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Austrian State of Styria Outlook Revised To Stable On Consolidation Efforts And Improved Liquidity; 'AA/A-1+' Affirmed

  • Styria's newly passed budget for 2019/2020 aims to gradually reduce its still-elevated deficit after capital accounts to levels compliant with the Austrian national stability pact by containing expenditure growth.
  • While implementing structural reforms will remain challenging, we consider that the Austrian economy's strong current performance and resulting positive dynamics for the state's tax revenues provide significant support to Styria's consolidation efforts.
  • Additionally, Styria has strengthened its liquidity management by adding committed credit lines and installing cash-pooling agreements with key state-owned enterprises.
  • We are therefore revising our outlook on Styria to stable from negative, and affirming our 'AA/A-1+' issuer credit ratings.
RATING ACTION
On Feb. 1, 2019, S&P Global Ratings revised its outlook on the Austrian State 
of Styria to stable from negative, and affirmed its 'AA/A-1+' long- and 
short-term issuer credit ratings.

OUTLOOK
The stable outlook reflects our expectation that, thanks to a politically 
backed focus on limiting expenditure growth and a benign macroeconomic 
backdrop, Styria's government will manage to largely achieve its budgetary 
consolidation objectives.

Downside scenario
We could lower our rating if Styria deviated significantly from its clearly 
communicated political ambition of budgetary consolidation and fails to reduce 
deficits as planned. This could result either from the administration 
weakening its focus on containing expenditure growth, or from meaningful 
deterioration in the macroeconomic environment reducing tax revenue growth 
below current expectations. If Styria faced difficulties aligning expenditures 
with actual revenues and implementing the steps outlined in its budgetary 
plan, we could also revise our assessment of the state's financial management 
downward. 

Upside scenario
We could consider taking a positive rating action on Styria if the state 
meaningfully outperformed its financial planning, characterized by sustainable 
surpluses after capital accounts and a quick reduction of outstanding debt 
volumes. However, given the continuing challenge for Styria to contain 
structural expenditure growth, we regard such developments as unlikely over 
the next 24 months. 


RATIONALE
Since 2016, Styria has posted sizable deficits after capital accounts, been 
noncompliant with the Austrian national stability pact's deficit target, and 
experienced rising debt. However, the state's financial management has now 
obtained parliamentary approval for a consolidation-focused budget for 
2019/2020 that aims to limit expenditure growth and gradually reduce deficits, 
with the goal of balancing the budget by 2021. Although we make some 
conservative adjustments to the state's budgetary planning, we expect strong 
overall budgetary performance and believe that Styria will manage to markedly 
reduce its deficits. 

The Austrian economy's outstanding performance and the resulting positive 
dynamics for the state's tax revenues support Styria's consolidation efforts, 
although implementing required structural reforms will remain challenging. 
Accordingly, we forecast that the state's debt ratio, although comparatively 
high if one includes unfunded pension obligations, should remain stable.

Styria has overhauled its liquidity-management strategy by adding committed 
bank credit lines, installing cash-pooling agreements with key state-owned 
enterprises, and smoothing its maturity profile by refinancing some 
shorter-dated debt with ultra-long, fixed-rate instruments. These steps, 
combined with the existing access to financing from the Austrian federal debt 
management agency and the capital market, in our view, result in exceptional 
liquidity. 

Styria also displays lower contingent liabilities than most of its Austrian 
peers, since it owns only a residual 25% stake in local lender 
Landes-Hypothekenbank Steiermark--the pending sale of which is scheduled to 
close in first-quarter 2019.


Budgeted consolidation efforts are supported by positive economic developments
The very positive macroeconomic conditions in Austria currently support the 
state's consolidation efforts. For Austria, we forecast real GDP growth of 
3.0% in 2018 and 2.0% in 2019. Styria's future tax revenues--which are 
collected at the national level and then distributed to the states primarily 
based on relative population--should benefit from this positive backdrop. 

In general, we observe an advanced economic structure in Styria, particularly 
in the core region around its capital Graz. Styria has succeeded in attracting 
a number of leading, technology- and knowledge-focused, export-oriented 
companies, led by automotive supplier Magna International. This has resulted 
in comparatively low local unemployment of only 5.9% (Austrian national 
definition) and an estimated GDP per capita of about €38,500 for 2018. 
However, it also requires the state to undertake the capital expenditures 
required to maintain an appropriate level of infrastructure for the 
fast-growing population of its central area.

The well-established and robust institutional framework for Austrian states 
affords Styria good predictability regarding future resources and 
requirements. This was illustrated by the outcome of the dispute with the 
federal government in 2018 over who bears the cost of the abolishment of the 
so-called "Pflegeregress," that is, the states' recourse to an individual's 
assets to pay for the cost of elderly care. The federal government essentially 
agreed to fully reimburse states for the cost, demonstrating that states' 
legal option to initiate a consultation mechanism in response to federal laws 
that give rise to new expenditures is a powerful tool to dispute fiscally 
detrimental changes. As such, we do not believe that the federal government's 
still very unspecific ideas for further cuts in taxes and social contributions 
for the years beyond 2020 will overburden Styria or its Austrian peers.

