Geneva (Republic and Canton of)

Transcription

1 January 5, 2011 Geneva (Republic and Canton of) Primary Credit Analyst: Christophe Dore, Paris (33) ; Secondary Contact: Bertrand de Dianous, Paris (33) ; Table Of Contents Major Rating Factors Rationale Outlook Comparative Analysis System Support And Predictability Economy Management Capacity And Institutional Legitimacy Financial Flexibility Budgetary Performance Liquidity And Debt Management Debt Burden Contingent Liabilities Financial Statistics Tables Related Criteria And Research 1

2 (Editor's Note: In the analysis published Dec. 23, 2010, we inadvertently misstated our estimate for Geneva's debt in The version that follows corrects the error and also provides our updated debt forecasts for the period, based on new data through year-end 2010 received from the issuer.) Major Rating Factors Strengths: Very stable and predictable institutional framework. Sustained solid budgetary performance and debt reduction. Wealthy and resilient economy. End of financing requirements related to BCGE. Issuer Credit Rating AA-/Stable/-- Weaknesses: Cyclical revenue and social-related expenditure base. High debt burden that we expect to increase temporarily. Still sizable unfunded pension liabilities, even though a reform of public pension pensions is under way. Rationale The rating on the Republic and Canton of Geneva in Switzerland reflects Standard & Poor's Ratings Services' view of Geneva's very stable, predictable, and supportive institutional framework; the canton's recent sustained solid budgetary performance; and its large debt reduction since The rating also addresses a wealthy economy, fuelling tax proceeds that account for the bulk of its revenues, and its resilience in the context of the economic slowdown. The rating also reflects the depletion of the financial requirements related to the "Fondation de valorisation" (ad-hoc defeasance entity guaranteed by the canton, in charge of managing the sale of real-estate-related nonperforming assets of the Banque Cantonale de Genève (BCGE, A/Stable/A-1) following its closing at year-end 2009 and the transfer of its residual assets and debt, representing Swiss francs (CHF) 193 million, to the canton. We view these positive factors as partially offset by the relatively high degree of sensitivity of the canton's budget to economic cycles, as well as its high unfunded pension liabilities. We consider that Geneva's financial performance remained solid in Despite a sharp 9% drop in corporate tax revenue--resulting from the recession--and the negative impact of Switzerland's federal equalization reform, the canton maintained a high operating surplus (before amortization and provisions) of 8.7% of operating revenues, in line with the 2008 level. Its balance after capital expenditures was also positive even though net capital expenditure was high, and helped further reduce debt to 140% of operating revenue, down from 149% in 2008 and 195% in Still, Geneva's revenues are very sensitive to economic cycles, especially taxes that make up the bulk of its resources. We think the recession, together with tax reductions and the expected fall in tax proceeds related to past years, will likely take a heavy toll on tax revenues, and we estimate that they will decrease by 13% in 2010 from Over Standard & Poor s RatingsDirect on the Global Credit Portal January 5,

3 , however, we expect tax revenues to resume growing, even if at a low pace. Despite management's strong commitment to control costs, this expected trend in tax revenues will likely result in a slightly negative operating margin over While sizable cash inflows from the tax years enabled the canton to reduce its debt recourse in 2009, this is likely to end as tax receivables descended to comparative lows at year-end Consequently, the deteriorating operating balance, together with an expected significant rise in capital expenditures, will likely result, in our view, in increasing financing requirements and debt from Consequently, we expect debt to potentially rise to 162% of operating revenues at year-end 2012 from 140% at year-end In the context of the Swiss government's aim to introduce a minimum mandatory coverage ratio of public pension funds, Geneva plans in the fall of 2010 a significant overhaul of its currently largely unfunded public pension funds (based on defined benefits and financed by a mix of capitalization and pay-as-you-go). We understand the canton intends to progressively restore coverage ratios through structural measures, such as hikes in the retirement age and in contribution rates and changes in benefit indexations, that would not necessitate capital injections from the canton. Unfunded pension liabilities represented 68% of operating revenues at year-end 2009, which is high by international standards. Liquidity The canton's liquidity position was still solid at end-2009, in our view, fostered by operating surpluses, still-sizable cash inflows from the tax years, and also the cash pooling system among the canton and its largest public satellites. The canton's liquidity position is also secured through significant credit lines with banks and public institutions. Together they represent 47% of estimated 2010 operating expenditures and 2.1x estimated cantonal long-term debt service in Cash inflows and outflows are well spread throughout the year. Outlook The stable outlook reflects our expectation that Geneva will likely continue its tight rein on expenditures. In our view, this should help the canton to limit the cyclical impact of both lower revenue resulting from recession and tax cuts and increasing charges (including social allowances and capital expenditure projects), partly stemming from Geneva's willingness to support the local economy and residents during the economic downturn. We expect the canton's operating margin to turn slightly negative as of this year and to remain so over In our opinion, debt may increase temporarily to roughly 162% of operating revenue by the end of If the recession has a more severe effect on the canton's budgetary performance than we currently expect, resulting in higher debt, or if unfunded pension liabilities grow significantly, the rating could come under downward pressure. Conversely, if Geneva maintains its recent robust budgetary performance and trims its debt burden and its unfunded liabilities markedly, we could envisage an upgrade. Neither scenario is likely at this stage, however. Comparative Analysis Compared with that of other local authorities, Geneva has a wealthy and dynamic economy, characterized by the prevalence of services. This is favorable given the importance of tax revenues in its budget, with transfers and subsidies representing only a small share of revenues, like other Swiss local governments and contrary to the City of 3

