Swedish Region of Skane 'AA+' Rating Affirmed; Outlook Stable

Overview

  • Skåne's political governance has changed and the regional tax rate has been increased, which we think will improve the region's budgetary performance and slow the buildup of debt.
  • Skåne continues to benefit from its prosperous and diversified economy, ample liquidity, low indebtedness, and Sweden's very favorable institutional framework.
  • We are affirming our 'AA+' long-term issuer credit rating on Skåne and maintaining the stable outlook.

Rating Action

On April 26, 2019, S&P Global Ratings affirmed its 'AA+' long-term issuer credit rating on the Swedish Region of Skåne. The outlook is stable.

Outlook

The stable outlook reflects our base-case expectation that Skåne's new political leadership will, notwithstanding its tax rate increase, commit to achieving sustainable budgetary performance in compliance with regulatory guidelines for a balanced budget and structural balance between revenue and expenditure growth. As such, we expect that the region will keep tax-supported debt below 30% of revenue and continue to display exceptional liquidity.
Downside Scenario
We could take a negative rating action on Skåne if we observed a structural deterioration in the region's budgetary performance, resulting in deteriorating operating balance and widening deficits after capital accounts. These deficits would likely strain the region's liquidity and result in tax-supported debt increasing above 30% of revenue. In this downside scenario, if Skåne's management were unable to adequately use its budgetary flexibility to counteract its deteriorating performance, liquidity, and debt position, we could lower the long-term rating.
Upside Scenario
We could take a positive rating action on Skåne if we observed structural improvement as regards the balance between operating revenue growth and operating expenditure growth, resulting in sustainable operating balances above 5% of operating revenue and surplus after investments. In this upside scenario, if we saw a broad political consensus on needed performance levels prudently incorporating demographic-related expenditure pressures, an upper limit for indebtedness and loan financing of investments, alongside Skåne's management maintaining exceptional liquidity, we could view more positively Skåne's financial management and raise the long-term rating.

