We continue to view as favorable the credit quality of New Zealand's local and regional governments, even as their debt burdens grow.

S&P Global Ratings has long-term issuer credit ratings on 23 local and regional governments (i.e., councils) in New Zealand, with ratings ranging between 'AA' and 'A+', nine of which have positive outlooks. Seven of these positive outlooks are connected with the positive outlook on the sovereign, with the remaining two for council stand-alone credit specific factors. None have negative outlooks.

Underpinning the high ratings--clustered in a three-notch band toward the top of our global ratings scale--is New Zealand's extremely supportive institutional and policy settings (see "Public Finance System Overview: New Zealand's Institutional Framework For Local And Regional Governments," published Nov. 12, 2018). This view of the institutional and policy settings recognizes that the local government system benefits from a stable policy environment, high levels of disclosure and transparency in reporting, and solid revenue and expenditure autonomy. While these sector-related factors are the cornerstone of our high investment-grade ratings, idiosyncratic factors differentiate our ratings. Table 1 provides a snapshot of our current scores and ratings.

Ratings have trended upward over the past five years (see chart 1). We have upgraded 10 councils since 2014, including Western Bay of Plenty District Council (Western Bay) twice. We last downgraded a council in July 2013, when we lowered our ratings on Christchurch City Council (Christchurch) to 'A+' from 'AA-' following the revocation of its building consenting powers and appointment of a Crown Manager. In December 2019, we upgraded Christchurch reflecting the recent global settlement between the council and the New Zealand sovereign, transferring key decision-making powers and major assets to the council.

We revised our outlooks on seven New Zealand councils to positive in January 2019 following our revision of the outlook on the New Zealand sovereign to positive. A further two councils-–Western Bay and South Taranaki District Council (South Taranaki)--are on positive outlook for reasons related to their improving individual credit profiles, due to declining or stabilizing debt levels, narrowing after-capital deficits, and improving financial management.

Chart 1

Wealthy National Economy With Regional Variations

New Zealand benefits from an open, prosperous, flexible, and resilient economy. We estimate New Zealand's GDP per capita to be around US$40,700 in 2020. High national GDP per capita is a key supporting factor for the economies in which the New Zealand councils operate.

Among the councils that we assess with the strongest local economies are Auckland Council (Auckland), which governs New Zealand's largest and most economically vibrant city, along with Greater Wellington Regional Council and Wellington City Council (Wellington), which oversees New Zealand's affluent capital. In December 2019, we raised Christchurch's economic assessment to incorporate its improving economic viability and stability after the bulk of earthquake reconstruction has been finalized.

While New Zealand is a relatively small economy in a global context it still has a wide variance in wealth across councils. Some smaller, rural councils tend to have more concentrated economies, weaker socioeconomic or demographic profiles, or limited growth prospects because of stagnant or declining populations. Some are concentrated in agriculture, particularly dairy; horticulture; or oil and gas.

We observe weaker socioeconomic profiles than the national average across about 65% of our 23 rated New Zealand councils. These councils represent less than half of the country's population. There are a few characteristics we believe could place pressure on the councils' ability to raise rates revenues over the longer term through the generation of new ratepayers or passing rate increases. These characteristics include the low income levels and local GDP of some councils, slow population growth rates, or aging populations compared to the national average. The country's regional areas tend to attract residents moving from cities upon retirement due to their affordability, such as the three Bay of Plenty councils, Tasman District Council (Tasman), Horowhenua District Council, and Marlborough District Council (Marlborough), amongst others. Other regions have relatively slow population growth that lags the national average, such as Dunedin City Council, Hastings District Council (Hastings), and South Taranaki.

Another distinguishing feature is concentrated or volatile local economies, which make up around 39% of our rated portfolio. We believe some councils can be more vulnerable to downturns in the primary sector than the broader New Zealand economy, potentially impacting council revenues. For instance, we assess the three Bay of Plenty councils as having large kiwifruit industry exposure, while Hastings and Marlborough are other areas concentrated in horticulture. Taupo District Council's (Taupo) domestic tourism exposure, as seen by a large number of holiday homes, is another observable instance of industry concentration potentially affecting a council. Councils in the Taranaki region are also vulnerable to large exposures to oil, gas, and dairy.

Financial Management Is Consistently Strong

We consider the general standard of financial management in New Zealand to be very high, supported by minimum standards set by the Crown government. Our financial management assessments for New Zealand councils are a clear strength relative to global peers. New Zealand councils typically focus on their core responsibilities as outlined in the Local Government Act 2002. New Zealand councils don't tend to undertake risker activities such as borrowing for financial or real estate investments as we observe in some other jurisdictions.