4 Barcelona and the Nord Pas de Calais Region. The budgetary performance of the canton is in line with local governments in the sample. Geneva was able to self-finance most of its investments over the past three years, but it did not report large surpluses like the Canton of Vaud. The rating on Geneva remains constrained by its high debt level, although the latter has significantly declined since Its debt ratio is now comparable to that of the City of Geneva. However, the Republic and Canton of Geneva's long-term commitments (including unfunded public pension funds liabilities) well exceed those of the City of Geneva, though remaining below those of the City of Lausanne. Table 1 Republic and Canton of Geneva Peer Comparison Issuer credit rating on Dec. 14, 2010 Country Geneva (Republic and Canton of) Geneva (City of) Lausanne (City of) Nord Pas De Calais (Region of) Barcelona (City of) Vaud (Canton of) AA-/Stable/-- AA-/Stable/-- A+/Stable/-- AA-/Stable/A-1+ AA/Negative/-- AA+/Stable/-- Switzerland Switzerland Switzerland France Spain Switzerland Three-year average, using actual results only Oeprating balance (% of operating revenues) Balance after capital expenditure (% of total revenues) Capital expenditures (% of total expenditures) (2.3) (4.8) (mil. CHF) Total revenues 7,656 1,165 1,735 2,365 4,207 7,944 Transfers received (% of total revenues) Direct debt (at year-end) 10,730 1,490 2,316 2,368 1,475 3,290 Direct debt (% of operating revenues) Net financial liabilities (% of adjusted operating revenues) Interest (% of operating revenues) CHF--Swiss franc. System Support And Predictability A strong and stable system The Swiss Confederation (AAA/Stable/A-1+) has an extremely stable and predictable political system. Swiss cantons have extensive responsibilities, in particular for education, health care, and welfare. The redistribution of responsibilities between the cantons and the municipalities in Switzerland varies from one canton to another. In Geneva, public services are concentrated largely at the cantonal level and municipalities account for only 18% of local public spending, compared with an average of 39% for all Swiss cantons. Standard & Poor s RatingsDirect on the Global Credit Portal January 5,

5 Swiss cantons benefit from significant tax autonomy, although this is limited in practice by the country's system of direct democracy, whereby some types of government legislation must be approved by the electorate, or can be challenged. In December 2007, for instance, the canton's citizens rejected several measures to raise some tax rates. Switzerland has a financial equalization system that compensates for the varying levels of financial and economic strength among cantons. A reform to strengthen equalization and better define the distribution of responsibilities became effective in Under this new equalization system, Geneva will be the third-largest net contributor to this equalization system after the Canton of Zurich (AAA/Stable/--) and the Canton of Zug. Geneva is responsible for the supervision of its municipalities, which overall are financially healthy, despite large discrepancies. The state council of Geneva must oversee and approve any decision that the municipal councils make relating to financial matters. Still, municipalities are autonomous and the canton is not financially responsible for them. For further details on the institutional framework, see article: "Public Finance System Overview: Swiss Cantons," published July 30, 2009, on RatingsDirect. Economy A small territory and a dynamic demographic profile Geneva is a small, densely populated Swiss canton with 462,343 inhabitants as of end-october 2010, increasing 1.8% year on year. Geneva's population dynamics are better than the national average, even if they are somewhat contained by the canton's small territory and low housing supply. This robust growth in population (see table 2) has been mostly triggered by positive net immigration, which we expect to continue in the medium term. The cantonal population could grow between 61,000 and 108,000 by The proportion of non-swiss nationals in the canton is high; they represented 39.2% of the canton's population at year-end 2009, almost twice the national level. Most foreigners are working age. Table 2 Republic and Canton of Geneva Demographic Statistics Canton of Geneva Switzerland Population 457,628 7,785,806 As % Of which foreigners Population average annual growth Population structure by category of age: > Foreign population structure by category of age: > Source: OCSTAT--Office cantonal de la statistique. CHF--Swiss franc. 5

