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Research Update: Auckland Council Ratings Affirmed At 'AA/A-1+'; Outlook Remains Stable

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Research Update: Auckland Council Ratings Affirmed At 'AA/A-1+'; Outlook Remains Stable

Overview

  • We forecast a large economic shock in New Zealand during 2021 because of the COVID-19 pandemic. We expect this to further weigh on Auckland Council's forecast large after-capital account deficits and rising debt levels over the next few years, as the council continues to address infrastructure needs to support its rapidly growing population.
  • We expect the city's strong economic and liquidity profile, the council's experienced management, and New Zealand's excellent institutional settings to help Auckland counter these challenges and underpin its rating.
  • We are affirming the 'AA' long-term and 'A-1+' short term issuer credit ratings on Auckland.
  • The outlook on the long-term rating remains stable.

Rating Action

On Sept. 29, 2020, S&P Global Ratings affirmed its 'AA' long-term foreign- and local-currency and 'A-1+' short-term issuer credit ratings on Auckland Council, a New Zealand local government. The outlook on the long-term ratings remains stable.

Outlook

The stable outlook reflects our expectation that the council will successfully manage the city's growth pressures and large capital expenditure requirements while maintaining its elevated debt at a level consistent with a 'AA' rating.

Downside scenario

Downward rating pressure might arise if we consider Auckland's financial management to be weakening. This could occur if management allows its budgetary performance to structurally deteriorate, driving debt levels substantially higher than our forecasts.

Upside scenario

Upward pressure on the ratings is unlikely, given the city's growth pace, size of its capital-expenditure requirement, and the rating on New Zealand. An upgrade could occur if we raised our rating on the New Zealand sovereign and Auckland's financial position and debt levels substantially improved.

Rationale

We affirmed the ratings to reflect our view that Auckland Council's strong financial management and prudent liquidity policies, as well as New Zealand's excellent institutional settings, would counter the effects of a large economic shock that we expect to occur in New Zealand during 2021 because of the COVID-19 pandemic. Auckland's budgetary performance and debt profile temper these credit strengths.

Nevertheless, we expect the economic shock to weigh on Auckland Council as the council incurs large after-capital deficits and rising debt levels over the next few years because of ongoing infrastructure projects that cannot be delayed. Asset recycling and a 3.5% council rates increase will alleviate immediate budgetary pressure in 2021, which has been affected by the COVID-19 pandemic.

Excellent institutional framework and supportive financial management with a strong economy support creditworthiness

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

In our view, Auckland Council has reacted deftly to the financial and economic fallout from the pandemic--a clear demonstration of its strong financial management. The council published its Emergency Budget 2021 to address pandemic-induced challenges. The council is increasing rates by 3.5% and has set aside NZ$50 million to address crisis-induced hardship experienced by the community, allowing deferral of rate payments without penalty.

Auckland's experienced financial management team is successfully managing its financial risks including debt elevated levels, despite substantial growth and demand for infrastructure in the large city. Its prudent fiscal strategy outlines key policies and financial targets around borrowing limits and liquidity coverage. Reflecting both its size and management capabilities, Auckland is permitted to borrow offshore. While there are some risks associated with this, we believe they are well managed by the team and the council hedges all of its foreign-exchange and most of its interest-rate exposure.

In line with New Zealand requirements, the council releases regular 10-year long-term plans and 30-year asset-management strategies, which outline its expected budgets and infrastructure spending. We believe its governance and oversight of council-controlled organizations ensure they are well managed, limiting potentially contingent liabilities from these entities. Like all of its domestic peers, Auckland is governed by an elected group of councilors, led by a mayor. The council has a newly appointed CEO, to whom the day-to-day management is delegated. A new CFO was also recently appointed. Both have strong leadership experience in the public and private sectors.

Auckland is New Zealand's largest regional economy, with an average GDP per capita of US$47,000 in 2019, higher than the national average of US$41,900. Auckland's GDP growth, like all its peers, has suffered due to the COVID-19 pandemic, falling 2.7% year on year. Auckland accounts for about 40% of national GDP, and we anticipate it to remain weak as international borders are not likely to open until at least March 2021. The border closure will result in weaker international tourism and a severe drop in migration for the near future. We believe the council's long-term prospects, as New Zealand's commercial center, remain sound.

Financial outcomes supported by rate increase; substantial infrastructure needs sustain deficits and very high debt levels

Auckland's strong population growth means infrastructure needs remain high, resulting in sustained after-capital deficits over the medium term. We forecast the council's after-capital account deficits will average about 12% of total revenues between the years ending June 30, 2019, and 2023. These deficits are reasonably large in a global context. The council is addressing a backlog of infrastructure renewals, as well as major spending on transportation facilities, keeping capital expenditure high across our forecast horizon.

Our forecasts incorporate a 15% underspend in the council's capital expenditure compared with its own budget. With this in mind, we believe it would be difficult for Auckland to further delay capital expenditure without adding to its infrastructure backlog. The council has embarked on a few large infrastructure projects currently in progress, including the City Rail Link (CRL), and water quality and treatment facilities, which are difficult to delay once they have commenced. CRL's cost escalations are incorporated in our financial forecasts.

The Crown government remains supportive of Auckland and continues to fund half of the City Rail Link project. The council also has approved funding from the Crown's Housing Infrastructure Fund and Crown Infrastructure Partners. The funds are aimed at increasing the pace of housing supply by allowing local councils to build infrastructure faster. In addition, the central government has agreed funding of about NZ$350 million for shovel-ready projects.

