Whangarei District Council Ratings Affirmed At #AA/A-1+#, Outlook Remains Stable

Stocks and Financial Services Press Releases Friday May 19, 2017 09:19
S&P Global Ratings--19 May--S&P Global Ratings

On May 19, 2017, S&P Global Ratings affirmed its 'AA' long-term foreign currency and local currency rating and 'A-1+' short-term issuer credit rating on Whangarei District Council, a New Zealand local government. The outlook on the ratings remains stable.

OUTLOOK
The stable outlook reflects our expectation that Whangarei will continue to   strengthen its budgetary performance and reduce its debt burden below 120% of   operating revenues.
Upside scenario

If we were to raise our rating on the sovereign, then we would likely raise   our ratings on Whangarei because the council's standalone credit profile is   currently stronger than our foreign currency rating on the sovereign.

Downside scenario

With a stand-alone credit profile stronger than the foreign currency rating on the sovereign, it would take a substantial deterioration in the council's credit profile to warrant lowered ratings. We may lower the rating if the council's after-capital account deficits weakened significantly, resulting in a sharp rise in its debt burden. This could occur if the council changed its current policy and added a significant amount of capital expenditure to its budget, resulting in significant increases in its after-capital account deficits, without offsetting adjustments to revenue or expenditure. This could also weaken its liquidity coverage and our view of its financial management.

RATIONALE

We have updated and extended our forecasts for Whangarei until 2019. Following this update, we still expect the council's financial management and budgetary flexibility to support Whangarei's credit profile. We expect Whangarei will continue to improve its operating surplus by sticking to its rates policy, further strengthening its after-capital accounts surplus and reducing its debt.

--A supportive institutional framework and excellent management underpin Whangarei's creditworthiness--The institutional framework within which New Zealand local governments operate is a key strength supporting Whangarei's credit profile. We believe the framework is one of the strongest and most predictable globally. The New Zealand local government system also promotes a strong management culture, fiscal discipline, and high levels of financial disclosure among local councils. The system allows Whangarei to support higher debt levels than some of its international peers can tolerate at its current rating.

Whangarei's management is focused on prudent financial management and has contributed to the council's strong financial position. The council is undergoing a management restructure that will help to align its business activities and enable better delivery of services. Further supporting our view of the council's management strength is the council's commitment to raise income through higher rates than in the past to strengthen its financial position. We consider its debt and liquidity policies to be prudent, as shown in its decreasing level of debt and higher liquidity coverage. The council does not borrow in foreign currency and interest exposure is mostly hedged.

Whangarei is the Northland region's main urban and servicing center, and its economy is broadly supportive of Whangarei's credit profile. Economic growth has been relatively strong in recent years, rising to about 3% in 2016 compared with average growth of 1.7% during the past 10 years. Some of this growth is being held up by an expanding population and higher levels of investment in housing due to the overflow from Auckland's buoyant housing market. We estimate Whangarei's GDP per capita was about US$32,600 on average between 2014 and 2016, which is relatively high in an international context, but lower than New Zealand's national level of US$43,100. Whangarei benefits from being home to New Zealand's only oil refinery, which contributed about 16% of districts GDP in 2016. Because much of the income generated from the oil refinery accrues to its nonresident owners, Whangarei's estimated per capita income doesn't fully reflect the council's ability to raise revenue through property rates charged to local residents. In addition, Whangarei's industry concentration in manufacturing, including the oil sector, is about 24% of the GDP output, which adds some economic vulnerability to the district.

--After-capital account surplus supports Whangarei's fiscal position and debt continues to decline, while liquidity coverage is improving--About 93.1% of Whangarei's cash operating revenues are modifiable, showing exceptional budgetary flexibility. The council's revenue flexibility is supported by the council's policy to increase property rates above inflation; the council is targeting an overall rate increase of 4.8% in 2018. Whangarei's rates compare favorably with the average rates paid throughout New Zealand, even after a one-off increase in overall rates of 9% in 2016. The absence of a significant infrastructure backlog provides Whangarei with some expenditure flexibility around capital works, and the council can delay smaller projects if the need arises. We forecast the council will spend between NZ$41 million and NZ$44 million per year on infrastructure, which is equivalent to about 31.6% of total expenditure. We expect Whangarei's capital expenditure to peak at about 32.9% in 2018, mainly due to the development of a new water treatment plant in Whau Valley.

We expect Whangarei's after-capital account to remain in surplus of about 1.9% of total revenues between 2017 and 2019, reflecting strong operating balancesand capital expenditure underspend. Whangarei's operating position continues to improve, with average surpluses of about 25% of operating revenues. This improvement reflects the council's commitment to increase operating revenues through rate increases to fund operating and capital expenditure.

We project Whangarei's debt metrics to continue improve in the medium term. The council's rate policy has strengthened its operating position and after-capital account balances. This decision is helping the council to be less reliant on borrowings and asset sales to fund capital expenditures, therefore reducing its debt burden to 116% of operating revenues in 2019 from 136% in 2016. Interest expenses reflect this decreased debt level, dropping to about 6.8% of operating revenues between 2017 and 2019 from 7.1% in our previous forecast. By taking into account the possibility of under-execution of the capital projects, borrowings might not be as high as we forecast.

Whangarei's liquidity coverage is high and it has improved during the past year. We forecast free cash, liquid assets, and bank facilities will average NZ$55 million during the next 12 months, covering about 145% of Whangarei's debt service. This compares favorably with 119% liquidity coverage last year. The council is prefunding NZ$20 million of debt maturing in December 2017, which will reduce refinancing risk.

Whangarei's contingent liabilities are small and represent about 2% of council's operating revenues. Most of the council's contingent liabilities reflect future claims arising from a weather-tightness building issue, at about NZ$2.4 million, small loan guarantees, and Marsden City's industrial subdivision. In 2015, the council discovered issues with the quality of new stormwater and wastewater concrete infrastructure assets in the Marsden City subdivision. The investigation identified a number of underground assets that are deteriorating due to erosion caused by acid sulphate soils. This has resulted in the council impairing about NZ$8.7 million of assets and initiating legal proceedings to seek damages against contractors involved.


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