent capital market discipline and scrutiny. SAFA has operated as the sole financing authority, captive insurer, corporate-treasury services provider and commercial-vehicle fleet manager for the state government, its public-sector entities and local councils since its inception in 1983. SAFA sources funds from domestic and international financial markets by issuing debt instruments for institutional investors. SAFA's incurred or assumed liabilities are guaranteed by the South Australian treasurer, in accordance with Section 15(1) of the Government Financing Authority Act 1982 (SA), similarly to other state financing entities. SAFA had AUD2.3 billion of short-term debt and AUD20.1 billion of long-term debt in the form of bonds, notes and debentures outstanding as of FYE20. The authority's 2020-2021 funding strategy aims to ensure sufficient liquidity for meeting the state's financial obligations. Liabilities and Liquidity Flexibility: 'Midrange' SAFA has adequate access to funding markets, with a focus on building bond lines of up to AUD3.0 billion in selected calendar years for term-funding purposes. Australian investors dominated the debt-ownership distribution in 2020, with a holding of around 80%; the dominant investor types were fund managers (40%) and local or foreign banks (33%). SAFA is required to maintain a base liquidity buffer of AUD1.5 billion or sufficient to cover debt maturing in the next 60 days on a rolling basis. The entity must also adhere to liquidity guidelines to fully fund 'select line' maturities 12 months in advance, with 80% to be funded 15 months prior, and demonstrate that it is able to remain liquid for at least 90 days. SAFA maintains a fully funded position in relation to its maturing debt for 2020 and 2021. Debt sustainability: 'aa' category Fitch's FY20-FY24 rating case expects South Australia's economic-liability burden - as measured by net adjusted debt plus pro rata share of central government debt/local GDP - to initially weaken across 2020 to 2022, before improving to 58.5% by 2024, against 49.1% in 2019. This lies within the 40%-70% threshold for a 'aa' assessment. The economic-liability burden is the primary metric of assessing the debt sustainability of 'Type A' local and regional governments. In terms of South Australia's secondary metrics, Fitch's rating case projects that the state's synthetic debt service coverage ratio will be 0.5x in 2024, from 0.2x in 2019, with a payback ratio of 24.9x in 2024, from 50.0x in 2019. These represent 'b' and 'bb' assessments, respectively. Movement in the economic-liability burden will be linked to the federal government's increasing debt level, and also to South Australia's higher debt-funded capital expenditure as well as operating balance movements over the forecast periods. The state's weaker secondary metrics and contingent liabilities related to the South Australia-guaranteed SAFA debt do not affect the overall debt sustainability score of 'aa', as the primary metric is in the 'aa' category. Issuer Profile South Australia is Australia's fourth-largest state by land area, the nation's fifth-largest economy - after New South Wales, Victoria, Queensland and Western Australia - and has a population of around 1.8 million to account for just under 7% of the country population. After the federal government, South Australia is one of six states and two major mainland territories that together form the Commonwealth of Australia. South Australia is a self-governing state that represents the second tier of government in Australia and controls a third, lower tier of local governments. South Australia's economy is diverse, with primary industries of health care and social assistance, financial and insurance services, construction, manufacturing as well as education and training. Derivation Summary South Australia's risk profile of 'High Midrange', debt-sustainability score of 'aa' and SCP of 'aa' lead to a Fitch rating that is two notches below that of the sovereign (AAA/Negative). There is no other rating factor affecting the ratings. South Australia's Short-Term IDR is driven by the Long-Term IDR. Key Assumptions Qualitative Assumptions and assessments: Risk Profile: High Midrange Revenue Robustness: Stronger Revenue Adjustability: Midrange Expenditure Sustainability: Stronger Expenditure Adjustability: Midrange Liabilities and Liquidity Robustness: Stronger Liabilities and Liquidity Flexibility: Midrange Debt sustainability: 'aa' category Support: n/a Asymmetric Risk: n/a Sovereign Cap and Floor: Yes and n/a Quantitative assumptions - issuer specific Fitch's rating-case scenario is a through-the-cycle scenario that incorporates a combination of revenue, cost and financial-risk stresses. It is based on 2015-2019 figures and 2020-2024 projected ratios, which contemplate pandemic-related economic headwinds. The key scenario assumptions include: - Operating revenue growth at a 2.4% CAGR over 2019-2024 (2015-2019: 4.6%) - Operating expenditure growth at a 1.9% CAGR over 2019-2024 (2015-2019: 4.2%) - Capital expenditure to average AUD2.3 billion a year over 2020-2024 (2015-2019: AUD1.4 billion) RATING SENSITIVITIES Factors that could, individually or collectively, lead to positive rating action/upgrade: South Australia demonstrating an improved fiscal position via continued adherence to prudent fiscal discipline that enables the state to strengthen its operating balance and improve its debt metrics. This would be evident in an economic-liability burden that is less than 40% on a sustained basis in our rating-case scenario together with an improvement in the payback ratio. Factors that could, individually or collectively, lead to negative rating action/downgrade: South Australia's Long-Term IDRs could be downgraded if there were a deterioration in its budgetary performance, weak fiscal discipline or failure to control capex, resulting in an economic-liability burden greater than 70% for a sustained period in our rating-case scenario. Best/Worst Case Rating Scenario International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579]. Summary of Financial Adjustments - On-passed grants from the Commonwealth government are excluded from the state's revenue and expense figures. - Depreciation and amortisation have been excluded from operating expenditure. REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING The principal sources of information used in the analysis are described in the Applicable Criteria. ESG Considerations The highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg. South Australia,State of; Long Term Issuer Default Rating; Affirmed; AA; RO:Sta ----; Short Term Issuer Default Rating; Affirmed; F1+ ----; Local Currency Long Term Issuer Default Rating; Affirmed; AA; RO:Sta ----; Local Currency Short Term Issuer Default Rating; Affirmed; F1+ Contacts: Primary Rating Analyst Paul Norris, Director +61 2 8256 0326 Fitch Australia Pty Ltd Suite 15.01, Level 15 135 King Street Sydney 2000 Secondary Rating Analyst Janet Liu, Director +852 2263 9983 Secondary Rating Analyst Henry Lee, CFA Director +852 2263 9613 Committee Chairperson Guido Bach, Senior Director +49 69 768076 111 Media Relations: Peter Hoflich, Singapore, Tel: +65 6796 7229, Email: peter.hoflich@thefitchgroup.com Leslie Tan, Singapore, Tel: +65 6796 7234, Email: leslie.tan@thefitchgroup.com Wai Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@thefitchgroup.com Alanis Ko, Hong Kong, Tel: +852 2263 9953, Email: alanis.ko@thefitchgroup.com Additional information is available on www.fitchratings.com Applicable Criteria Rating Criteria for International Local and Regional Governments (pub. 13 Sep 2019) (including rating assumption sensitivity) (https://www.fitchratings.com/site/re/10087140) Additional Disclosures Dodd-Frank Rating Information Disclosure Form (https://www.fitchratings.com/site/dodd-frank-disclosure/10133139) Solicitation Status (https://www.fitchratings.com/site/pr/10133139#solicitation) Endorsement Status (https://www.fitchratings.com/site/pr/10133139#endorsement_status) Endorsement Policy (https://www.fitchratings.com/site/pr/10133139#endorsement-policy) ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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