Overview

• Hamilton City Council's fiscal metrics are underperforming our previous expectations. Operating surpluses are roughly half of our previous forecasts because inflation, interest rates, and other costs are outstripping revenue growth.
• The council is delivering a large capital expenditure program that is resulting in substantial after-capital account deficits and rapidly rising debt. Its debt is among the highest in the world for 'AA-'-rated local peers.
• Liquidity coverage will be structurally lower than in the past, driven by increased budgetary needs and higher interest expenses.
• Therefore, we revised our long-term rating outlook on Hamilton to negative from stable. At the same time, we affirmed our 'AA-/A-1+' long- and short-term issuer credit ratings.

Rating Action

On Sept. 26, 2023, S&P Global Ratings revised its long-term rating outlook on Hamilton City Council, a New Zealand local government, to negative from stable. At the same time, we affirmed our 'AA-/A-1+' long- and short-term issuer credit ratings on the council.

Outlook

The negative outlook reflects our view that Hamilton's budgetary metrics will remain weak over the next two years, leading to rapidly rising debt and narrowing tolerances within the 'AA-' rating.

Downside scenario

We could lower our ratings on Hamilton if we believed its financial management is weakening. This could be displayed by after-capital account deficits regularly exceeding 25% of total revenues, debt rising beyond our forecasts, or liquidity coverage weakening. The New Zealand central government's (the Crown) water service reforms could be a driver behind this.

Upside scenario

We could revise our outlook on Hamilton to stable if the council were to materially reduce its after-capital account deficits. This would result in debt not rising as rapidly, and liquidity coverage improving compared with our forecasts. The Crown's water service reforms could be a driver behind this.

Rationale

The outlook revision reflects the risk that Hamilton's after-capital account deficits will regularly exceed 25% of total revenues, structurally weakening the council's credit metrics. We estimate Hamilton will continue to deliver record high levels of capital expenditure (capex) each year across fiscals 2024-2026 (years ending June 30) as it tries to address growth pressures. Capital grants from the Crown will likely remain elevated, only partially offsetting some of the pressure on the council's budget.

Very large after-capital account deficits of about 25% of total revenues will pressure Hamilton's debt levels and liquidity coverage. We forecast the council will have one of the highest debt-to-operating revenue metrics among 'AA-'-rated peers globally.

Hamilton's financial management, growing local economy, and New Zealand's institutional settings continue to support the council's credit profile. We have updated our analysis for Hamilton through to financial year 2026 following the release of the council's annual plan for fiscal 2024.

Our base case excludes the potential effects of the Crown's proposed water reforms. The reform program, as currently envisaged, could shift the responsibility for drinking water, wastewater, and stormwater assets from local government councils to 10 new regional water service entities from early 2025. The reforms are still under development, and subject to Crown election outcomes.

Weaker operating margins and very high capital spending will accelerate debt beyond previous forecast; rising interest costs and larger deficits will pressure liquidity coverage

We estimate Hamilton will deliver after-capital account deficits averaging 27.7% of total revenues over fiscal years 2022-2026 as it proceeds with its large infrastructure program. We expect capex of around NZ$260 million per year across 2024-2026. Hamilton is a high-growth council and expects strong population increases over the next decade. The council is responding by building infrastructure to support residential housing growth. Nearly one-third of the capital program in 2024 is related to the Peacocke and Rotokauri greenfield developments. This includes building wastewater capacity, water treatment plant upgrades, and transport and road projects (such as the Waikato River Bridge), connecting Peacocke to the rest of the city. Once complete, Peacocke will provide housing for up to 20,000 residents.

The council almost fully delivered on its NZ$325 million capital budget outlined in the 2022-2023 plan. This resulted in a hefty after-capital account deficit of 42% of total revenues in 2023, significantly higher than our previous expectation. The improved delivery reflects a large concentration of the capital program in growth developments at peak delivery phase and one-off land purchases. Rated New Zealand councils, including Hamilton, typically underdeliver on capex compared with budget, due to planning delays, supply chain constraints, labor shortages, and difficulties in obtaining external approvals. Our capex forecasts include haircuts of 10%-20% compared with the council's estimates.

Additional grants and subsidies only partially offset the substantial fiscal weakening of Hamilton's metrics. These include substantial roading subsidies from Waka Kotahi (New Zealand Transport Agency). More recently, the council was successful in its NZ$150 million grant-funded Infrastructure Acceleration Fund application to support brownfield development within the city center.

We view Hamilton's fiscal flexibility as neutral to the rating. We believe it would be difficult for the council to substantially reduce expenses such as capex relative to our forecasts without creating large backlogs, given its acute growth pressures. Further, its general property rate increase for 2024 was well below inflation.

Operating margins are narrowing for Hamilton. We expect operating surpluses to average about 13% of operating revenues in 2022-2026; down from our previous forecasts of about 21% for 2021-2025. While high in a global context, these operating surpluses are at the lower end among rated New Zealand councils. Hamilton's operating expenses rose about 13% in 2023, underpinned by high inflation, rising payments to suppliers and employees, and a sharp rise in interest costs. Average property rates rose by 4.9% in fiscal 2024, excluding the effect of growth in the ratepayer base. This is the lowest property rates increase in the Waikato region and among the lowest of rated New Zealand councils.