Each council is governed by a group of elected councilors and conducts local elections every three years. Political and executive management teams tend to respect their separate spheres of power and responsibilities. Councils demonstrate a culture of long-term planning and transparency. They are required to produce 10-year long-term plans every three years, annual plans (budgets) in the intervening years, and audited annual reports. Plans are subject to extensive community consultation. Long-term debt is incurred only for funding capital expenditure, with Crown agencies, such as the Auditor-General or Audit New Zealand, raising issues if it is not. All councils, except Auckland, are restricted from issuing foreign-currency debt, and all limit interest-rate risk on their borrowings. Given the long-standing nature of these rules and processes, we believe a material change in culture is unlikely. The New Zealand Local Government Funding Agency (the LGFA) requirements also supports debt and liquidity management for its 64 participating councils.

We previously considered a few councils to have satisfactory financial management, in the middle of our assessment range. We improved Christchurch's satisfactory financial management assessment in December 2019, reflecting the recent "global settlement" between the council and the sovereign around matters relating to the Christchurch earthquake, which transfers key decision-making powers and major assets back to the council. Historically, our view of the council had been mired by uncertainty over funding and issues with management. South Taranaki's management has also improved over the years and was behind its upgrade in 2017.

Significant Fiscal Disparities Due To Infrastructure Spending

All rated councils in New Zealand consistently post strong cash operating surpluses. This is in part because of their limited public policy mandate in the areas of public health, education, and social welfare--unlike many other systems such as in Australia, Europe, and the Americas where the local governments have broader responsibilities. However, many New Zealand councils have large or lumpy infrastructure programs, largely related to water supply, storm water, waste water, and roading, that result in relatively weak after-capital account positions.

Comparatively weak after-capital account deficits compared to international peers offset the strong operating surpluses and weigh on the budgetary performance for most New Zealand councils. Nevertheless, we consider the overall fiscal flexibility of most New Zealand councils to be strong in global comparison, in part supported by very strong flexibility within council budgets via rate increases and the ability to delay capital expenditure, and large investment funds held by some councils.

We forecast that some councils will record after-capital account deficits of as high as 30% of their total revenues over the next few years. In the latest 2020 annual plans, we observe that many councils are ramping up their capital spending to cater to growing populations, respond to new Crown government standards in areas such as water quality, replace aging infrastructure, or strengthen physical assets against natural disaster risks.

Councils often under-deliver on their capital expenditure budgets. This is due to a number of factors, including capacity constraints, lengthy approval processes for new projects, and, sometimes, poor planning. For many councils, we will typically apply a "haircut" of 10%-30% to their capital budgets in producing our own forecasts. As such, we typically do not expect growth in aggregate local government gross debt to be as large as that implied by projections in the most recent annual plans or long-term plans.

Most New Zealand councils have a high degree of fiscal flexibility, which supports their budgetary performance. This reflects their strong rate-collection powers. Many councils also have flexibility to postpone or reschedule a portion of their capital spending from year to year because capital expenditure comprises a large proportion of their total outlays compared with other systems. Some councils such as New Plymouth District Council (New Plymouth), South Taranaki, and Taupo hold large financial assets as a proportion of their revenue bases from previous asset sales such as their power companies. These assets provide councils with additional funding sources to support their budgets if needed.

We view a handful of our rated councils as having only a neutral level of flexibility compared to domestic and international peers. In these cases, we may see limited political will to increase general property rates, or a greater proportion of total group revenues are derived from subsidiary companies whose income streams may be subject to market forces or economic regulation. For some councils, we see difficulties in further delaying capital expenditure projects without adding to their infrastructure backlogs.

Liquidity Coverage Varies Depending On Investment Assets And Bank Facilities

The liquidity of New Zealand councils is mixed, in our view. Many councils hold very little cash or liquid assets as a proportion of their balance sheets. Many rely on committed bank facilities for working capital. We consider bank facilities to be less secure than cash reserves because banks have the discretion to change their terms and, in some cases, withdraw access to these facilities. Significant after-capital account deficits and maturing debt within the next year places pressure on the liquidity of a number of councils that are running sizeable infrastructure-related capital expenditure programs, hold small cash reserves, and leave the refinancing of upcoming debt until several months before maturity.