Rationale

Our rating on Skåne continues to reflect the very favorable institutional framework under which all Swedish local and regional governments (LRGs) operate, as well as the region's prosperous local economy. Furthermore, Skåne's ample liquidity, sound debt burden, and almost nonexistent contingent liabilities also support the rating. However, we note that Skåne's financial performance against the balanced budget requirement has been somewhat uneven over the past four years. Over this time, the region's ruling political coalition was unable to obtain sufficient support for a proposed tax increase. However, the region has a new coalition government and, after a recent Swedish krona (SEK) 0.49 per SEK100 regional tax increase, our forecast indicates that Skåne will demonstrate significantly stronger budgetary performance through 2021.
The institutional framework and economy remain key strengths, but we will monitor the new regional government's ability to pass its budget
We consider Sweden's institutional framework for LRGs, which we assess as extremely predictable and supportive, to be a key supporting factor for our assessment of Skåne's creditworthiness. In our view, the equalization system and widespread taxation autonomy--on which LRGs' revenue and expenditure management are based--provide a high degree of institutional stability. We currently have a stable view of the system and see no reason for amendments.
Because the Swedish equalization system balances wealth levels among the LRGs, we use Sweden's national GDP per capita of $53,300 as a starting point for our analysis of Skåne's economy (even though Skåne's income levels are somewhat lower than the national average). Skåne is Sweden's third-largest regional government, and its main responsibilities are health care and regional transportation. The region has about 1.4 million inhabitants, about 13% of the national population. Demographically, Skåne's population growth is in line with Sweden's average, but with a somewhat younger population.
Since the opening of the fixed-link toll road between Malmö and Copenhagen in 2000, Skåne has increasingly integrated into the Swedish-Danish Öresund region, which supports Skåne's growth prospects and diversification. Nevertheless, unemployment levels in Skåne are slightly higher than the national average (9.4% versus 6.3%).
The outcome of the September 2018 elections resulted in a shift in political leadership from the previous red-green minority government to a conservative four-party minority government. In contrast to the previous mandate period, the prospects for gaining sufficient support for policies appear fairly high, as populist sentiment in many aspects seems to support the new minority government.
Overall, we think Skåne boasts a long record of effective budgetary discipline and financial control, which has helped the region achieve one of the lowest operating expenditures per capita of Swedish regional governments.
We also note that Skåne's tax rate, even after the recent increase of its regional tax rate, compares fairly well with other Swedish regional governments'. But over the past few years, Skåne has been politically deadlocked on using its taxing autonomy to achieve balanced accounts. Therefore, we currently assess Skåne's management as weaker than that of most of its rated Swedish LRG peers. We will monitor the developments in the new political administration and evaluate its impact on our assessments of Skåne.
Continued healthy liquidity and debt positions, with an improving budgetary performance thanks to the increased tax rate
Skåne recorded a 2018 operating surplus of 4.9% of revenue compared with 4.8% in 2017. We have updated our projections for budgetary performance through 2021, based on Skåne's 2018 annual report and updated budget figures for 2019 (including the effect of the increased regional tax rate). We have adjusted our tax revenue forecast with the latest tax base data for personal income tax (also based on the higher regional tax rate). Furthermore, we have somewhat reduced our forecast of investment levels, since management has informed us that there may be some delays in construction works.
We forecast that, helped by the recent tax rate increase, Skåne will improve its operating surplus to 6.8% of operating revenue in 2019 (up from 4.9% in 2018), and post a lower deficit after capital expenditures of 2.0% of total revenue, thanks to increasing investments (deficit of 4.0% in 2018). We anticipate a stronger budgetary performance in our base case for 2020-2021, stemming from higher tax revenue growth, proposed cost savings, and amended completion rate by the region against its investment plan. Over the past few years, Skåne has displayed a degree of revenue-expenditure imbalance, with spending growth slightly outpacing revenue increases. After the 2018 elections, a new minority government was formed from political parties that previously opposed a tax increase. The new government increased the regional tax rate by SEK0.49 per SEK100. Although our previous base case assumed a tax rate increase would occur, the actual increase was larger and took place earlier than we expected, which improves our base case for Skåne.
In line with Skåne's plans, we project that Skåne's capital expenditure will increase. The region's investments are largely for property maintenance, major rebuilds, and upgrades of its four largest hospitals, and sizable infrastructure investments of its public transport unit, Skånetrafiken. Overall, we expect capital expenditure will average about SEK5.4 billion annually in 2019-2021, up from SEK4.2 billion in 2018, translating into a deficit after capital accounts averaging 3.3% of total revenue over that period.
In our view, Skåne has average budgetary flexibility, supported by a share of modifiable revenue at 69% of operating revenue and, excluding last years' political deadlock, strong autonomy to set the regional personal income tax rate without approval or limitations set by legislation or other tiers of government. However, in line with its rated Swedish LRG peers, we negatively assess its expenditure structure as rigid with fairly limited means of making large expenditure cuts.
Because Skåne's investment financing needs in its planning period through 2021 will not be entirely met by cash flow from operations or a drawdown of liquidity, we expect that the region will have to rely partly on external loan funding. Consequently, we think Skåne's modest debt burden will increase slightly and we forecast tax-supported debt at about 24% of consolidated operating revenue by year-end 2021. In line with its Swedish regional government peers, Skåne's gross pension liabilities comprise about 65% of operating revenue and weigh negatively on its overall debt position.
Since Skåne performs virtually all operations within the core organization, we assess its contingent liabilities as almost nonexistent. In contrast to most Swedish regional governments, Skåne includes its regional transportation entity, Skånetrafiken, in its own balance sheet and not as a separate subsidiary. We consider Skåne's co-ownership of rolling stock leasing company AB Transitio and the related guarantee arrangements in our assessment of Skåne's contingent liabilities. However, Skåne's ultimate recapitalization risk linked to Transitio is limited to a small pro rata share of the leasing that it has participated in. Other forms of external guarantees and commitments are minimal.

We assess Skåne's liquidity position as exceptionally strong. Skåne has a policy stating that it should hold liquidity (own liquidity and liquidity facilities) amounting to SEK3 billion at all times. As of Dec. 31, 2018, Skåne's liquidity sources, consisting of cash, bank deposits, and liquid short-term investments, totaled about SEK1.8 billion. Furthermore, Skåne has additional liquidity through a SEK1.0 billion checking account and a SEK2.5 billion loan facility from the European Investment Bank. Altogether, Skåne's net free cash, liquid assets, and available funds on the checking account amount to 163% of its liquidity needs over the coming 12 months. Furthermore, we view positively the region's access to the capital markets, which it taps with its medium-term note program and its commercial paper program.
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