6 A highly productive economic center Geneva reports an exceptionally large employment base of two jobs for every three inhabitants. This reflects its attractiveness to both businesses and their employees: The number of cross-border workers--those who live in France but work in Geneva--has doubled since 2002 and now represents an estimated 23% of the canton's jobs. Including the cross-border workers, the population of Geneva would account for 6.7% of that of Switzerland, but contribute 8.6% of its GDP. This highlights the concentration of high-value-added operations in the canton, as confirmed by the gross value added (GVA) per salary of about 20% above the national average. Geneva ranks first for top-of-the-range salaries in Switzerland, according to data from its federal statistics office (OFS). The average wage is 13% higher than the national average, which is good news from a credit standpoint because about 49% of the canton's revenues come from income tax. Services make up 85.3% of the cantonal workforce (excluding agriculture) at end The public sector employs about 24.5% of the canton's workforce at end-2009, which provides significant stability to the employment base. This is triggered by the presence of a wide variety of international organizations. Although most of their personnel are tax exempt, employees contribute to Geneva's development through their exceptional skills and high purchasing power, while their organizations pay business tax. Total expenditure by international organizations reached CHF4.5 billion in Geneva ranks second worldwide after Paris for conference activities, which boosts revenues from tourism. The economic downturn took a bite out of this sector in 2009 and hotel bookings fell 7% at end-july 2009 on a year-on-year basis. However, the situation improved in 2010 with a 12.5% growth year on year in hotel bookings as of end-july Geneva's financial sector was hit by the economic downturn According to the Global Financial Centers Index ranking, Geneva is the world's eighth-largest financial center. On the wake of the economic downturn, the financial sector now ranks second in terms of its weight in the cantonal GDP, representing 20.9%. However, 10 out of the canton's 30 biggest employers are financial institutions. Compared with other financial centers such as Zurich, Geneva was relatively sheltered from the recent turmoil in the capital markets, because investment banking is not the canton's main financial activity. Instead, this position is held by asset management and commodities trading. And though the crisis has also damaged these sectors, they have shown more resilience. In addition, some significant hedge funds recently decided to settle in Geneva. However, international pressure to struggle against tax evasion and fraud could negatively affect the Swiss banking sector, including Geneva, in the medium term. We cannot assess their potential financial impact on the Canton's finances at this stage. Overall, we expect this sector, which had been the main impetus behind tax revenue growth, accounting for 35% of the corporate tax, to post lower profits from 2010 onward, leading to lower tax revenues for the canton. Public and "parapublic" (semipublic) activities (including health, education and social services) now contribute to 23.3% of Geneva's GDP. Retail and wholesale trade activities represent 15.3% of cantonal GDP and business services for 12.3%. Standard & Poor s RatingsDirect on the Global Credit Portal January 5,

7 Sector diversification has softened the impact of the international slowdown The cantonal economy has increasingly diversified since the beginning of the 1990s. The industrial sector (excluding construction) is comparatively modest in employment terms because it accounts for 9.6% of the cantonal workforce at end-2009, but it is focused on high-value-added activities such as high technology, luxury goods (particularly jewelry and watches), telecommunications, fine chemicals, and biotechnologies. For instance, Geneva is home to the headquarters of large multinationals such as STMicroelectronics N.V. (BBB+/Stable/A-2), Motorola Solutions Inc. (BB/Stable/NR), and Hewlett-Packard Co. (A/Stable/A-1), Givaudan (not rated), Firmenich (not rated), Procter & Gamble Co. (AA-/Stable/A-1+), Clarins (not rated) or Merck & Co. Inc. (AA/Stable/A-1+). Overall, these sectors are largely geared toward international markets and they make up the bulk of Geneva's exports, with concentration on high-growth countries, notably in Asia (37% of Geneva's exports compared with 19% nationwide in 2008). Geneva's economy and employment are sensitive to economic cycles Given its economic activities, Geneva is dependant upon the international economic situation. From 2004 up until mid-2008, Geneva's economy has been above the national average, mostly fuelled by export-oriented industries, trade, and financial and real estate services. After peaking in mid-2008, Geneva's open economy fell off sharply in the last quarter of that year because of the global economic downturn. The depressed financial sector, drop in exports, and shrinking tourism all contributed to a rise in Geneva's unemployment rate back to its 2005 level, to 7.4% in February 2010 (4.4% nationwide) from a low 5.5% in July 2008 )(see chart 1). Since then, improving economic conditions led to a slight improvement in unemployment to 6.8% at end-september 2010, even though the improvement was below the national average. 7

