New Plymouth District Council Outlook Revised To Positive After Similar Action On New Zealand; Ratings Affirmed

OVERVIEW
  • On Jan. 31, 2019, we revised the rating outlook on New Zealand to positive from stable.
  • Consequently, we are revising our rating outlook on New Plymouth District Council to positive from stable because the ratings on the council are constrained by the long-term foreign-currency rating on New Zealand.
  • At the same time, we are affirming our 'AA/A-1+' long- and short-term issuer credit ratings on New Plymouth.
  • New Plymouth's standalone credit profile is currently higher than New Zealand's, but we believe the council could not withstand a distress scenario better than the sovereign, and that the council's credit metrics would deteriorate in line with those of the sovereign in a distress scenario.
RATING ACTION
On Feb. 1, 2019, S&P Global Ratings revised its outlook on New Zealand's New 
Plymouth District Council to positive from stable. At the same time, we 
affirmed our 'AA/A-1+' long- and short-term issuer credit ratings on New 
Plymouth. 

OUTLOOK
The positive outlook on New Plymouth reflects that on the sovereign because 
the ratings on the council are constrained by the long-term foreign-currency 
rating on New Zealand. We could raise the ratings on New Plymouth within the 
next two years should the same occur for New Zealand.

Downside scenario
We could revise the outlook on New Plymouth to stable if we were to take a 
similar action on New Zealand, or if New Plymouth's own creditworthiness 
deteriorates substantially from our current expectations. The latter could 
occur if New Plymouth's fiscal performance were to deteriorate over a 
prolonged period, resulting in a steep rise in the council's debt. Such 
developments might also cause us to lower our assessment of New Plymouth's 
financial management.

RATIONALE
The outlook revision reflects a similar action on the New Zealand sovereign 
(see "New Zealand Outlook Revised To Positive On Improving Fiscal Position; 
'AA+' LC And 'AA' FC Ratings Affirmed," Jan. 31, 2019). Although New Plymouth 
has a stand-alone credit profile higher than the sovereign's, we cap our 
rating on New Plymouth to that of the sovereign because New Plymouth does not 
meet the conditions to be rated above the sovereign in accordance with our 
criteria. We do not believe any New Zealand local council, including New 
Plymouth, could maintain stronger credit characteristics than the sovereign in 
a stress scenario. 

We expect New Plymouth's after-capital deficit to temporarily widen in the 
year ending June 30, 2019, during the upgrade of the airport terminal. 
However, we still expect the council to maintain its excellent liquidity, high 
level of budgetary flexibility, and moderate debt burden. New Plymouth's 
relatively large Perpetual Investment Fund helps the council to sustain a 
significantly higher liquidity position than many domestic peers can. We 
expect the council's robust financial management and New Zealand's supportive 
institutional settings to continue to underpin the ratings. 

--Financial management and New Zealand institutional framework support the 
ratings; economy sound despite potential headwinds--
We continue to cap our ratings on New Plymouth at the level of our long-term 
foreign-currency rating on New Zealand. We believe that New Zealand local 
authorities cannot withstand a stress scenario better than the sovereign can, 
and that the council's credit metrics would deteriorate in line with those of 
the sovereign in a stress scenario. 

Meanwhile, the institutional framework in which New Zealand councils operate 
is a key strength supporting New Plymouth's credit profile. The framework 
promotes a robust management culture, fiscal discipline, and high levels of 
financial disclosure. It allows New Zealand councils to support higher levels 
of debt than some international peers can tolerate at similar ratings.

New Plymouth is governed by an elected mayor and 14 elected councilors, who 
together delegate day-to-day management of the council to a full-time chief 
executive. A new chief executive commenced in November 2017, having previously 
held the equivalent position at nearby South Taranaki District Council. The 
council's chief financial officer resigned in December 2018, and the council 
has recently recruited a successor. New Plymouth prepares 10-year long-term 
plans every three years and annual plans in the intervening years, in line 
with New Zealand requirements. Like most of its peers, New Plymouth borrows 
only in local currency, and mitigates its interest-rate risk exposure through 
hedging. We do not expect changes in New Plymouth's executive team to lead to 
material shifts in its financial strategy during our forecast horizon.

