Aichi #A+/A-1# Ratings Outlook Stable

Stocks and Financial Services Press Releases Wednesday March 28, 2018 20:58
TOKYO--28 Mar--S&P Global Ratings

TOKYO (S&P Global Ratings) March 28, 2018--S&P Global Ratings today said it has affirmed its 'A+/A-1' foreign and local currency long- and short-term issuer credit ratings on the Prefecture of Aichi (Aichi). The outlook is stable.

Our ratings on Aichi primarily reflect its very strong economy, supported by a strong industrial base of manufacturers, which generates strong own-source revenues that have improved the prefecture's operating balance under prudent expenditure management. We expect these factors to continue to underpin Aichi's sound financial standing. While we view the institutional framework in which Aichi operates as favorable for Japan's local and regional government (LRG) sector, chief constraints on the ratings are the prefecture's huge debt burden compared with rated peers globally and a common characteristic of limited budgetary flexibility among Japanese LRGs. We expect these factors to remain weaknesses for the prefecture. These factors lead us to assess the stand-alone credit profile (SACP) for Aichi as 'aa-', but the final ratings on Aichi reflect our sovereign ratings on Japan because we do not believe Japanese LRGs could withstand a stress scenario in which the sovereign defaults.

Aichi has the third-largest economy in Japan and hosts the headquarters of a number of internationally competitive manufacturers. Its GDP per capita has exceeded US$40,000 in our estimation and its population continues to grow marginally thanks to incoming migration despite a decrease at the national level. We expect the local economy to perform stronger than the national economy over the next two years. Aichi is central to both the broader regional and national economies, and we expect its export industries to continue to generate growth.

The prefecture had a healthy operating margin until the global financial crisis that began in 2008. But its margins deteriorated sharply in succeeding years as tax revenues stagnated and national equalization transfers failed to plug revenue gaps. However, Aichi's operating margins have recovered since fiscal 2012 (ended March 31, 2013) thanks primarily to improved corporate tax revenues, as a result of manufacturers' robust operating performance, and the prefecture's management of its operating expenditures. Increased revenues have also helped Aichi record surpluses after capital accounts and reduce gross debt outstanding.

While we view the prefecture's level of own-source revenue as high compared with peers globally, institutional limitations constrain the prefecture's ability to raise taxes. In addition, its revenues are relatively susceptible to its external environment, such as economic conditions including currency fluctuations. Even if we consider these factors, we forecast the prefecture's balance after capital accounts will be close to zero for the next two years, in line with our expectations that it will have stable economic growth.

S&P Global Ratings believes Japan's institutional framework is mature and favorably supports Aichi's prospects. Japan has a mature intergovernmental system, and strict central government control of regulations and budgets for LRGs ensures the system's predictability, transparency, and accountability. We consider the central government's weak fiscal position a constraint on the system's strength, but we also have a positive view of the LRG sector's balance of revenues and expenditures compared with those of the central government.

Aichi's management demonstrates prudent financial policies and practices that ensure good fiscal discipline through electoral cycles, in our view. Gov. Hideaki Ohmura is in his second term, which helps sustain continuation of Aichi's prudent management practices.

However, we expect debt ratios for the prefecture to remain very weak compared with those of rated peers globally. While we estimate Aichi's tax-supported debt peaked at about 350% of consolidated operating revenue in fiscal 2012 and has been improving since, we believe the ratio will deteriorate in fiscal 2017 and hover around 320%-330% toward the end of fiscal 2019. This expected deterioration in fiscal 2017 reflects a decline in operating revenues stemming from a partial transfer of salaries for public school teachers and staffers, along with associated revenue sources, to the City of Nagoya. With an almost balanced budget and a slower increase in revenues, we expect existing debt levels to continue for the next two years.

Despite Aichi's high debt burden, we view its contingent liabilities as limited. The prefecture owns stakes in many government-related entities, including those of other governments. Guarantees on the external borrowings of Nagoya Expressway Public Corp. (not rated), central Aichi's toll-road operator, amount to about 17% of Aichi's operating revenues. However, we see only a remote likelihood of the actual burden of payment falling on Aichi, given stable cash flow from toll-road operations.

We believe Aichi has ample internal cash holdings and strong access to external liquidity. We estimate that as of March 31, 2017, the prefecture's internal cash holdings covered more than 200% of its annual debt service costs. Aichi has a close relationship with Bank of Tokyo-Mitsubishi UFJ Ltd., a quasi-commitment line provider that ensures its short-term liquidity. In addition, Aichi has an established position in the bond market.

The stable outlook reflects the outlook on our sovereign rating on Japan (A+/Stable/A-1). Our view that a Japanese LRG cannot be rated higher than the sovereign is a further constraint on the ratings. Any changes in the ratings, the outlook, or both would likely depend on any change in those on the sovereign.

Our ratings on Aichi could come under pressure if the prefecture's SACP deteriorates substantially. That could happen in the event of unfavorable modifications in central government support for local governments and if an economic downturn weakens the prefecture's tax base--producing ongoing deficits after capital accounts that lead Aichi to draw on cash reserves to fund revenue shortfalls--and its liquidity coverage declines. While these factors may materially worsen Aichi's credit metrics, we do not consider these scenarios likely at this time.

We incorporate central government support for Aichi into our ratings. Changes to the sovereign rating on Japan or the Japanese public finance system may trigger a review of our ratings on Aichi and the institutional framework in which it operates.


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