8 Chart 1 Recession in 2009, swift rebound in 2010 The cantonal GDP declined in 2009 (for the first time since 1995) by 1.6% in real terms, which is slightly below the Swiss GDP (-1.9%). Given Geneva's higher sensitivity to economic cycles, it has recovered from the economic crisis faster the rest of Switzerland since mid This reflects its attractiveness to highly qualified foreign workers, its well-diversified economy, and the canton's recent measures to support the local economy (especially the construction sector) by speeding up investments in transports and housing. Thus, the cantonal GDP grew by 4% year-on-year at the end of June 2010, against 3.4% for Switzerland. However, we remain uncertain about how sustainable the economic recovery will be, although we believe the long-term growth potential for Geneva is about 1.5% to 2% per year. Management Capacity And Institutional Legitimacy Use of accrual accounting is a credit strength Geneva applies harmonized principles based on accrual accounting and annually posts balance sheets. In addition, Geneva is the first canton in Switzerland to report its budget according to International Public Sector Accounting Standards (IPSAS) since This change mostly affects mostly the balance sheet by introducing the fair-value Standard & Poor s RatingsDirect on the Global Credit Portal January 5,

9 concept, to a lower extent the profit and loss statement with nonmonetary items, and the reclassification of expenses from the capital side to the operating side. We view Geneva's financial accounts as well-documented, comprehensive, and disclosed in a timely manner. In 2009, the canton's budget was reported according to public policy to enhance accountability. While financial relationships with cantonal companies (including transport, hospital, and multiutility companies) are clearly highlighted in the cantonal budget, the financial accounts of these firms are not consolidated, except those reporting a balance sheet above CHF100 million that were consolidated starting in Subsidies to these organizations are set beyond the scope of four-year financing laws and accompany service contracts stating clear targets and indicators. Since 2005, the Accounts Court ("Cour des Comptes") is in charge of performing an independent audit of the canton, the cantonal firms, and the subsidized firms. Comprehensive and stable budget procedures The budget is adopted promptly, on a consensus basis, and must be balanced. If there is a deficit, it cannot be higher than the sum of the amortization and the net variation of the provision. In addition, the canton must put together a consolidation plan aiming to return to a budgetary balance within four years. If these conditions are not met, sanctions apply. During the year, each new expense has to be covered by a corresponding additional resource. Deviations between actual and budgeted figures are minor for expenditures and larger for revenues due to the tax estimation system, which so far has not allowed fully reliable tax projections. Cost control is the main driver of budget decisions, even though the operating part is increment-based. The provisioning policy is subject to cantonal laws and is quite conservative, especially for doubtful taxpayers (provision represents about 7% of tax receivables while 3% are usually never collected). Geneva makes four-year projections; the last one ( ) was published on Sept. 29, These projections are made with clear-cut and conservative assumptions that comply with publicly released fiscal targets. Consensus-based governance supporting fiscal balance strategy The canton's citizens choose Geneva's parliament and government for four-year terms in simultaneous elections. The parliament is dominated by a right-wing majority coalition, which holds 57% of the seats, while a left-wing majority holds the government. This situation further enhances consensus-based governance, already favored by the semidirect democratic system (using frequent referenda). Throughout its mandate, which ends in 2013, the government intends to act in three main fields: Employment and sustainable development, chiefly by developing adequate professional training policies, reducing energy costs, and supporting Geneva's attractiveness to domestic and international firms; Housing, by building 2,500 new residences per year, notably through the renovation of former industrial areas; and Transportation, primarily with the development of cross-border railway infrastructure and the enlargement of the motorway linking Geneva to the rest of Switzerland. We believe there will be a continuation of the previous legislature's budgetary discipline in order to restore fiscal balance and stabilize debt. Thus, the principle of capping expenditure growth has been reaffirmed in the four-year 9

