City Council credit rating affirmed

In its annual review of the Council’s creditworthiness, S&P says the Council is expected to incur large deficits over the next few years as it increases capital expenditure while COVID-19 drags on council revenue growth – but that its financial outlook is positive.

It says debt will increase, but not materially weaken, the Council’s balance sheet. 

Mayor Andy Foster, in welcoming the AA/A-1+ credit, says the Council’s finances are in good hands. 

“I’d like to pay tribute to the extremely hard work that the Chief Executive, Barbara McKerrow, and her team have put into the fiscal response to COVID in the past few months. The coming years will be financially very challenging at both governance and management levels and we will need to continue to be very tightly focused on sound financial and asset management.”

Ms McKerrow added: “We’re acutely aware the Council and the community are facing big financial challenges, partly due to COVID but also due to the major capital investments we’re dealing with in the next few years. The Standard and Poor’s rating is a great vote of confidence in our fiscal performance.” 

S&P says New Zealand’s institutional settings and Wellington’s wealthy economic profile continue to support the Council’s rating.

Other commentary from S&P

We continue to cap our rating on Wellington 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 Wellington'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. The framework is supportive of councils' rate-collection abilities. This system allows Wellington to support higher debt levels than some of its international peers can tolerate at the current rating.

Wellington prepares a long-term plan every three years and annual plan each year, setting an important forward-looking approach to prudent financial management. This sets an important baseline for the council's operating and capital expenditure requirements as well as its funding strategy. Debt and liquidity policies are prudent, with no issuance of foreign-currency and interest exposure being mostly hedged.

We expect the council to incur large after-capital account deficits to narrow to about 12% of total revenues during 2021-2023, and average about 14% between 2019-2023. This reflects the council ramping up its capital spending while its operating revenues suffer from the COVID-19 pandemic.

We forecast capital expenditure to average more than NZ$230 million per year between 2021 and 2023, up from NZ$130 million in 2013 to 2017. Capital expenditure will focus on water, stormwater, wastewater, and transport networks as well as multiyear projects to earthquake-strengthen the Town Hall, St James Theatre, and the city's new Convention and Exhibition Centre. Capital revenues from the Crown will somewhat support Wellington's financial outcomes over the next few years.

The council had a very large after-capital account deficit of 19% of total revenue in 2020. The council posted much stronger performance before the November 2016 Kaikoura earthquake, with after-capital account deficits averaging 3% of total revenue per year during 2013-2017, when its capital expenditure was lower.

The council's operating balance will remain strong, averaging 18% of operating revenue during 2019-2023. The ratio dropped to about 13% during 2019-20 as capital project-related costs (employees and supplier costs) and COVID-19 spending increased, and revenues fell slightly because of the pandemic. Revenue from fees and charges in 2020 were negatively affected by the pandemic and were about NZ$9 million lower than the 2020 budget estimate. Receipts from rates were also NZ$9.4 million lower than the 2020 budget. Revenue growth will recover over the next three years. Dividends from Wellington International Airport Ltd., however, will not because airport traffic will take years to recover.

The council's decision to continuing raising rates to fund its larger capital expenditure programme to support its financial position demonstrates its ability and willingness to raise revenues. More than 90% of income comes from rates, fees, and charges.

The council's larger capital program is driving the council's debt levels higher. We expect total tax-supported debt will reach 173% of operating revenues in 2023, compared with the current level of 162% in 2020. We forecast that the council's debt borrowings will increase to about NZ$969 million at the end of 2023 from NZ$776 million at the end of 2020. Debt is also higher because of the council's prefunding strategy, which grosses up debt and cash assets. With debt levels forecast to rise, we expect interest expenses to average about 5% of operating revenues between 2020 and 2022, aided by the low interest-rate environment.

Wellington's contingent liabilities are limited but rising. They reflect the council's provisions for weathertight homes (NZ$39 million) and landfill post closure costs (NZ$22 million) as well as council's share of the joint equity underwrite provided to the Wellington International Airport Ltd. of up to NZ$25.8 million.

The council's insurance policies and adequate provisions reduce its exposure to contingent liabilities that could arise from natural disasters. Additionally, supporting our assessment is the support the Crown is likely to provide in the event of a natural disaster such as the 2016 Kaikoura Earthquake.

The council's liquidity position is improving. Debt service coverage ratio, including bank lines and contracted funding, stands at 170% of upcoming debt service. We expect the ratio to remain well above 120% during the next 2-3 years. This improvement reflects the council's prefunding strategy and lower use of commercial paper as a proportion of its debt levels.

We expect the council to have NZ$129 million in cash and term deposits at the end of 2020, NZ$130 million in bank lines, and NZ$146 million in funding raised since July 2020 to cover NZ$186 million debt maturities, including NZ$68 million in commercial paper, and NZ$23 million in interest and spending needs in 2021.

The council has extended its allowable period for prefunding from 12 months to 18 months before debt matures to reduce refinance risk and take advantage of favorable market conditions. As of Sept. 30, 2020, the council had NZ$103 million prefunded out to May 2021, and additional prefunding of NZ$23 million was planned in October to prefund out to November 2021.

Supporting the council's liquidity is its access to the New Zealand Local Government Funding Agency (LGFA). This provides Wellington, along with most of its New Zealand peers, 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 Wellington to both lengthen its maturity profile and reduce its interest expenses.