Morningstar DBRS Confirms Swiss Confederation at AAA, Stable Trend

DBRS Ratings Limited (Morningstar DBRS) confirmed the Swiss Confederation’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, Morningstar DBRS confirmed the Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS
The confirmation of the Stable trend reflects Morningstar DBRS’ view that the risks to Switzerland’s credit ratings remain limited. Switzerland’s solid public finances and strong macroeconomic fundamentals have helped mitigate risks posed by the weaker external environment and the challenges in the Swiss banking sector. Following 2.5% real GDP growth (seasonally, calendar and sport-event adjusted) in 2022, the Swiss economy is expected to have moderated in 2023, due to weaker external environment and tighter financing conditions. Switzerland's prudent fiscal policy, underpinned by its debt brake rule and the low public debt level at 36.9% of GDP in 2022 will continue to provide ample room to support the economy against severe shocks. The crisis at Credit Suisse Group AG (CS) resulted in a state facilitated takeover of CS by UBS Group AG (UBS). The Swiss authorities’ decisive actions prevented the failure of CS and the package of measures adopted, facilitated the acquisition by UBS highlighting Switzerland’s financial flexibility to weather potential shocks. However, the new group could lead to higher concentration risks for the Swiss banking sector. Authorities are currently reviewing the too big to fail (TBTF) regulations.

Switzerland’s AAA credit ratings are underpinned by its wealthy and diversified economy, sound public finances, and solid external position. Strong institutions, predictable policies, and historical neutrality have long made Switzerland a safe haven for investors. Switzerland benefits from a highly productive workforce, high levels of educational attainment and labor force participation. These credit strengths counterbalance the challenges associated with Switzerland’s high mortgage debt and recent financial market developments. In addition, the future of Swiss-EU relations remains uncertain after the negotiations for the institutional framework came to halt in May 2021. However, after 18 months of exploratory talks, in December 2023 Switzerland and the European Union (EU) announced that a Common Understanding was reached. The Common Understanding will serve as a guideline for both sides to be followed in the negotiation package. The EU is Switzerland’s largest trading partner and the failure of agreement on Swiss-EU relations could ultimately result in an increase in trade barriers with its EU partners, nonetheless we expect that Switzerland will continue to maintain strong relationships with its EU counterparts in the foreseeable future.

CREDIT RATING DRIVERS
Morningstar DBRS considers the likelihood of a downgrade of Switzerland’s credit ratings to be low. Nonetheless, the credit ratings could be downgraded if severe external shocks or a sustained deterioration in growth prospects materially affect Switzerland’s financial stability and fiscal position. Moreover, a materialization of substantial contingent liabilities stemming from the financial sector could put negative pressure on the credit ratings.

CREDIT RATING RATIONALE

Economic Activity Will Slow Down, But Swiss Fundamentals Remain Strong

Following 2.5% real GDP growth in 2022, the Swiss economy’s growth rate is expected to have moderated in 2023. The slowdown is largely attributed to the challenging external environment, primarily weaker external demand and tighter financing conditions. The energy crisis, triggered by Russia’s invasion of Ukraine increased economic headwinds and as a result of supply side energy issues, inflationary pressures increased significantly. That said, average HICP in Switzerland stood at 2.7% in 2022, significantly below the euro area average of 8.9%, before slowing down to 2.3% in 2023. Price growth was relatively contained in Switzerland compared to other advanced economies primarily due to the lower reliance on fossil fuels for electricity generation, low energy intensity in Swiss manufacturing and the strengthening of the Swiss franc. Subdued demand from Switzerland’s main trading partners and tighter financing conditions will continue to weigh on the Swiss economy. In the first nine months of 2023 the Swiss economy grew by 1.3% YoY. Against this backdrop, the Swiss Federal Government’s expert group on economic forecasts (SECO) projects growth to come in at 1.3% in 2023, 1.1% in 2024, and 1.7% in 2025 (GDP is adjusted for sporting events).

Switzerland’s AAA credit ratings are underpinned by its wealthy and diversified economy, and solid economic performance. GDP per capita currently stands at USD 93,657, one of the highest in the world and its global competitiveness ranking is consistently one of the highest in Europe. This reflects Switzerland’s highly productive workforce, which is characterized by a highly educated labor force and high labor force participation (86% as of Q3 2023) and internationally competitive industries and companies.