10 financial plan for , with a 2% annual ceiling, and the canton aims to balance its accounts by-end 2012 and limit its cumulative operating deficit to its cyclical reserve (CHF905 million at end-2009). This cap on expenditure is in line with mid-2008 decision to raise the ceiling of the growth of loads to 2% from 1%, as part of a countercyclical policy consisting of tax cuts for families and the middle class, of maintaining a high level of investment, and relaxing personnel charges. Efficient budget monitoring Geneva exercises intense budgetary monitoring through monthly reporting on both expenditures and revenues. Two packs of measures aiming at optimizing the administrative organization and rationalizing miscellaneous costs have been implemented since At year-end 2009, the canton estimates that savings for CHF134 million were already achieved and a further CHF30 million should be generated in The capital program is well detailed and effectively monitored over time, which allows reliable debt projections. New investment procedures have been launched, enhancing pluriannual planning and classification by nature and degree of priority to ease political decisions. For general administration expenses--representing only 6% of operating expenses--25% of the budgeted items not spent during the year are lost. An additional 25% is reallocated centrally. The two percentages combined are an incentive for the canton's services to lessen the difference between actual and budgeted figures. Prudent debt and cash management We view Geneva's medium-term debt policy as well formulated and primarily consisting of taking advantage of the low interest rates to turn part of the short-term and variable debt into fixed debt with longer maturities. This strategy relies on the following goals: Reporting exposure to variable rates not higher than 30% of the stock of debt; Containing short-term debt at 25% of total debt; Targeting an average maturity of medium- and long-term debt to 6.7 years; and Smoothing the debt amortization profile at an average of CHF1 billion per year until 2013, and decreasing it further after Debt monitoring reports are performed on a bimonthly basis and may be complemented by the end of the year by stress test and benchmarking, as recommended by the Cour des Comptes. We view cantonal cash management as efficient and proactive. It should be enhanced by the gradual expansion of the cash pooling system launched in 2006 and consolidating the treasury management of all cantonal departments and the most important satellite companies. This system, which encompasses a daily monitoring of cash inflows and outflows, is set to optimize debt recourse and its cost. Canton's companies are under control Geneva's management has tight relationships with the companies in which it holds stakes, in order to monitor their economic and financial situation. Based on the improvement of the financial profile of some of these firms, the canton decided to sell some assets used by the controlled companies but still the property of the canton; this decision was approved by referendum in June The canton received CHF239 million in 2007 and CHF438 million in 2008 from these asset sales. Standard & Poor s RatingsDirect on the Global Credit Portal January 5,

11 All the organizations that benefit from the canton's subsidies must provide their financial accounts and show--for those with subsidies above CHF200,000--that they implement an internal control system. Financial Flexibility Low flexibility on tax revenues Although, like all Swiss cantons, Geneva has extensive legal flexibility in setting personal income and corporate profit tax rates, we regard Geneva's revenue raising flexibility as limited, because: There is strong tax competition between cantons; and A referendum is necessary to approve any change in the tax code. Tax hikes are therefore difficult to implement, which the referenda in 2005 and 2007 show. Geneva's operating revenues rely to a limited extent on federal transfers and a share of federal taxes, and largely comprise locally collected taxes (see chart 2). These taxes are sensitive to economic cycles, notably the corporate tax, but as they are mostly levied on individuals, limiting their volatility. The canton estimates that a 1%-change in Swiss GDP has a CHF70 million impact on Geneva's tax revenues levied on households, which is quite limited (1.2% of tax revenue in 2009). There is, however, some concentration on personal income tax, which includes revenues from private bankers. Corporate tax represents a comparatively high share of operating revenues (at 15.5% in 2009 compared with 9% for Vaud) which has evolved erratically over the recent years, reflecting its concentration on a few large companies (20 first taxpayers accounted for 46% of corporate profit tax in 2006). The 9% fall in revenues from the corporate tax in 2009 illustrates this volatility, all the more as this incorporates proceeds from tax arrears and exceptional items. 11