Underpinning New Plymouth's economy are the large oil, gas, and dairy 
industries operating in the Taranaki region. The district's gross domestic 
product (GDP) per capita averaged about US$54,400 during fiscal years 2015 to 
2017, according to data from the Ministry of Business, Innovation, and 
Employment. This is high by international standards, though New Plymouth's 
economic performance is somewhat volatile due to fluctuations in oil and dairy 
prices. We believe that the GDP data overstate New Plymouth's relative 
economic strength because profits from the oil and gas sector are mostly 
repatriated to equity owners outside of the district. In contrast, New 
Plymouth's average household income is roughly in line with the national 
average. 

In April 2018, the New Zealand central government announced a moratorium on 
new offshore oil and gas exploration. The moratorium is effective immediately, 
though it does not affect existing permits. While we do not believe these 
developments will have a significant impact in the short term, there may be 
longer-term ramifications from lower investment in the regional economy.

--Fiscal performance to dip temporarily, though budgetary flexibility and 
liquidity remain key strengths--
Like all New Zealand councils, New Plymouth has recently published its 
triennial long-term plan setting out its priorities for fiscal years 2019 to 
2028. During the next three years, we expect New Plymouth's capital outlays to 
be larger than they have been in recent years. 

We now consolidate New Plymouth Airport's financial metrics with those of the 
parent council. The council is now the airport's sole owner following the 
council's acquisition of the Crown's 50% share of New Plymouth Airport on July 
1, 2017, at a cost of NZ$3.25 million. The airport is redeveloping its 
terminal at a cost of around NZ$21.7 million to NZ$28.7 million. Most of this 
expenditure--about NZ$18.3 million--is scheduled to take place in fiscal 2019, 
and will be funded by borrowing from the council. The council anticipates the 
new terminal being operational by the end of calendar 2019. 

As a result, New Plymouth's after-capital deficit, as a proportion of total 
revenues, would widen to 20.6% in fiscal 2019 before reverting to around 5%-6% 
in the outer years of our forecasts. We also expect New Plymouth's operating 
surpluses, as a proportion of operating revenues, to remain solid, averaging 
about 20.9% during fiscal years 2017 to 2021.

New Plymouth's debt burden is likely to about 107% of operating revenues by 
the end of fiscal 2021, from 87% at the end of fiscal 2018. This debt burden 
remains moderate, in our view. We also expect the council's interest expenses 
to remain low, averaging about 4.4% of operating revenues. Similar to most of 
its domestic rated peers, New Plymouth sources the majority of its external 
debt through New Zealand's Local Government Funding Agency. The council 
intends to on-lend funds to New Plymouth Airport to fund the latter's terminal 
redevelopment, and we count these borrowings as part of New Plymouth's total 
tax-supported debt. 

Budgetary flexibility remains one of the council's key strengths. We estimate 
that about 86% of the council's operating revenues are modifiable, which means 
they can be raised or lowered at the council's discretion.

New Plymouth's liquidity remains excellent. Buttressing its liquidity is the 
council's Perpetual Investment Fund (PIF), which had a balance of about NZ$289 
million as of June 30, 2018. The council has outsourced management of the PIF 
to Mercer (NZ) Ltd. An independent board of guardians monitors the PIF, and 
its assets are diversified across listed equities, fixed income, alternative 
assets, private equity, and cash. 

After applying our standard haircuts to the PIF's holdings, we estimate that 
New Plymouth's free cash and liquid financial assets will average about NZ$122 
million during the 12 months from October 2018. We expect its debt-servicing 
needs to comprise NZ$15 million in maturing long-term loans, NZ$39 million in 
short-term paper, and about NZ$7 million in interest payments, resulting in an 
overall debt-service coverage ratio of about 199%. New Plymouth also has 
access to two undrawn bank facilities totaling NZ$24 million.

The PIF aims to pay an annual "release" to the council of 3.3% of assets under 
management, equivalent to about NZ$8 million to NZ$9 million per annum. We 
treat these releases as operating revenues because they are effectively used 
to subsidize rates. We note that if the PIF's investment returns are below 
expectations, the council might reduce the annual PIF release. We consider New 
Plymouth's 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.

We assess New Plymouth's contingent liabilities as very low. The council's 
insurance policies are adequate and on par with peers'. New Plymouth has made 
provisions for potential claims under the weathertight homes resolution 
service. Like many of its rated domestic peers, New Plymouth is a shareholder 
and joint guarantor of the Local Government Funding Agency's borrowings. We 
consider it very unlikely that this guarantee will be activated in the near 
future.

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