Taupo District Council Ratings Affirmed At #AA/A-1+#; Outlook Remains Stable

Stocks and Financial Services Press Releases Monday May 28, 2018 09:03
S&P Global Ratings--28 May--S&P Global Ratings
OVERVIEW
  • Taupo's financial management, budgetary performance, and liquidity continue to support the ratings on the New Zealand-based district council.
  • We expect Taupo's debt burden to decline relative to revenues as the council maintains its strong operating position.
  • We are affirming our 'AA' long-term and 'A-1+' short-term issuer credit ratings on Taupo.
  • The outlook is stable.
RATING ACTION

On May 28, 2018, S&P Global Ratings affirmed its 'AA' long-term foreign currency and local currency and 'A-1+' short-term issuer credit ratings on Taupo District Council (Taupo), a New Zealand local government. The outlook on the rating remains stable.

OUTLOOK

The stable outlook reflects our expectation that the rating on the sovereign will continue to constrain the rating on Taupo, while we see only a low likelihood that the council's stand-alone credit profile (SACP) will deteriorate substantially.

Downside scenario

With an SACP stronger than the foreign-currency rating on the sovereign, it would take a substantial deterioration in the council's credit profile to warrant a downgrade. This could occur if we perceive Taupo's financial management to be deteriorating significantly, resulting in a substantial rise in council spending that leads to a rapid decline in the council's after-capital account balance, a sharp rise in its debt burden, and stress on its liquidity position.

Upside scenario
If we were to raise our rating on the sovereign, then we would likely raise our ratings on Taupo because the council's SACP is currently stronger than our foreign-currency rating on the sovereign.

RATIONALE We have updated and extended our forecasts for Taupo until 2020. Following this update, we still expect the council's financial management, budgetary performance, and liquidity to support its credit profile. We expect balances after capital accounts to remain in surplus due to the council's strong operating position and relatively low capital expenditure requirements.

--Financial management and institutional framework supports ratings; economy is vulnerable to tourism preferences--

We continue to cap our rating on Taupo at the level of our long-term foreign currency rating on New Zealand (AA/Stable/A-1+) because we believe the council could not withstand a default scenario better than the sovereign could, and that the council's credit metrics would deteriorate in line with those of the sovereign in the event of a distress scenario.

The institutional framework within which New Zealand councils operate is a key strength supporting Taupo's credit profile. The New Zealand local government system promotes a strong management culture, fiscal discipline, and high levels of financial disclosure among local councils. Additionally, the framework is supportive of councils' rate-collection abilities. This system allows Taupo to support higher debt levels than some of its international peers can tolerate at the current rating.

In our opinion, Taupo's financial management is strong, similar to that of most New Zealand councils. The council has focused on fiscal consolidation following years of key infrastructure spending. Taupo prepares a long-term plan every three years, setting an important forward-looking approach to prudent financial management, which sets an important baseline for the council's operating and capital-expenditure requirements, and its funding strategy. Debt and liquidity policies are prudent, with no issuance of foreign-currency and interest exposure being mostly hedged. Further supporting our view is Taupo's policy of cash funding its depreciation.

Taupo's economy is supported by a large proportion of nonresidents that own holiday homes and a strong tourism sector, with GDP per capita income of about US$38,000 on average during the three years from 2015 to 2017. Taupo's estimated per capita income partially overstates the actual income level of its economy as nonresidents do not form part of the district population. This also exposes Taupo's property market to New Zealand's broader economic conditions, which could weaken the economy and revenue streams in the event of an economic downturn. Also contributing to our view of Taupo's economy is the concentration risk in the tourism sector.

--After-capital account surplus supports the council's fiscal position and debt continues to decline--

We expect Taupo's after-capital account to remain in surplus of about 8% of total revenues between 2018-2020, reflecting strong operating balances and relatively low capital expenditure. Additionally, the council benefits from the large proportion of residential housing that is owned by nonresidents. This means the council effectively is able to collect the same value of rates on properties that only use the council's resources during certain periods of the year.

The council's capital expenditure was broadly in line with our expectation for 2017, with an under-spend of about 6.5%. This contributed to a large after-capital account surplus of about 20% of total revenue. We forecast smaller surpluses in the medium term, reflecting the council's plan for a new council building and waterworks. Aside from this, we don't envisage any major infrastructure projects given the council's previous key infrastructure upgrades. We expect Taupo to spend between NZ$18 million and NZ$24 million on infrastructure, predominately renewals, which is around 26% of total expenditure. This is significantly lower than 2010 when capital expenditure was over 60% of total expenditure.

We project Taupo's debt metrics to improve through to 2020 due to after-capital account surpluses. We forecast the council's total tax-supported debt to be 149% of operating revenues in 2020, down from 187% in 2017. However, we expect interest expenses to remain high, at 10.9% of operating revenue for 2017-2019, gradually declining in line with the council's lower debt burden, hedging position, and margins from its participation in the Local Government Funding Agency. Taupo's average interest costs will begin to decline as its legacy hedges unwind.

We estimate that Taupo's liquidity sources--average free cash and liquid assets--to average about NZ$102 million during the next 12 months, covering 171% of its debt service. Taupo's debt service during the next 12 months includes a NZ$30 million bond, NZ$21 million of short-term paper, and about NZ$9 million in interest payments. When including unutilized bank facilities of NZ$29 million, Taupo's debt-servicing ratio reaches 220%. Both of these ratios could improve next year because Taupo's next bond maturity of NZ$20 million isn't until May 2021.

We expect the council's modifiable revenues to be about 91% of operating revenues (after S&P Global Ratings' adjustments) between 2016 and 2020, providing the council with a high degree of budgetary flexibility. Modifiable income streams such as property rates and user charges are key sources of council income. Taupo's above-average capability to generate revenues from asset sales such as the sale of property and land, term deposits, commercial paper, and other liquid assets held in its investment fund help to support its revenue flexibility. The sale of these assets could generate additional council revenue, should that become necessary to support debt repayment.

While debt remains high compared with peers, Taupo's contingent liabilities are low. The council's insurance policies, disaster recovery fund, and its investment fund limit its exposure to contingent liabilities that could arise from natural disasters. The district is susceptible to volcanic eruption and the flooding of Lake Taupo. The resulting landslides, clean-up operations, and loss of tourism could have a financial impact on the council.


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