12 Chart 2 Favorable economic conditions until 2009 fuelled tax revenue growth In 2009 tax revenues exceeded budget estimates by 4.7%, but this is due largely to delayed fiscal revenue cashed in 2009 (CHF216 million) because of the evaluation method enforced in This gap tends to decrease and was CHF321 million in Operating revenues were up 1.5% in 2009 compared with 2008, with falling taxes on households (-2.7%) and companies (-9%) more than offset by exceptional items, including inheritance tax (which almost tripled to CHF308 million in 2009) and growing property taxes. We expect taxes to be impacted by the economic downturn from 2010, as well as by the "tax package" (including tax cuts for families) introduced in 2010 and a "tax shield" for The canton estimates that the tax package could result in a loss of tax revenue of CHF355 million, or about 6% of 2009 total tax revenue. Accordingly, the canton has conservatively budgeted a 10% tax revenue drop in 2010 from 2009 levels. Fairly rigid cost structure The canton's expenditure flexibility is limited by the high proportion of operating costs in its budget (92% of total spending in In addition, 95% of operating charges consist of fixed items (including as personnel and interests) and of rather rigid responsibilities: social care and health care subsidies (68% of total subsidies), together with subsidies to higher education and public transportation, represent 48% of total operating expenditures (see chart 3). Standard & Poor s RatingsDirect on the Global Credit Portal January 5,

13 Chart 3 Controlled growth in operating expenses The canton has implemented some consolidation measures since 2006, which it estimates have generated recurrent savings of CHF134 million in 2009, with an additional CHF30 million expected by end Cost control remains a chief priority, as evidenced by slow growth of operating expenses (net of amortization and provisions) at 3.4% per year over the period, and at 0.8% in Despite a sharp increase in charges related to the cantonal equalization system in 2008, this largely results from controlled staff costs, thanks to a cap on hiring, cuts in temporary jobs, and limited indexation of wages. Personnel cost growth of 4.5% in 2009 stemmed from some wage indexation and from the introduction of a 13th paid month, as part of the measures to raise the ceiling on growth in operating expenses decided in mid-2008 to 2% from 1%. This ceiling was confirmed in September 2010 under the four-year ( ) financial plan. This entails some reallocation of existing charges in 2011, and improved productivity that the canton expects will help reduce its expenses by 0.5% in Standard & Poor's considers this limited growth of operating charges as an ambitious target because we anticipate some additional pressures on the cantonal budget in the short and medium term--particularly related to assistance to the elderly and the unemployed. However, thanks to the reform of unemployment aid, to improved budgetary procedures, and to some rationalization in administrative costs, the canton should avoid an abrupt increase in its operating costs. A major investment effort planned for the period In 2007, the canton raised the amount of net investments (net of capital revenue) to CHF450 million (up from CHF400 million in 2006 and CHF330 million in ). Given the economic downturn in , 13

14 Geneva's countercyclical policy consisted notably in accelerating the implementation of some projects already approved but whose completion was scheduled over a period of several years. Net investments totaled CHF508 million in 2009 and CHF712 million has been budgeted in Under the four-year financial plan ( ), adopted in September 2010, the canton has confirmed major investments totaling CHF3.67 billion of net investments (or CHF0.9 billion per year on average), including the completion of several large projects such as the extension of the public transport network, construction of new schools, and renovation of Geneva's public hospital. We believe the investment program offers some flexibility to the canton, allowing it to partially defer implementation in case of need. We note in particular that the canton wishes to reduce the share of renewal investment (40% of total net investment in 2009) to concentrate on new projects for the territory and population. Moreover, while some structural projects are likely to experience lags, some of them offer little flexibility once started because the canton has to begin to pay for them and continue to do so at each stage of completion. Finally, in light of past achievement, we believe the cantonal services has the technical capacity to realize CHF600 million to CHF700 million net capital expenditures a year. Budgetary Performance Strong performance until 2009 Fuelled by dynamic revenue growth and controlled operating expenditure, and despite the adverse impact of the reform of the equalization system, Geneva's financial performance has been constantly growing between 2004 and 2007 and the canton posted a positive operating surplus (before amortization and provisions), of 15% of operating revenue in In 2008 and 2009, the canton posted solid budgetary performance, primarily on the back of strict cost control, delayed tax revenues from the past years, and exceptional revenue, so that it was able to fully absorb the last remaining losses related to the Fondation de valorisation and to self-finance growing investments. The canton deleveraged until An expected deterioration in fiscal performance in 2010 We believe that cantonal finances for 2010, income and expenditure (especially social expenditure), will see the effects of the economic downturn of and the tax package with tax cuts for families. Despite adherence to strict fiscal discipline, the canton should, according to our estimates, post a slightly negative gross margin before amortization for the first time since We believe that net investments could reach about CHF550 million. Accordingly, we believe that Geneva's debt could decrease limitedly to CHF10.5 billion at end We view that the expected deterioration in gross margin (given low tax revenue growth in and the expected 2% growth in operating expenses) should result in increasing debt as investments increase, with debt reaching 162% of operating revenues at end-2012, against 140% at end Standard & Poor s RatingsDirect on the Global Credit Portal January 5,

