OREANDA-NEWS. August 17, 2015.  Fitch Ratings has affirmed the Canton of Zurich's (Zurich) Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AAA' and its Short-term foreign currency IDR at 'F1+'. The Outlooks on the Long-term IDRs are Stable.

The affirmation reflects Zurich's high degree of autonomy, in line with all Switzerland's cantons, its wealthy and dynamic economy and its track record of sound financial performance and flexibility. They also consider a slightly weaker-than-envisaged budgetary performance in 2015-2018 and an increasing debt burden. The Stable Outlooks reflect our expectations that the canton's ratings will remain well in line with 'AAA' peers, despite a forecast small deterioration in its financial metrics over the medium term.

KEY RATING DRIVERS
The ratings reflect the canton's strong tax autonomy, a solid and diversified economy, and in particular, a strong private banking sector. They also take into account a high level of contingency liabilities, albeit with limited real risk exposure.

Zurich's operating margin in 2014 remained low at 0.5%, due to lower-than-expected tax revenues and higher-than-budgeted personnel costs. Its current margin was 3.2%, supported by strong financial revenues and low and reduced interest expenditure, and as a result covered a large part of its investments. However, an increasing amount of investments and lower capital revenues resulted in a deficit before debt variation of 1.6%. The canton's 2015-2018 medium-term plan foresees small improvements starting from this year.

Zurich's direct risk amounted to CHF5,349m at end-2014, up from CHF5,064m in 2013. The increase reflected funding requirements for CHF1bn maturing debt. Zurich will continue to increase debt, which we estimate will total CHF6,367m in 2018. The canton's debt coverage remains sound. Zurich's debt structure is reasonable and does not expose the canton to material risk. A new CHF700m bond issue in 2014 has exposed the canton to floating-rate risk, although Fitch views this as negligible.

Zurich has material contingent liabilities, and net overall risk amounted to CHF22bn at end-2014. Most of this relates to guaranteed obligations of the 100%-owned Zuercher Kantonalbank (ZKB; AAA/Stable/F1+) and the unfunded portion of the pension fund. Recapitalisation measures should protect the canton from a future higher burden, and Fitch views these steps as prudent management. Fitch's calculations do not include the debt of the canton's public-sector entities as we assume such debt to be entirely self-supporting.

At end-2014, Zurich had cash and cash equivalents of CHF1.54bn (end-May 2015: CHF1.9bn). Part of this comes from debt contracted in prior periods to replace debt maturing during 2015. Nevertheless, Zurich's ample cash reserves and committed credit lines ensure short-term liquidity in case of need, thus mitigating the canton's refinancing risk.

Fitch expects Switzerland to see real GDP growth of 0.9% in 2015 and 1.6% in 2016. Due to the canton's well-diversified and dynamic economy, Zurich should mirror or even outperform national growth. However, the abolition of the euro-CHF peg in January 2015 affected the canton's industry, trade and tourism, resulting in slower economic growth, which we expect to be sustained.

RATING SENSITIVITIES
Given the canton's large tax potential, a downgrade is unlikely. However, the ratings may come under pressure from a sustained period of increasing debt and corresponding weakening of debt servicing ability with a debt payback of above 20 years. An operating margin close to zero constraining the canton's financial flexibility or contingent risk above Fitch's expectations would also result in a negative rating action.

Significant changes in the cantons' financial leeway or additional financial obligations, in either the intra- or inter-cantonal context, could also be rating-negative. Any negative rating action on Switzerland would too trigger a rating action on Zurich.

KEY ASSUMPTIONS
- Our base case scenario relies on the following assumptions:

- Continuing strong cantonal financial autonomy.
- Zurich's economic progress will at least be in line with Switzerland's expected growth rates.
- Expected growth of Zurich's direct risk will not be accompanied by a decline of budgetary performance and weakening of debt coverage beyond Fitch's expectations.