Styria's financial management has demonstrated political strength by 
successfully negotiating and obtaining the required parliamentary approval for 
its consolidation-focused budget for 2019/2020. Essentially, the budget 
requires almost all government departments to cut planned expenditure volumes 
by 6%-8% compared with previous planning, with the exception of a few specific 
areas. Full implementation of the new budget, which we consider a challenge, 
would limit overall expenditure growth to below projected revenue growth and 
gradually reduce the currently elevated deficits to levels compatible with the 
Austrian national stability pact by 2020. By agreeing to bring forward the 
publication date for 2019 results to April 2020, which is ahead of the next 
state election in May of that year, Styria's financial management has 
increased its political commitment to actually execute its budgetary plan. 

The state's only average budgetary flexibility, however, makes budgetary 
consolidation challenging, in our view. Shared taxes and transfers determined 
by the federal government constitute 70% of Styria's operating revenues and 
are not controlled by its financial management. Similarly, personnel costs, 
representing about 50% of operating expenditures, are also quasi-fixed. 
Selling assets (such as the state's 75% stake in local utility ESTAG, or €2.8 
billion remaining housing loan receivables) would not solve the state's 
structural issues and is, as we understand, not on the current political 
agenda. The agreed sale of Styria's remaining 25% stake in local lender 
Landes-Hypothekenbank Steiermark, which is scheduled to close in the 
first-quarter of this year, is an exception, but only yields €52 million of 
revenues. 


Gradual return to more moderate deficits forecast
We understand that Styria's actual budgetary performance in 2018 exceeded 
initial budgetary planning by about €90 million, which is roughly in line with 
our previous base case and mainly due to good tax collection. Applying our 
cash-focused calculation approach, we estimate that this will result in an 
operating surplus of about 5.9% of operating revenues and a deficit after 
capital accounts of 5.2% of total revenues for 2018. 

Over 2019-2022, we expect that Styria will achieve operating margins of 
6.5%-7.6% of operating revenues, and deficits after capital accounts of 
1.8%-3.0% of total revenues. We base our forecast on the assumption that 
Austria's economic performance will remain strong and that Styria will largely 
achieve the targeted restraint on expenditure growth, although we allow for 
some slippage in our modelling. As such, we consider that Styria should be 
able to make significant progress toward compliance with the Austrian national 
stability pact's deficit target.

Commensurate with the state's predicted budgetary performance and operating 
revenue growth, we anticipate Styria's ratio of tax-supported debt to 
operating revenues will remain broadly stable at about 90%. Adding the net 
present value of the state's unfunded pension obligations, which we estimate 
at roughly €3 billion, we consider the resulting total to be high in an 
international comparison. The composition of Styria's debt portfolio was 
further simplified in recent months. The state refinanced maturing debt 
previously incurred by its hospital company's financing arm, KIG (€500 million 
in 2017), and its real estate holding vehicle, LIG (€200 million in 2018), 
with funds borrowed directly through its budget. Furthermore, €355 million of 
near-term maturities of direct debt were refinanced in 2018 with ultra-long, 
fixed-rate debt sourced from the Austrian federal debt management agency, 
OeBFA. 

Styria has strengthened its liquidity management by adding four committed bank 
credit lines totaling €300 million, and by installing cash-pooling agreements 
with two key state-owned enterprises. While previously a sufficiently sized 
cash-advance facility provided by OeBFA acted as the state's pivotal 
liquidity-management tool, we understand that management intends to actively 
use the newly established instruments in order to source short-term liquidity 
when required. Calculating a coverage ratio of debt service over the coming 12 
months with committed commercial bank credit lines and existing cash in excess 
of 100%, and additionally taking into consideration Styria's established 
access to funding from OeBFA and the Austrian capital market, we now consider 
the state's liquidity exceptional. 

Our ratings also benefit from Styria's comparatively low volume of contingent 
liabilities. Despite the agreed, but not yet closed, sale of Styria's 25% 
stake in Landes-Hypothekenbank Steiermark, we continue to include about €800 
million of remaining grandfathered guarantees for debt issued by the bank in 
our assessment of the state's contingent obligations. However, we view a call 
on these guarantees as unlikely and understand that, following completion of 
the sale, it is foremost the contractual obligation of the bank's future sole 
owner (Raiffeisen-Landesbank Steiermark AG) to ensure its proper 
capitalization. Furthermore, we consider that Styria's 75% stake in local 
utility ESTAG, about 40 other much smaller participations, and various 
granular guarantees granted create contingent liability risk that is only 
limited in size and probability.
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