15 Chart 4 Liquidity And Debt Management Large treasury facilities The canton currently benefits from extensive short-term facilities, comprising CHF688 million of committed bank lines (with three counterparties) and CHF2.6 billion uncommitted lines with public sector entities. Together they represent 47% of 2010 budgeted operating expenditures and 2.1x the budgeted cantonal long-term debt service for We consider that the canton's cash inflows and outflows are well spread throughout the year. Geneva maintains a minimum liquidity level and extensively uses committed bank lines for its daily treasury management. Thanks to the implementation of the cash pooling system with the largest public companies, Geneva's draws on these lines have been less frequent than in the past. Prudent and efficient debt management About 77% of Geneva's long-term debt was at fixed rates at end-2009, which largely protects the canton from interest rate risk. In a European context, Geneva's average interest rate remained low at 2.58% on Dec. 31, In addition, foreign currency debt is limited (4% of total debt outstanding at end-2009) and fully hedged through 15

16 currency swaps to avoid currency risk. Debt amortization is relatively even at about CHF1 billion over the period, following significant annual principal repayment in the period with a CHF1.5 billion peak in Geneva managed this spike in several ways in 2008: by enhancing its liquidity position through the extension of the cash-pooling system to big public companies; accelerating the tax litigation process; introducing monthly installments for federal tax; and sizable cash inflows from asset sales. The canton currently aims to reduce its annual principal repayment to CHF1 billion by lengthening its total debt maturity, which was 5.6 years at end-2009, up from 2.3 years at end Geneva's long-term debt outstanding at year-end 2009 is largely made up of private placements (89% or CHF8.3billion) and public bonds of CHF1.1 billion. Meanwhile, short-term debt stood at 11% of total debt (at CHF1.3 billion), well below the internal target set at 25%. The canton has discarded entering into swaps, derivatives, and options other than plain-vanilla currency or interest rate instruments with the sole purpose of hedging. Debt Burden Significant debt reduction since 2006 Geneva's debt declined significantly in 2009 to CHF10.7 billion, down from CHF13.2 billion at year-end 2006 (see chart 5). Many factors underpin this downward trend. These comprise: The absence of financing needs reported since 2006 thanks to a high operating balance; the proceeds of asset sales to public companies; an enhanced liquidity position through the extension of the cash-pooling system to the largest public satellites; the acceleration of the tax litigation process; and the introduction of monthly installments for federal tax. Debt represented about 140% of operating revenue at end However, we estimate it may reach 162% by end Despite this debt reduction, debt service has remained above 20% over the past two years--owing to both the structure of the debt (which included bullet bonds)--and this should also be the case in From 2011, we expect debt service to decrease, reflecting low interest rates on recently drawn debt and lower debt repayment installments. Standard & Poor s RatingsDirect on the Global Credit Portal January 5,

17 Chart 5 Tax-supported debt (including debt of non-self-supporting companies, notably public transport operator TPG) reached 147% of consolidated operating revenue at end Large pension liabilities, but expected to decrease following envisaged reforms Geneva's pension obligations are based on defined benefits and financed by a mixture of contributions to the pension scheme and pay-as-you-go. Pensions are currently managed by four public pension funds. The coverage of future pension payments by reserves for Geneva's largest pension fund (CIA, for the canton's civil servants including teachers) stands at 59.4% at end-2009, up from 2008 (57.7%) following better financial market conditions in This coverage ratio is nevertheless still significantly lower than its level of 2007 (72.2%) following 2008's negative market effects, even though it still exceeds its current statutory floor (50%). Geneva's pension funds do not face short-term liquidity problems, but, if unaddressed, their unfunded portion represents, in our view, a significant future liability for the canton. We estimate the total unfunded liability to CHF5.2 billion at year-end 2009 or 68% of the canton's operating revenues, which is high by international standards. In the context of the Swiss government's aim to introduce a minimum mandatory coverage ratio of public pension funds (with a target of 80% to be achieved within a 40-year period), Geneva plans a significant overhaul of its public pension funds system in the fall of We understand the canton intends to progressively restore coverage 17

