Tauranga's new council's ability to significantly alter the council's financial position appears to be dashed by the latest Standard and Poors credit rating.

While Tauranga City Council has retained its A+/Stable/A-1 credit rating, the agency is warning the city's deteriorating financial performance could change that.

Tauranga's debt-servicing ratio has reduced to the point where the agency is warning the credit rating will be lowered should it drop much further.

The ratio was 105 per cent of the next 12 months' debt servicing in 2010, 88 per cent in 2011, and 50 per cent in 2012. If the ratio were to fall below 40 per cent, the ratings are likely to be lowered.

Tauranga's 'very high” debt burden also attracts comments in the report released this week. It weighs on the ratings but Standard and Poors expects Tauranga's total-tax supported debt to reduce to about 240 per cent of operating revenues by 2016, down from its peak of 270 per cent in 2012.

'Its debt remains very high compared to peers. In our assessment, Tauranga's debt burden significantly underperforms our benchmarks, as set out in our criteria. Further, Tauranga's interest expenses are very high and average about 16 per cent of operating revenues from 2013-2015.”

On the positive side the report states Tauranga's individual credit profile reflects the predictable and supportive institutional framework available to local and regional councils within New Zealand.

Standard and Poors regard the New Zealand local government system as promoting a strong management culture and fiscal discipline among New Zealand councils. This provides a source of credit strength for Tauranga, and allows it to support higher debt burdens than some of its international peers can tolerate.

Other positives for Tauranga are its financial management, high budgetary flexibility, and limited contingent liabilities, but Tauranga's moderate budgetary performance, high debt burden, and the agency's neutral view of its economy partially offset the strengths.

In spite of the qualifiers, Tauranga's outlook is stable. Standard and Poors expects Tauranga will continue to manage its financial position within the current metrics of a 'A+' rating for a New Zealand council, that correspond to S&Ps base-case forecasts of its budgetary performance and debt burden.

'We consider the likelihood that the rating will be changed in either direction over the next two years is low.”

Ratings could improve if Tauranga's debt burden reduces toward 200 per cent of operating revenues with a downward trajectory, and its debt-servicing ratio improves to more than 80 per cent of the next 12 months' debt and interest payments. In addition, if its capital programme were to reduce, resulting in average after-capital account deficits of less than 5 per cent of total operating revenues, upward momentum may occur.

Credit ratings could be lowered if there is a significant change in policy, such as bringing forward capital-expenditure projects resulting in average after-capital account deficits of more than 22 per cent of total revenues, and debt levels increasing above 290 per cent of operating revenues.

Further, the ratings could be lower if Tauranga's liquidity weakens with its free cash, liquid assets, and unutilised bank facilities falling to 40 per cent of the next 12 months' debt servicing.

Tauranga's budgetary flexibility is high. Tauranga's modifiable revenues account for about 95 per cent of its operating revenues after Standard & Poor's adjustments, and its capital expenditure is about 40 per cent of total expenditure over the next three years.

About 38 per cent of Tauranga's total expenditure is for capital expenditure for 2014-2016.

'We consider the council's ability to further reduce or defer capital expenditure over the next three years to be limited because its population is still expected to grow by 1-1.5 per cent per year,” says the report.

'In our view, Tauranga's limited ability to postpone capital expenditure over the next 2-3 years somewhat offsets this high starting position.”

Standard and Poors accountants expect Tauranga to consistently achieve strong operating surpluses of more than 20 per cent over the next three years.

Tauranga's average after-capital account deficits of 6.4 per cent from 2012-2016 offset these strong operating surpluses.

However, in 2013 Tauranga's after-capital account moved into surplus of about nine per cent in 2013 because a number of capital projects were delayed until 2014.

S&P have not included the NZ$45 million sale of the ASB Arena to Tauranga City Venues Ltd, considering it to be an asset transfer within the consolidated council. S&P expect Tauranga's after-capital account to average deficits of more than 10 per cent over the next three years. It is expected to remain less than in the past when it averaged more than 25 per cent between 2008 and 2011. Tauranga is reducing its capital-expenditure program by about 15 per cent compared to 2008-2011.

Tauranga's after-capital account performance depends on the lumpy nature of its capital-expenditure program, and the income from its developer contributions.

After-capital account balances have historically been weak due to large capital-expenditure programs and weaker-than-expected developer contributions. For example, between 2007 and 2011 Tauranga averaged significant after-capital account deficits of about 25 per cent after Standard & Poor's adjustments, when the council undertook investment in growth-related infrastructure and asset repairs in the wake of the 2005 floods

Tauranga's liquidity management is considered another negative ratings factor, in the view of S&P.

At June 30, 2013, the council's debt-servicing ratio of free cash, liquid assets, and unutilised bank facilities is relatively lower than peers, at 56 per cent of Tauranga's next 12 months' debt and interest repayments.

Tauranga has approximately $39.2 million in cash and short-term deposits, and an undrawn committed bank facility of $50 million available to cover commercial paper of $50 million, other debt maturities of $82 million, and interest of about $26.6 million.

Tauranga is managing its liquidity by maintaining committed bank facilities to cover its commercial paper program, setting aside $38 million in short-term deposits to help repay upcoming debt maturities, and plans to pre-fund its $50 million bond maturing in December 2013.

'We consider Tauranga's access to external liquidity to be satisfactory. New Zealand's capital markets are comparatively liquid, but, given its small size, are not considered by Standard & Poor's as being particularly deep.

'This was highlighted during the severe market dislocation in 2008 and 2009, during which some New Zealand councils had difficulty issuing unrated commercial paper.”

Tauranga's participation in the New Zealand Local Government Funding Agency is helping Tauranga to lengthen its debt-maturity profile, which may further improve the council's liquidity by extending the maturities of its borrowings, says S&P.

Standard & Poor's make some accounting adjustments to Tauranga finances so that international comparisons can be made.

The major adjustments relate to the exclusion of capital grants from both operating revenue and cash flow from operating activities. This adjustment is made because these grants generally are tied to specific capital projects and cannot be used to service debt if required. Developer contributions and vested assets are considered a key risk to fiscal outcomes being achieved, primarily because of uncertainty as to whether they are received as projected.

S&P have reduced our expectations of Tauranga's income from developer contributions because of volatility. The agency estimates Tauranga will receive about 70 per cent of its forecast developer contributions over the next three years.