Hastings District Council Assigned #AA/A-1+# Outlook Stable

Stocks and Financial Services Press Releases Tuesday February 13, 2018 18:20
S&P Global Ratings--13 Feb--S&P Global Ratings
RATING ACTION

On Feb. 13, 2018, S&P Global Ratings assigned its 'AA' long-term foreign-currency and local-currency issuer credit ratings and 'A-1+' short-term ratings to Hastings District Council, a New Zealand local government. The outlook on the long-term ratings is stable.

OUTLOOK

The stable outlook reflects our base-case expectation that although Hastings' budgetary performance will weaken during the next few years as it continues to roll out a program of capital upgrades, the council's debt burden will remain moderate relative to peers. Meanwhile, we expect the ratings to continue to be supported by New Zealand's institutional framework and Hastings' robust management and high level of budgetary flexibility.

Downside scenario

We could lower our ratings on Hastings if its budgetary performance were to deteriorate more sharply and for a longer period than we currently expect, resulting in larger after-capital-account deficits and higher interest expenses and debt. This could occur, for instance, if rates revenue does not grow as quickly or if capital works are more costly than we currently forecast. We consider this scenario unlikely in the next few years.

Upside scenario

Any upward pressure on the ratings would currently be constrained by New Zealand's 'AA' foreign-currency sovereign rating. If we were to raise our sovereign rating on New Zealand, then upward pressure on the ratings on Hastings could eventuate if the council's liquidity coverage were to improve and budgetary performance turned out better than in our base case. This could occur, for instance, if rates revenue grows faster or if capital works are delivered more efficiently than we currently forecast.

RATIONALE

Our ratings on Hastings District Council (Hastings) reflect its robust management and supportive institutional framework, high level of budgetary flexibility, and moderate debt burden relative to peers. We expect Hastings to maintain an elevated level of capital spending during the next few years, resulting in a period of after-capital-account deficits. We also expect rates revenue to continue to grow, which will help the council to maintain its debt burden at a moderate level.

--Ratings supported by strong financial management and the country's institutional framework--

We consider Hastings' financial management to be a key strength. Its budgets are credible and processes well established, with the council preparing 10-year long-term plans every three years and annual plans in the intervening years, in line with New Zealand requirements. The next long-term plan, covering 2018 to 2028, is due out this year. The council's treasury management policy sets prudent limits on external borrowing, liquidity and interest-rate risk. Hastings borrows only in local currency, in accordance with legislation. Consistent small cash surpluses have allowed Hastings to keep debt at a roughly stable level for the past five years to fiscal 2017 (the year ending June 30, 2017). Like all of its domestic peers, Hastings is governed by an elected group of councilors, led by a mayor. The current mayor was elected at a by-election in November 2017, having previously served as deputy mayor. Day-to-day management is delegated to a full-time chief executive.

The district's economy is somewhat dependent on the agricultural industry, which accounts for 16.7% of local employment (compared with a national average of 6.2%, according to Infometrics) and supports related jobs in manufacturing and other industries. Hastings is New Zealand's largest producer of apples, pears, and peaches, and the second largest producer of grapes and wines. It forms part of New Zealand's Hawke's Bay region, a major agricultural and food-processing hub. We estimate that the region's GDP per capita averaged about US$30,400 between 2015 and 2017, which is relatively high in an international context, but lower than the national average of US$41,300. We use the region's GDP in our economic assessment because we believe it is a good proxy for Hastings' economy, given the council's linkages with neighboring councils. The district has a population of about 79,900, while the broader region's population is closer to 164,000.

The institutional framework within which New Zealand local governments operate is a key factor supporting Hastings' credit profile. We believe this framework is one of the strongest and most predictable globally. It promotes a robust management culture, fiscal discipline, and high levels of disclosure.

--Deficits forecast but debt should remain moderate relative to peers; finances are weakening from a historically strong position--

We expect Hastings' budgetary position to be weaker during the forecast period than in recent years. Hastings increased its capital works program in fiscal 2017 to NZ$54 million from NZ$39 million the preceding year, and we expect capital expenditure to remain elevated through fiscal 2020. This is partly attributable to new investment in upgrading the water supply network. In August 2016, there was a widespread outbreak of gastroenteritis in the suburb of Havelock North. A subsequent Crown inquiry traced the outbreak to contamination of an underground aquifer, which was the source of drinking water supplied by the council to the local population. In response, Hastings has allocated NZ$12 million in fiscal 2018 and a further NZ$35.7 million during the next three years to install new pipes and treatment systems. The council's infrastructure budget also includes funds to strengthen the Hawke's Bay Opera House and local bridges and to develop the central business district. Similar to many domestic peers, Hastings typically under-delivers on its infrastructure plans each year. As such, our base-case forecasts incorporate a 20% haircut to budgeted capital expenditure.

Operating expenses increased in fiscal 2017 because of the Havelock North inquiry, and are likely to remain higher than the historical trend as the council expands its water services team and spends more on ongoing water quality monitoring and treatment. We forecast operating surpluses, as a proportion of adjusted operating revenues, to average a relatively strong 22.2% during fiscal years 2016 to 2020. The after-capital-account balance fell into deficit in fiscal 2017 after a number of years in surplus, and we expect it to remain in deficit through fiscal 2020.

In our view, Hastings has a high level of budgetary flexibility. We estimate that about 94% of the council's operating revenues are modifiable, which means they can be raised or lowered at the council's discretion. The largest single source of revenue is from rates. Although Hastings has limited its rates increases to around 3% per annum or less in the past, we believe it likely that there will be upward pressure on rates increases, including targeted water supply charges, during the forecast period. This should help fund capital spending and slow the growth in debt.

We project that Hastings' tax-supported debt burden will rise to 89% of consolidated operating revenues by fiscal 2020, up from 61% at the end of fiscal 2017. We forecast that interest expenses, as a proportion of adjusted operating revenues, will average about 4% between fiscal 2017 and fiscal 2019. Aside from cash, the council does not hold liquid financial assets but has access to an undrawn NZ$10 million facility with Westpac. We expect the council's debt servicing needs during the next 12 months to comprise NZ$5 million in maturing commercial paper and about NZ$4 million in interest payments. As a result, we estimate that Hastings' free cash and available committed bank lines stand at about 190% of the next 12 months' debt service.

Factored into Hastings' current ratings is its debt maturity profile, which is somewhat lumpy. Hastings has NZ$20 million in notes due to mature in March 2019, which is relatively large compared with cash and bank facilities. Absent mitigating actions, this could weaken its debt-service coverage ratio in the future. We consider Hastings' access to external liquidity to be satisfactory. While New Zealand's capital markets are comparatively liquid, they lack depth, given their relatively small size. During the severe market dislocation of 2008 and 2009, some New Zealand councils had difficulty issuing unrated commercial paper. Similar to most of its domestic rated peers, Hastings sources its external debt through the New Zealand Local Government Funding Agency (LGFA).

We believe that Hastings has minimal contingent liabilities. There are a small number of unquantifiable claims against the council in relation to past weathertightness issues in some residents' homes. Hastings owns 24% of Hawke's Bay Airport Ltd., in conjunction with the central government and a neighboring council. We consider its share of the airport's borrowings, which are currently nil, though we expect them to rise in future years, to be a contingent liability. Hastings is one of 31 local authorities that are shareholders and guarantors of the LGFA's borrowings; we consider it unlikely that this guarantee would be activated in the near future.


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