The council's operating revenue will be hit in fiscal 2021 due to COVID-19 pandemic-related closures of businesses and services. We forecast a dip in cash revenues from rates, fees, and charges, taking the council's operating balance to 12.4% of operating revenues in 2021. We expect the council's operating balance to remain strong, averaging 19% of operating revenue over fiscals 2019 to 2023.

Auckland's tax-supported debt burden (including non-cancellable operating leases) will peak at about 290% of operating revenues as of fiscal 2021. This temporary jump exceeds the council's internal limit, and is caused by funding the council's elevated capital program, and lower revenues than we expected due to the pandemic. The tax-supported debt-to-revenue ratio is likely to ease back to around 270% in fiscal 2022 as revenues recover. Interest expenses as a proportion of operating revenues will average about 11% between fiscal years 2020 and 2022 due to high debt levels.

We estimate that the council's debt-service coverage ratio, including internal sources of cash and liquid assets, and NZ$1.4 billion of undrawn bank facilities, to be 143.7% of debt maturities and interest payments over the next 12 months.

Auckland is the only New Zealand local council that is permitted to issue foreign-currency bonds in international capital markets. This results in diverse funding sources that support the council's strong access to external liquidity. Currently, the council issues in Australian dollars, euro, Norwegian krone, and Swiss francs. Further, we consider that access to the New Zealand Local Government Funding Agency (LGFA) provides Auckland with an additional, well-established source of external liquidity.

Key Statistics

Table 1

Auckland Council--Selected Indicators
--Year end June 30--
Mil. NZ$ 2019 2020e 2021bc 2022bc 2023bc
Operating revenues 3,914 4,043 4,023 4,430 4,613
Operating expenditures 3,148 3,346 3,525 3,459 3,553
Operating balance 766 697 498 972 1,060
Operating balance (% of operating revenues) 19.6 17.2 12.4 21.9 23.0
Capital revenues 650 781 892 827 797
Capital expenditures 1,899 2,303 2,204 2,390 1,975
Balance after capital accounts (483) (825) (814) (591) (118)
Balance after capital accounts (% of total revenues) (10.6) (17.1) (16.6) (11.2) (2.2)
Debt repaid 2,351 3,005 1,098 1,257 807
Gross borrowings 2,467 4,136 1,912 1,848 925
Balance after borrowings (367) 306 0 0 0
Tax-supported debt (outstanding at year-end) 9,711 10,865 11,679 12,270 11,844
Tax-supported debt (% of consolidated operating revenues) 248.1 268.7 290.3 277.0 256.8
Interest (% of operating revenues) 11.9 10.8 11.8 11.2 10.9
National GDP per capita (single units) 62,023 62,615 62,175 66,305 68,886
The data and ratios above result in part from S&P Global Ratings' own calculations, drawing on national as well as international sources, reflecting S&P Global Ratings' independent view on the timeliness, coverage, accuracy, credibility, and usability of available information. The main sources are the financial statements and budgets, as provided by the issuer. bc--Base case reflects S&P Global Ratings' expectations of the most likely scenario. N/A--Not applicable. N.A.--Not available. N.M.--Not meaningful.

Ratings Score Snapshot

Table 2

Ratings Score Snapshot
Key rating factors
Institutional framework 1
Economy 1
Financial management 1
Budgetary performance 4
Liquidity 1
Debt burden 5
Standalone credit profile aa
Issuer credit rating AA

Key Sovereign Statistics

Sovereign Risk Indicators. An interactive version is available at http://www.spratings.com/sri.

Related Criteria

Related Research

  • COVID-19: Fiscal Response Will Lift Local And Regional Government Borrowing To Record High, June 9, 2020
  • Ratings History List: Asia-Pacific Local And Regional Government Ratings Since 1975, May 29, 2020
  • COVID-19's Effects Will Pressure New Zealand Council Ratings, May 24, 2020
  • New Zealand 'AA/A-1+' FC And 'AA+/A-1+' LC Ratings Affirmed; Outlook Positive, May 3, 2020
  • COVID-19: Emerging Market Local Governments And Non-Profit Public-Sector Entities Face Rising Financial Strains, April 6, 2020
  • Default, Transition, and Recovery: 2018 Annual International Public Finance Default And Rating Transition Study, Aug. 19, 2019
  • Institutional Framework Assessments For International Local And Regional Governments, July 4, 2019
  • Public Finance System Overview: New Zealand's Institutional Framework For Local And Regional Governments, Nov. 11, 2018

In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision.

After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts.

The committee's assessment of the key rating factors is reflected in the Ratings Score Snapshot above.

The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria And Research').

Ratings List

Ratings Affirmed

Auckland Council

Issuer Credit Rating AA/Stable/A-1+

Auckland Council

Senior Secured AA
Senior Unsecured AA
Commercial Paper A-1+

S&P Global Ratings Australia Pty Ltd holds Australian financial services license number 337565 under the Corporations Act 2001. S&P Global Ratings' credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale client (as defined in Chapter 7 of the Corporations Act).

Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at www.standardandpoors.com for further information. Complete ratings information is available to subscribers of RatingsDirect at www.capitaliq.com. All ratings affected by this rating action can be found on S&P Global Ratings' public website at www.standardandpoors.com. Use the Ratings search box located in the left column.

Primary Credit Analyst:Rebecca Hrvatin, Melbourne (61) 3-9631-2123;
rebecca.hrvatin@spglobal.com
Secondary Contact:Anthony Walker, Melbourne + 61 3 9631 2019;
anthony.walker@spglobal.com

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