Switzerland’s Creditworthiness is Underpinned by Its Strong Public Finances and a Low Debt Ratio, Contingent Liability Risks for the Sovereign From CS’s Acquisition Have Receded

Switzerland’s prudent fiscal policy, underpinned by its debt brake rule, and its low public debt ratio constitute an important credit strength. The debt brake, which was introduced in 2003 mandates a balanced budget over the business cycle. Higher expenditures have to be financed by increased revenues or corresponding expenditure cuts. The support measures to mitigate the adverse impact of the pandemic on households and businesses resulted in deficits of 3.1% of GDP in 2020 and 0.3% in 2021. Swiss public finances improved to a general government surplus of 1.2% of GDP in 2022. The general government's result is expected to have remained positive in 2023 and also in 2024.

Switzerland’s public debt levels remain low relative to other AAA-rated peers. The modest increase in the debt ratio due to the pandemic from 39.7% in 2019 to 43.2% in 2020 has been already reversed. The economic recovery and the withdrawal of fiscal stimulus resulted in the debt ratio declining to 36.9% in 2022. The Maastricht debt ratio, which excludes pensions and healthcare, increased from 25.6% in 2019 to 28.2% in 2020 and has now stabilized at around 26% of GDP. Switzerland’s low public debt levels combined with substantial financial flexibility and favourable debt profile supports the country’s resilience to shocks and helps the country to stand out among other highly-rated sovereigns. All debt is denominated in local currency, and despite the increase in bond yields in 2022, interest expenditures for the general government, as estimated by the IMF, will remain low. The government’s debt maturity structure remains favorable, with average maturity of marketable debt (bonds and T-bills) at 10.2 years.

In H2 2023 the contingent liability risks associated with the takeover of Credit Suisse by UBS have reduced significantly. In August 2023, UBS terminated the Public Liquidity Backstop (PLB) with the Swiss National Bank (SNB) of up to CHF 100 billion, guaranteed by the Swiss government and also decided to terminate the CHF 9 billion Loss Protection Agreement (LPA) with the Swiss government. Therefore, the Confederation will not have to assume any losses. With highly transparent public finances and consistent efforts to address medium- and long-term fiscal challenges, Morningstar DBRS views Swiss fiscal management and policy to be very strong.

Swiss Authorities Intervention Protected Financial Stability Last Year, But Risks Remain

2023 has been a challenging year for the Swiss banking sector, largely dominated by the state facilitated takeover of Credit Suisse by UBS. In March 2023, the mounting issues at Credit Suisse, a result of shortcomings in its governance and risk management, combined with the failure of SVB in the US, resulted in temporary financial market instability eventually leading to a state-facilitated merger with UBS. The transaction was completed on 12 June 2023 and the new entity started to operate as a consolidated banking group. The new group, which has a combined mortgage market share of 26% and a combined deposit market share of 26%, is leading to a higher concentration in the Swiss banking system, which could ultimately increase contingent liability risks attached to a single bank. Nevertheless, the combined bank will have to comply with capital requirements that reflect the change in its systemic importance. In addition, Switzerland's wealthy economy and strong fiscal position provide a degree of resilience to withstand a substantial shock. Noteworthy, the contingent risks for the sovereign emanating from the CS acquisition have receded in August 2023 after UBS voluntarily terminated the PLB guarantee facility and the CHF 9 billion loss protection guarantee.

The financial sector is one of the most important pillars of the Swiss economy contributing around 9% of GDP and employing around 218,000 people equivalent to 5.2% of the total workforce. However, the size of the banking sector, which is nearly 470% of GDP, suggests that shocks to banks, especially if systemically important, can have more pronounced effects on the economy. The banking sector’s exposure to the real estate sector, remains a source of vulnerability for financial stability. Following the interest rate increases in 2022 and 2023, real estate price growth has started to slow down, with single family home prices growing by 1.0% YoY in the first 9 months of 2023 down from 4.9% in the same period in 2022. Switzerland’s mortgage-to-GDP ratio remains high at 149% in Q3 2023 up from 135% in 2015. In addition to UBS, now Switzerland’s sole global systemically important bank, the Swiss banking system has domestically focused banks (DFBs) with significant exposure to the real estate market, making them vulnerable in the event of a further significant rise in interest rates. Nevertheless, the SNB’s stress scenario analysis suggests that most domestically-focused banks’ capital buffers remain sufficient to cover the potential loss stemming from a deterioration of Swiss mortgage and real estate markets and in a scenario involving a severe recession. While the domestically focused banks would suffer losses, the significant capital buffers currently available will help absorb the losses under a stress scenario. Furthermore, the SNB continues to monitor mortgage and real estate market developments closely and has reactivated the countercyclical capital buffer which aims to enhance the resiliency of the financial system.

