Analysis and Opinion
On 2 October 2020, Moody’s Investors Service downgraded the Province’s debt to Aa3 from Aa2 while revising the outlook to Stable from Rating under Review. The short report and review was initiated on 31 August 2020 shortly after the provincial government’s skeletal First Quarter Fiscal Update. The downgrade leaves Alberta one notch above the single A rating category. Downgrades in theory mean the borrower will have to pay higher rates of interest on its debt.
The downgrade was expected and gave a balanced view on the fiscal picture acknowledging the province’s strong liquidity position and the province’s fiscal capacity to “enact additional tax measures to support revenue growth, which nevertheless the provincial governments have been reluctant to fully use in recent years (emphasis added).” The message from Moody’s, I believe, is time is running out on the province in seeking to maintain its historic “tax advantage.”
The agency cited “elevated idiosyncratic risks” facing the Province including years of “material deficits,” an “elevated debt burden,” and a “weaker credit profile” resulting from twin economic shocks of COVID and weak oil prices.
Credit Strengths
Alberta continues to have a relatively low burden of debt, the result of about a decade of strong surpluses in the 2000s. Given Alberta’s Heritage Trust Fund and cash reserves ($46.8 billion) equal to almost a year’s expenses and 43 per cent of net debt, there is no immediate need for creditors to be worried. Fortunately, the cost of servicing the debt remains very low given the historically low rates of interest the province has borrowed at for the past five years or so.
Another source of credit strength cited was the federal government in the form of predictable transfers and what the agency terms as “a high level of extraordinary support from the Government of Canada (Aaa stable).”
The move to stable status is based on Moody’s assumption “that despite continued fiscal and economic challenges, further downside revenue risk from additional oil price decline has eased, and the province retains significant fiscal capacity to respond to economic challenges given its tax competitiveness and strong liquidity (emphasis added).”
Credit Weaknesses
Alberta’s rapidly mounting debt is a particular concern for Moody’s as net debt and indirect debt to revenues will increase to 280 per cent in 2020-21 from 180 per cent two years ago. Another principal weakness is the province’s fiscal profile is the government’s exposure to volatility in oil prices “influenced by global pressures.” While the fiscal condition is partly in the hands of the province in terms of its management of spending and revenue, the uncertainty of the oil market is decidedly a problem.
Environmental, Social and Governance (ESG) considerations
Securities regulators are now requiring rating agencies to monitor and report on ESG considerations applicable to the entity being rated. In the case of Alberta, Moody’s assigned a moderate rating for environmental risks based on its significant GHG emissions and susceptibility to natural disasters. The report’s authors however noted a decline in the intensity of emissions of the oil and gas sector.
Social risk was also rated as moderate given the Province’s exposure to the Covid-19 pandemic, which has negative implications on the Province’s credit profile.
Significantly governance considerations are rated as material but overall governance risk is low because of transparent reporting and prudent debt management practices will involve the full hedging of foreign currency exposures.
It is curious that the agency would rate governance concerns as material but only treat environmental considerations as moderate in developing their opinion on the province’s credit. The statement leaves this observer scratching his head at the seeming contradiction in less concern on the environment than governance. This judgment could be related to the comment about a “material deterioration in the financial health of its large crown corporations” leading to a downgrade.
Other Factors
The agency also addressed what developments could lead to an upgrade or downgrade of the credit rating. Factors which would lead to an upgrade are the improvement in the oil price resulting in lower projected deficits. Conversely, weak oil prices and the continued pandemic pressures on the economy leading to a higher debt burden could produce future downgrades.
Other factors which could spur a downgrade are material reductions in liquidity and, as noted above, “a material deterioration in the financial health of its large crown corporations.” The latter reference could only be to two provincial agencies: ATB Financial and AIMCo. These two agencies are responsible for the management of approximately $55 billion in loans and securities (ATB) and well over $100 billion in financial assets in the Heritage Fund, a variety of other provincial agencies, and several large provincial pension funds (AIMCo).
Response of Province
There has been no official response by the Minister or the Premier to this recent downgrade.
Implications
Overall, the downgrade was predictable and a measured response to the Province’s worst financial predicament since 1993. The Premier’s use of the undefined term “fiscal reckoning” is an honest recognition that the predicament is probably as deep as that which the Province faced during the Great Depression. Should Alberta’s oil patch remain moribund and investment weak, there is little the government can do but borrow more money, pray that interest rates will remain low, pray Ottawa will continue support for the economy (i.e. borrow more), and pray that oil and natural gas prices will stage a major recovery.
A as the table below illustrates, Alberta’s debt is yielding more than British Columbia, Ontario, and Quebec for almost the same maturity dates This higher relative cost of debt goes back several years reflecting the persistently low oil prices and the absence of any concrete plans to wrestle a structural deficit to the ground.
With the second wave of COVID encircling the world economy again and the likelihood a a vast wave of personal and corporate bankruptcies or creditor protection applications, November’s fiscal update will likely prove as brutal as the first quarter update.
| Issuer | Maturity | Coupon | Current Yield |
| ALBERTA 2.9% 01DEC28 | 01-Dec-28 | 2.9 | 1.238 |
| BC 2.95% 18DEC28 | 18-Dec-28 | 2.95 | 1.048 |
| ONTARIO 6.5% 08MAR29 | 08-Mar-29 | 6.5 | 1.18 |
| ONTARIO 1.1% 08MAR29 | 08-Mar-29 | 1.1 | 1.261 |
| ONTARIO 2.7% 02JUN29 | 02-Jun-29 | 2.7 | 1.167 |
| MANITOBA 2.75% 02JUN29 | 02-Jun-29 | 2.75 | 1.221 |
| PROV QUEBEC 2.3% 01SEP29 | 01-Sep-29 | 2.3 | 1.137 |
| MANITOBA 3.25% 05SEP29 | 05-Sep-29 | 3.25 | 1.263 |
| PROVINCE OF ALB 2.900% 20SEP29 | 20-Sep-29 | 2.9 | 1.342 |
| QUEBEC 6% 01OCT29 | 01-Oct-29 | 6 | 1.185 |
| ALBERTA 2.05% 01JUN30 | 01-Jun-30 | 2.05 | 1.439 |
| SASKATCHEWAN 2.2% 02JUN30 | 02-Jun-30 | 2.2 | 1.347 |
| ONTARIO 2.05% 02JUN30 | 02-Jun-30 | 2.05 | 1.267 |
| MANITOBA 2.05% 02JUN30 | 02-Jun-30 | 2.05 | 1.342 |
| BC 2.2% 18JUN30 | 18-Jun-30 | 2.2 | 1.192 |
Source: RBC Direct Investing, Fixed Income prices quotes for lots of $500,000- 4 October 2020
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