We forecast total tax-supported debt will be about 312% of operating revenues in 2026, up from 243% in 2023. Interest expenses will average about 10.4% of operating revenues between 2023 and 2025, in our assessment. Reflecting Hamilton's debt levels and rising interest rates, its interest expenses will likely reach 12.2% of operating expenses in 2026. This is more than twice the ratio in 2022.

Included in Hamilton's tax-supported debt is NZ$129 million of drawdowns from a loan facility as part of the Housing Infrastructure Fund. Hamilton may draw up to NZ$180.3 million from this facility to support the Peacocke development. Drawdowns are interest-free for 10 years. The council has negotiated with the Ministry of Business Innovation and Employment to defer NZ$16.4 million of loan payments originally scheduled for June 2023 to July 2027.

Hamilton's debt-service coverage ratio, which includes interest costs and upcoming budget needs, has weakened by our measures. Widening after-capital account deficits and ballooning interest costs have led the council's debt-service coverage ratio to be structurally lower than in the past. Hamilton has a total free cash position sufficient to cover about 114% of debt service during the next 12 months. We estimate the council has about NZ$174 million in cash and NZ$100.5 million of bank lines to cover NZ$95 million of upcoming debt maturities, and NZ$37 million of interest in fiscal 2024.

Further, we consider that access to the New Zealand Local Government Funding Agency (LGFA) provides Hamilton with strong access to a well-established source of external liquidity. In our view, the LGFA benefits from an "extremely high" likelihood of extraordinary central government support and has helped Hamilton to both lengthen its maturity profile and reduce its interest expenses compared with the past.

We consider Hamilton's contingent liabilities to be very small, with little uninsured exposure to natural disasters or to off-balance sheet council-controlled organizations. The council is part of the Waikato Local Authority Shared Services syndicate with 11 other councils in the region, and is jointly insured for above- and below-ground assets.

Strong local economy, experienced financial management, and New Zealand's institutional framework support the rating

New Zealand's extremely strong and predictable institutional framework underpins Hamilton's credit profile. We believe the country's institutional framework is one of the strongest and most predictable globally.

The New Zealand local government system promotes a strong management culture and high financial disclosure among local councils. Additionally, the framework supports the rate-collection ability of the councils. The system allows Hamilton to support higher debt than some of its international peers at the current rating level.

Hamilton's financial management supports our ratings. Its budgets are credible and processes are 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 council's treasury management policy sets prudent limits on borrowing, liquidity, and interest-rate risk. Hamilton only borrows in local currency, in accordance with legislation.

Local council elections held in October 2022 saw the reelection of Mayor Paula Southgate and seven new councilors. We believe the new council will continue to focus on infrastructure development to alleviate growth pressures. Day-to-day management is delegated to a full-time chief executive. The council has recently restructured its executive leadership team to establish a leaner and more agile organization.

Persistent inflation, supply chain disruptions, and rising interest rates have weighed on economic growth nationally. Our real GDP growth projections for New Zealand have been revised to 1.4% for calendar 2023 (see "Economic Outlook Asia-Pacific Q4 2023: Resilient Growth Amid China Slowdown" published Sept. 25, 2023). We forecast national GDP per capita will be about NZ$75,600 in 2023.

According to provisional estimates by economic consultancy Infometrics, the local Hamilton economy grew by about 3.8% in the year to June 2023, higher than the national average. This reflected strong consumer spending and construction activity in the back half of 2022. As with the national economy, rising headwinds have dampened economic activity more recently.

Hamilton's economy is supported by a diverse range of industries as well as being the nation's third-fastest-growing urban area behind Auckland and its surroundings. According to Infometrics, Hamilton city has recorded average yearly population growth of 2.1% per year over the past 10 years, compared with 1.6% nationally. Strong population growth will add to the knowledge-intensive labor force and benefit the local economy. The population is among the youngest of New Zealand's territorial authorities--79% of the population is below 55 years, compared with 71% nationally.

The city region historically relied on the dairy industry for most of its income and associated jobs, but employment is now more diversified. Research, education, and services have been expanding as the population grows. We believe large ongoing greenfield projects such as Peacocke and Rotokauri will contribute to the recovery of the city's economy and meet residential housing demand.

Key Statistics

Table 1

Ratings Score Snapshot

Key Sovereign Statistics

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

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• Criteria | Governments | International Public Finance: Methodology For Rating Local And Regional Governments Outside Of The U.S., July 15, 2019
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011

Related Research

• Economic Outlook Asia-Pacific Q4 2023: Resilient Growth Amid China Slowdown, Sept. 25, 2023
• Default, Transition, and Recovery: 2022 Annual International Public Finance Default And Rating Transition Study, May 24, 2023
• Institutional Framework Assessment: New Zealand Local Governments, May 17, 2023
• New Zealand Local Government Funding Agency, March 1, 2023
• Pipedream Or Panacea: New Zealand's "Three Waters" Reforms Pt.1, Feb. 27, 2023
• Pipedream Or Panacea: New Zealand's "Three Waters" Reforms Pt.2, Feb. 27, 2023
• Global Ratings List: International Public Finance Entities 2023, Jan. 9, 2023
• Local And Regional Governments Outlook 2023: Rougher Seas Ahead, Nov. 29, 2022
• Credit FAQ: Lifting The Lid On New Zealand's "Three Waters" Reforms, Oct. 12, 2022
• Comparative Statistics: Local And Regional Government Risk Indicators: Asia-Pacific LRGs' Post-Pandemic Appetite For Capital Spending Is Strong, Sept. 22, 2022

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