OREANDA-NEWS. Fitch Ratings has affirmed the Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) on Australia's State of Queensland (Queensland) and Queensland Treasury Corporation (QTC) at 'AA'. The Outlooks are Stable. At the same time, Fitch has affirmed QTC's Commonwealth of Australia guaranteed outstanding senior unsecured debt rating at 'AAA'. A full list of ratings is at the end of this commentary.

KEY RATING DRIVERS - Queensland

The ratings reflect Australia's strong institutional framework, and Queensland's high but stable debt position and improving budgetary performance. Stronger operating performances and growing revenues will support improved debt metrics, although Fitch expects operating margins to remain weak relative to other 'AA'-rated international peers, and this limits financial flexibility. Moreover, future operating margins are sensitive to reduced royalty revenue from lower commodity prices, and deficits before debt variation are expected to continue over the current budget period to the financial year ended June 2019 (FYE19) - the forward estimates.

The Stable Outlooks reflect Fitch's expectations that Queensland, supported by economic growth, will continue to strengthen its budgetary performance and debt metrics despite our expectation that royalty revenue growth and operating margins will be lower than budgeted.

The state expects its gross state product to grow modestly by 2.0% in FY15 (FY14: 2.3%), but more strongly by 4.5% in both FY16 and FY17. Business investment is declining rapidly as construction is completed on major liquefied natural gas (LNG) projects, but exports will grow strongly as LNG production ramps up. Strong dwelling investment has been supported by low interest rates, and helps offset weak household consumption as a result of low income growth.

Australia's institutional framework supports Queensland's ratings. Grant income accounts for a large portion (around 50%) of Queensland's revenue, and helps offset high operating expenditure in service areas, such as education and health. Moreover, adjustments in the distribution of goods and services tax based upon the performance of a state or territory help mitigate any potential relative financial underperformance. In addition, the Australian sovereign (AAA/Stable) has mechanisms to limit the financial impact on a state from natural catastrophes.

Fitch expects Queensland's absolute general government direct debt levels to remain high but relatively stable over the forward estimates. The state estimates that general government direct debt reached AUD43.9bn at FYE15 and will decline to AUD41.4bn at FYE19. Our calculations forecast a smaller decline in direct debt to around AUD43bn by FYE19, but due to solid revenue growth, the ratio of general government direct debt to current revenue will improve to 80% from 94% at FYE14.

Queensland has taken a number of strong measures over the last couple of years to improve its budgetary performance, reduce future general government debt and rebuild its financial position. The state produced a positive operating margin in FY14 and we believe this will strengthen through to FYE19. However, its operating balances are likely to be revised down because of lower royalty assumptions. Fitch expects the state to continue to run deficits before debt variation over FY15 to FY19; it has not produced a surplus before debt variation since FY06. As a result, Fitch expects any adverse variation in operating margins will result in higher debt levels than forecast by the state, if no additional offsetting actions are taken.

The ratings also take into account Queensland's considerable contingent liabilities in Queensland Treasury Corporation (QTC), as Queensland guarantees the obligations of all debt securities issued by QTC, and obligations from QTC's derivative transactions. Fitch estimates that the funds QTC raised for the general government and local councils added AUD52bn to the state's net overall risk at FYE15. This is mitigated by the fact that a large proportion of QTC's debt is self-supporting as it is raised for state-owned entities, and the AUD10.2bn in surplus assets held in excess of the state's superannuation liability.

Fitch forecasts an increase in net overall risk to AUD87.3bn at FYE19 from AUD85.3bn at FYE15, although net overall risk as a ratio of current revenue will improve to 162% at FYE19 from a peak of 207% at FYE13.

KEY RATING DRIVERS - QTC and Debt Ratings

QTC's ratings are credit-linked to those of Queensland through the state's statutory guarantee, and QTC's 100% state ownership. Under Fitch's criteria, QTC has been classified as a credit linked entity of the state, due to its strategic importance to Queensland's local government sector and the state's high level of control. QTC is the state government's central financing authority, and provides debt funding and management, and other services to the state's public entities and local governments.

The affirmation of the ratings of QTC's senior unsecured debt guaranteed by the Commonwealth of Australia reflects the affirmation of Australia's Long-Term Issuer Default Rating (IDR) at 'AAA' on 18 March 2015. QTC had AUD8.2bn in debt at end-March 2015 that benefited from a guarantee from Australia.

RATING SENSITIVITIES
Negative rating action could occur if a significant, unexpected increase in Queensland's debt levels occurs along with a large deterioration in its operating performance. Forecast operating margins do not allow much room for unexpected shocks.

An upgrade in the short term is unlikely as Queensland's operating and current margins would need to improve unless it reduces its debt more significantly.

QTC's ratings will move in line with any rating action on Queensland.

The ratings of the Australia-backed securities are linked to the ratings of the sovereign. A downgrade of the sovereign's IDR would result in a downgrade of QTC's guaranteed senior unsecured debt rating.

The rating actions are as follows:

State of Queensland
Long-Term Foreign-Currency IDR affirmed at 'AA'; Outlook Stable
Short-Term Foreign-Currency IDR affirmed at 'F1+'
Long-Term Local-Currency IDR affirmed at 'AA'; Outlook Stable
Short-Term Local-Currency IDR affirmed at 'F1+'

Queensland Treasury Corporation
Long-Term Foreign-Currency IDR affirmed at 'AA'; Outlook Stable
Short-Term Foreign-Currency IDR affirmed at 'F1+'
Long-Term Local-Currency IDR affirmed at 'AA'; Outlook Stable
Short-Term Local-Currency IDR affirmed at 'F1+'
Rating on senior unsecured debt guaranteed by Queensland affirmed at 'AA'
Rating on senior unsecured debt guaranteed by the Commonwealth of Australia affirmed at 'AAA'