18 ratios through structural measures, such as hikes in the retirement age and in contribution rates (by 1% a year) and changes in benefit indexations (inflation-linked rather than wage-indexed), that would not necessitate capital injections from the canton. The merger of the two largest pension funds (CIA and CEH) is also envisaged: together with economies of scales, this should help raise the coverage ratio and better balance the demographic profile. Contingent Liabilities Reduction in contingent liabilities following the liquidation of Fondation de valorisation Until year-end 2009, Geneva's largest contingent liabilities related to BCGE's turbulent past. The bank, whose main activities are commercial banking and residential mortgages, underwent a severe crisis in the 1990s. Following a series of bad loans and lengthy real estate problems, BCGE had to be bailed out by its shareholders. In 1999, the canton increased BCGE's equity to 53.3% of voting rights. In June 2000, Geneva set up an ad hoc defeasance structure, the Fondation de valorisation (Fondation), where it transferred CHF5.2 billion of nonperforming loans from BCGE's balance sheet, with the cantonal guarantee. The Fondation was in charge of gradually selling these assets. If the disposal value was less than the book value, the canton would make up the difference. In 2000, Geneva set aside a provision of CHF2.7 billion for this purpose. However, the financing requirements were spread over time, in line with asset sales. Given the favorable evolution of the canton's real estate market since 2000, the Fondation has been able to sell most of the assets. At year-end 2009, when the Fondation was liquidated, the canton inherited only CHF194 million of residual assets and liabilities (compared with the initial CHF5.2 billion). In addition, the Fondation also reported lower losses on the sale of its assets than it had expected, enabling the canton to reabsorb provisions each year from 2005 onward. In total, cumulative funding needs for the canton, relative to the Fondation's asset sales, amounted to an estimated CHF1.94 billion at year-end Currently, BCGE's only guarantee from the canton consists of the legal guarantee on a portion of the bank's retail savings deposits, which amounted to CHF5.2 billion at year-end The canton is contemplating ending this guarantee scheme from 2017, which would further reduce its off-balance-sheet commitments. The canton has also granted its guarantee on life annuities proposed by Rentes Genevoises, a public right, not-for-profit, mutual insurance institution, supervised by the canton. At end-2009, these guarantees amounted to CHF1 billion. We view related risk as limited given the entity's currently solid coverage ratio. We understand the canton does not currently report material risks related to litigation. Financial Statistics Tables Table 3 Republic and Canton of Geneva - Financial Statistics --Year ended Dec (Mil. CHF) 2012f 2011f 2010f Operating revenues 7,314 7,136 6,962 7,656 7,424 7,361 6,770 6,086 Operating expenditures 7,281 7,124 6,985 6,989 6,554 6,280 6,236 6,107 Standard & Poor s RatingsDirect on the Global Credit Portal January 5,

19 Table 3 Republic and Canton of Geneva - Financial Statistics (cont.) Operating balance (% of operating revenues) (0.3) (0.4) Capital revenues Capital expenditures (capex) Fondation loss* Balance after capex (% of total revenues) (10.2) (8.4) (8.1) (9.6) Debt repaid 1,050 1,038 1,259 1,257 1,500 7,181 8,894 14,187 Balance after debt repayment and onlending (% of total revenues) (24.3) (22.7) (25.9) (15.2) (9.2) (86.0) (129.9) (241.0) Gross borrowings 1,803 1,645 1, ,268 9,359 14,460 Balance after borrowings (% of total revenues) (11.3) (7.6) (0.7) (3.5) 7.2 (5.2) Direct debt (debt outstanding at year-end) 11,860 11,107 10,500 10,730 11,370 12,257 13,171 12,706 Direct debt (% of operating revenues) *Ad hoc defeasance structure. f--standard & Poor's forecast. CHF--Swiss franc. Related Criteria And Research Methodology For Rating International Local And Regional Governments, Sept. 20, 2010 Public Finance System Overview: Swiss Cantons, July 30, 2009 Ratings Detail (As Of January 5, 2011)* Geneva (Republic and Canton of) Issuer Credit Rating Senior Unsecured (5 Issues) Issuer Credit Ratings History 20-Sep Dec Apr-2004 AA-/Stable/-- AA- AA-/Stable/-- A+/Stable/-- A/Stable/-- Default History None Population 462,343 (source: OCTSAT, October 2010) Current Government A right-wing coalition has the majority in both the parliament and the executive body Election Schedule Last: October 2009 Next: October 2013 *Unless otherwise noted, all ratings in this report are global scale ratings. Standard & Poor's credit ratings on the global scale are comparable across countries. Standard & Poor's credit ratings on a national scale are relative to obligors or obligations within that specific country. Additional Contact: International Public Finance Ratings Europe; PublicFinanceEurope@standardandpoors.com Additional Contact: International Public Finance Ratings Europe; PublicFinanceEurope@standardandpoors.com 19

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