TEXT-Fitch affirms Canton of Zurich at 'AAA';outlook stable

Wed Feb 20, 2013 5:57am EST

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(The following statement was released by the rating agency)

Feb 20 - Fitch Ratings has affirmed the Canton of Zurich's (Zurich) Long-term foreign and local currency ratings at 'AAA' and its Short-term foreign currency rating at 'F1+'. The Outlooks for the Long-term ratings are Stable.

RATING RATIONALE

The affirmation reflects Zurich's high degree of autonomy, in line with all of Switzerland's cantons, its wealthy and dynamic economy, its long track record of sound financial performance and its financial flexibility including postponing investments if required. The ratings also factor in an envisaged budgetary performance not sufficient to cover all investment requirements and a likely increase of debt.

Fitch expects real GDP growth of 1.1% for 2013 and of 1.8% for 2014 for Switzerland. Since a large part of national GDP is generated in Zurich and given its well above average economic wealth and diversity, these figures should at least reflect the canton's growth. Some uncertainties exist for the local banking sector and from the strength of the Swiss franc, but Zurich's economy outperformed expectations in 2012 and generated higher than expected tax proceeds.

Zurich's pension fund for the cantonal employees - BVK Personalvorsorge des Kantons Zuerich (BVK) - has been underfunded since 2008. A specific law requires minimum coverage of the pension fund of 90% and the coverage was 86.5% at end-2010. Consequently, the canton agreed on recapitalising BVK and made provisions amounting to CHF2.6bn at end-2011. Of this, CHF2bn were paid as a one-off payment to the fund on 1 January 2013 and the remaining CHF600m is envisaged as ongoing annual support for 2013-2019.

While the 2011 results were heavily influenced by the recapitalisation of BVK, 2012 may have performed better than budgeted. According to the canton, the expected deficit of CHF82m declined to CHF46m, mainly driven by additional tax revenues (CHF190m) and dividends received from the Swiss National Bank (CHF117m). This helped to comply with the proposal by the cantonal parliament (Kantonsrat) of a budget improvement of CHF300m for 2012, after the Kantonsrat rejected the increase of tax rates. For 2013, Zurich has budgeted a surplus of CHF104m.

Total direct debt amounted to CHF4.3bn at end-2012. According to the canton's mid-term financial plan for 2013-2016, debt is likely to further increase all over the planning period and may end at CHF6.3bn in 2016. Fitch does not forecast the debt to increase that high but even taking into account this debt level, this would correspond to about 42% of current revenues at that time. This would be in line with the ratio reported in 2008 and well below the past 10 years' peak of about 76% reported in 2004.

Zurich has material contingent liabilities and net overall risk amounted to CHF19.7bn at end-2011. Most relates to guaranteed obligations of its 100% owned Zuercher Kantonalbank ('AAA'/Stable/'F1+') and the unfunded portion of the pension fund which has now materialised. The recapitalisation measures should prevent the canton from a future higher burden and Fitch considers that these are prudently managed by the canton.

RATING SENSITIVITIES

A negative rating action could result from a material increase of debt beyond the level indicated in the medium-term financial plan or a large commitment stemming from the canton's contingent liabilities. In Fitch's view, a rating downgrade would also result from a deterioration of the debt to current revenue ratio of above 50% and debt service requirements largely limiting Zurich's financial flexibility. Significant changes in the cantons' financial leeway could also be negative for the ratings.

KEY ASSUMPTIONS

The ratings are sensitive to a number of assumptions.

- Fitch assumes that the cantons well above average wealth levels and its strong and diversified economy should contribute to a strong tax base allowing Zurich to consolidate its financial position.

- Fitch also assumes that an economic decline could temporarily seriously affect large part of the cantons revenues and may further increase debt.

- Fitch further assumes the canton's ability to consolidate its budget in the case of need - Zurich managed to reduce debt by more than 50% from 2005 to 2011.

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