Taupo District Council Outlook Revised To Positive After Similar Action On New Zealand; 'AA/A-1+' 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 Taupo 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 the 'AA/A-1+' ratings on the council.
  • Although Taupo's stand-alone credit profile is currently higher than New Zealand's, 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.
RATING ACTION
On Feb. 1, 2019, S&P Global Ratings revised its outlook on New Zealand's Taupo 
District Council to positive from stable. At the same time, we affirmed our 
'AA/A-1+' long- and short-term issuer credit ratings on Taupo.

OUTLOOK
The positive outlook on Taupo 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 Taupo within the next two 
years should the same occur for New Zealand. 

Downside scenario
We could revise the outlook on Taupo to stable if we take a similar action on 
New Zealand, or if Taupo's own creditworthiness deteriorates substantially 
from our current expectations. 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.

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", published Jan. 31, 2019). Although 
Taupo has a stand-alone credit profile higher than the sovereign's, we cap our 
rating on Taupo to that on the sovereign because Taupo 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 Taupo, could maintain 
stronger credit characteristics than the sovereign in a stress scenario. 

We 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 support 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/Positive/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. In addition, 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.

Supporting Taupo's economy is a large proportion of nonresidents that own 
holiday homes and a strong tourism sector, with GDP per capita income of about 
US$38,200 on average during the three years from 2014 to 2016. 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 and 2020, reflecting strong operating balances and 
relatively low capital expenditure. In addition, 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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