(The following was released by the rating agency)
Overview
-- We believe Kapiti's large capital program, along with lower revenue projections in its latest Long-Term Plan, will lead to a higher ratio of tax-supported debt than previously expected. We also anticipate a period of high deficits after capital spending.
-- The ratings continue to be supported by the very strong institutional framework.
-- We are lowering our long-term rating on Kapiti Coast District Council to 'A+' from 'AA-' and short-term rating to 'A-1' from 'A-1+'.
-- The stable outlook reflects our expectation that the council's debt will peak at 237% of revenue in fiscal 2014, and thereafter stay below 230%.
Rating Action
On Oct. 11, 2012, Standard & Poor's Ratings Services lowered its long-term issuer credit rating on Kapiti Coast District Council (KCDC) to 'A+' from 'AA-'. Consequently, we lowered the short-term rating on KCDC to 'A-1' from 'A-1+'. The outlook is stable.
Rationale
The downgrade on KCDC reflects our view that the larger capital program outlined in its recently released Long-Term Plan (LTP) will lead to a worsening of its financial ratios.
Although the capital projects in the new LTP are largely unchanged from the previous LTP, we believe the council's decision to accelerate a number of big-scale projects will lead to an earlier-than-expected increase in its net borrowing in the current year until the fiscal year ending June 2016. Lower revenues over the forecast period in the LTP are also projected due to a weaker economic environment and slower growth in the rate base. As a result, we project the tax-supported debt to rise to 237% of revenue by fiscal 2014. This breaches the 190% threshold that we had specified in our previous outlook statement.
Likewise, we expect the large capital program to further weaken the council's budgetary performance. In fiscal 2012, the council's deficit after capital expenditure reached 33.5% of revenue. Over the next two fiscal years, we forecast the deficit to be in the range of 24% to 55% of revenue. We previously expected the council to keep its deficits below 25%.
The ratings on KCDC continue to reflect our opinion of the very strong institutional framework benefiting local governments in New Zealand, the council's strong liquidity and positive financial management, and zero exposure to Council Controlled Organizations (CCO). Moderating these strengths are KCDC's very heavy debt burden and a weak budgetary performance with moderate fiscal flexibility.
Our views on the strength of the council's financial management are somewhat diminished because of the accelerated pace of its borrowings. Nonetheless, we assess it as "positive". The New Zealand national framework sets international best practices for its local governments. Despite KCDC's relative small size, the council meets these standards, and, on occasions, surpasses them; for example, the council engages in long-term planning of up to 20 years, even though the central mandate calls for 10 years. Its debt management has a strong focus on intergenerational equity, and financial targets are well-defined.
The council's high share of modifiable revenue offers some revenue flexibility, in case it faces an extended period of financial stress. More than 90% of Kapiti's revenues are deemed modifiable. There are no statutory restrictions on the council to increase rates, and we note that it has demonstrated some political willingness to do so. The council does not have a self-imposed rate-cap policy. However, its large share of elderly population would dictate that affordability weighs heavily on the council's considerations in any adjustments of rates. In addition, the need to deliver an expanded infrastructure program to match population growth constrains KCDC's expenditure flexibility.
Notably, aside from the council's zero exposure to CCO, it has no other known material contingent liabilities. This limits potential unwelcome surprises to KCDC's fiscal position, in our view.
Liquidity
The short-term rating on KCDC is 'A-1', reflecting our positive view of the council's liquidity. Over the next 12 months, KCDC has NZ$13.5 million of principal repayment and interest due. The council's cash on hand (NZ$1.35 million at end August 2012), plus its NZ$65 million in unutilized committed credit facilities, gives KCDC a very comfortable debt-servicing coverage of close to 500%. The council's debt-maturity profile is weighted toward longer-term borrowings. This further mitigates short-term liquidity risks. Nevertheless, we note that KCDC's rapid pace of debt accumulation will give rise to higher debt-servicing needs, and inevitably will affect its liquidity ratios.
Outlook
The stable outlook reflects our expectation that the council's debt will peak at 237% of revenue in fiscal 2014, and thereafter stay below 230%. Likewise, we envisage the council's budgetary performance will improve from fiscal 2015 once major capital projects are completed. Our estimates are based on the council's projections in its latest LTP. The stable outlook on the long-term rating extends up to two years.
The rating could come under pressure if the council's budgetary performance deteriorates over a prolonged period, with deficits above 25% of revenue after capital spending. Deficits of such magnitude would not be sustainable if they become structural in nature. This could happen if the council decides to take on additional capital spending or if revenues are significantly lower than projected.
There is limited upside to the ratings, given that KCDC is set to increase debt rapidly over the next few years. An improvement in the council's budgetary performance and reduced debt levels would likely be the drivers for any positive rating action in the medium to long term.
Related Criteria And Research Methodology For Rating International Local And Regional Governments, Sept. 20, 2010 Ratings List Downgraded To From Kapiti Coast District Council Issuer Credit Rating A+/Stable/A-1 AA-/Stable/A-1+
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