Switzerland’s Strong External Position Remains a Key Credit Strength

Switzerland exhibits a strong external position with structural current account surpluses and a positive net creditor position. Switzerland’s current account surpluses averaging around 8% of GDP over the last ten years reflect its role as a financial center, its high value-added exporting industries, high per-capita income levels, and high savings rate. From a stock perspective, Switzerland benefits also from large net international investment asset position (NIIP) amounting to 99.7% of GDP in Q3 2023 reflecting the substantial accumulated net wealth of Swiss residents and official foreign exchange reserves. Switzerland’s overall foreign exchange reserves rose from USD 340 billion in 2011 to USD 1,111 billion in 2021 and are currently over USD 800 billion.

Policy Continuity After the Federal Elections, Strong Institutions Support the Credit Ratings

Federal elections to elect the members of the National Council and the Council of States were held in October 2023. The right-wing Swiss People’s Party (SVP) performed strongly winning 27.9% of the vote followed by the Social Democrats with 18.3% of the vote and the FDP. The Liberals and the Centre with approximately 14.3% and 14.1% respectively. Following the October elections, the parliament elected the Federal Council in December 2023. The composition of the Council signals economic policy continuity. Switzerland’s political environment is characterized by its federal democratic system, high institutional capacity and low level of corruption as reflected in the World Governance Indicators. The stable political system combined with neutrality in international conflicts have long made Switzerland a safe haven for investors. Despite the fact that the Swiss constitution prohibits Switzerland being a member of any defense union such as NATO and disallows any military engagement, Switzerland has implemented all the EU economic sanctions on Russia which include financing restrictions and asset freezes, travel bans, and the prohibition of sale/transfer of key technologies.

Switzerland is not part of the EU and its unique relationship is based on bilateral agreements (two packages known as Bilaterals I & II) and several other agreements ensuring, among other things, access to the EU’s single market for several sectors. Between 2014 and 2021 Switzerland and the EU negotiated on a common institutional framework to streamline Switzerland’s market access to the EU. The Swiss Federal Council halted the discussions due to substantial disagreements mainly on the Citizens’ Rights Directive and wage protection in May 2021. In December 2023, the European Commission announced that a Common Understanding was reached after 18 months of exploratory talks. The Common Understanding will serve as a guideline for both sides to be followed in the negotiation package. The EU is Switzerland’s largest trading partner and the failure of talks could ultimately result in an increase in trade barriers with its EU partners. Morningstar DBRS nonetheless expects that Switzerland will continue to maintain strong relationships with its EU counterparts in the foreseeable future.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental, Social and Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (04 July 2023) https://dbrs.morningstar.com/research/416784/dbrs-morningstar-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://dbrs.morningstar.com/research/426904.

Notes:
All figures are in Swiss Franc unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (06 October 2023) https://dbrs.morningstar.com/research/421590/global-methodology-for-rating-sovereign-governments. In addition, Morningstar DBRS uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/416784/dbrs-morningstar-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for these credit ratings include Federal Council, State Secretariat of Economic Affairs (Economic Forecasts December 2023), Federal Department of Finance (Federal Finances at a glance 2024 Budget), Federal Statistics Office (FSO elections results), Swiss National Bank (Quarterly Bulletin 4/2023 (December 2023), Financial Stability Report 2023); Federal Department of Foreign Affairs (Switzerland’s European Policy), European Central Bank (ECB), Eurostat, OECD, IMF (WEO October 2023), World Bank, BIS, Our World in Data, the Social Progress Imperative, the 2019 and 2020 Global Competitiveness Reports from the World Economic Forum, and Haver Analytics. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

Morningstar DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS’s outlooks and ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/426905.

These credit ratings are endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Spyridoula Tzima, Vice President, Credit Ratings, Global Sovereign Ratings,
Rating Committee Chair: Nichola James, Managing Director, Credit Ratings, Global Sovereign Ratings
Initial Rating Date: July 14, 2011
Last Rating Date: July 21, 2023

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