A few councils, such as New Plymouth, South Taranaki, and Taupo, manage relatively large investment funds formed from the proceeds of earlier sales of physical assets, such as council-owned electricity companies. They invest these funds in financial assets such as bonds and listed equities. Where we consider these funds to be liquid and accessible in a timely manner, they can support a council's liquidity coverage. However, we do haircut their value--up to 50%--depending on the underlying risk of the investments.

In recent years, we have observed many councils prefund upcoming debt maturities up to 18 months in advance and hold the proceeds in linked term deposits, taking advantage of a positive interest-rate differential between term deposit rates and the cost of borrowing. While prefunding may help to mitigate refinancing risk, it is unclear how councils would respond if the cost of carry were to turn negative. We believe some councils are engaging in prefunding primarily to make a small financial return, rather than to address refinancing risk, and this would see coverage weaken when yields change.

We consider that the LFGA provides local councils with strong access to a well-established source of external liquidity. This improves the liquidity of councils borrowing through the LGFA as it has lengthened the maturity profiles, and reduced borrowing costs, of New Zealand councils.

High Debt Burdens Relative To Other Rated Jurisdictions

Consistent with the principle of intergenerational equity, many councils use debt to fund part or all of their capital expenditure programs, rather than taxing current ratepayers more. This means New Zealand councils have some of the highest debt burdens among jurisdictions where we maintain public ratings.

Debt levels are also high because we assess gross debt levels, instead of the locally preferred measure of net debt used by New Zealand councils and LGFA. In our view, using net debt levels doesn't accurately represent the underlying credit risk faced by councils, further it would double count the benefit of any liquid assets as they are included our measure of liquidity.

While most debt burdens are high, we believe debt management is very strong in New Zealand with little interest rate risk as most councils fix the bulk of their debt. Further, no council, other than Auckland, has exposure to currency risk on its debt issuance. Auckland limits the amount of potential currency risk by hedging its exposure. For these reasons, New Zealand local governments are able to maintain credit ratings at levels higher than some international peers with the same level of debt. The vast majority of councils also have maturity limits in place to avoid large concentration of debt within any 12 month period.

Our debt assessments also incorporate debt of wholly owned subsidiaries such as Dunedin City Treasury Ltd., Dunedin City Holdings Ltd., WRC Holdings Ltd., Quayside Holdings Ltd., and Christchurch City Holdings Ltd. This is because we believe councils hold the ultimate responsibility for these entities, and provide financial support during periods of stress.

We view New Zealand councils' contingent liability risks to be low compared with their global peers. Nevertheless, we consider contingent liabilities to be significant enough to impact their debt burden for three entities: Bay of Plenty Regional Council (Bay of Plenty), Christchurch, and Tasman. Bay of Plenty's contingent liabilities reflect the size and business activities of Quayside Holdings Ltd. and the council's exposure to natural disasters, such as the floods that occurred in 2017. Christchurch's contingent liabilities reflect the council's earthquake risk and uncertainties associated with its large capital expenditure program. Our assessment for Tasman reflects the council's guarantee of up to NZ$29 million over a loan to Waimea Water Ltd., and construction risks related to the Waimea Community Dam including potential cost overruns.

Sovereign Risk Factors

We revised our outlook on seven New Zealand councils to positive in January 2019 following our revision of the New Zealand sovereign outlook to positive. This is because these seven councils have stand-alone credit profiles higher than New Zealand's long-term foreign-currency rating. Nevertheless, we don't rate them higher than the sovereign because we believe that it is unlikely that any of the New Zealand councils could withstand a stress scenario better than the sovereign could.

Six years ago, Wellington was the only council to be capped by the sovereign ratings (see "Peer Comparison: New Zealand Councils Cluster Within A Narrow Investment-Grade Band," published April 8, 2013).

Table 1

Related Research

• Default, Transition, and Recovery: 2018 Annual International Public Finance Default And Rating Transition Study, Aug. 19, 2019
• Global Ratings List: Local And Regional Governments 2019, Aug. 3, 2019
• 2020 Outlook For Local And Regional Governments Outside The U.S., Nov. 18, 2019
• New Zealand Councils Remain Highly Rated Even As Debt Expands, June 25, 2019
• New Zealand Outlook Revised To Positive On Improving Fiscal Position; 'AA+' LC And 'AA' FC Ratings Affirmed, Jan. 31, 2019
• Public Finance System Overview: New Zealand's Institutional Framework For Local And Regional Governments, Nov. 12, 2018
• Peer Comparison: New Zealand Councils Cluster Within A Narrow Investment-Grade Band, April 8, 2013