OREANDA-NEWS. Fitch Ratings has assigned Rotorua District Council (which operates as Rotorua Lakes Council or Rotorua) Long- and Short-Term Local-Currency Issuer Default Ratings (IDR) of 'AA-' and 'F1+', respectively. The Outlook is Stable.

The ratings reflect the support gained from a robust institutional framework for local and regional councils in New Zealand, as well as Rotorua's improving fiscal performance, strong management, positive socio-economic profile, amid debt metrics that remain weaker than other highly rated peers, even though they are forecast to improve over the long term.

KEY RATING DRIVERS

New Zealand's strong and predictable institutional framework is an important positive rating factor. It includes transparent reporting and financial disclosure, strong controls and supervision, flexibility from a high level of own-source revenues (rates) and responsibilities primarily for capital spending, mainly for water and road infrastructure.

Fitch calculated a (cash-flow based) operating margin of 20.3% in the financial year ending June 2015 (FY15), down from 22.6% in FY14. Fitch deems Rotorua's recent financial management to be a strength, with long-term projections consistent with local peers and well above similarly rated international peers. Rotorua has addressed previously weak performances through a mix of restructuring, expense reductions and revenue increases. Fitch believes financial forecasts as outlined in the district's long-term plan are achievable, with operating margins forecast to average 28.3% over the four years to FY19 (average over the four years to FY15: 22.7%).

Tourism is the largest industry in the small but economically diverse region, and it continues to be a key component in Rotorua's long-term strategic vision. Tourism supported strong GDP growth of 3.8% to NZD2.7bn in the year to end-September 2015. Tourist expenditure in Rotorua rose 17% to NZD593m in the year to end-March 2015 against the national growth rate of 10%. The unemployment rate was 7.8% at end-September 2015, and has historically been above the national rate, although improved by 0.5pp over the year. The region does not have any significant concentration in any one employer due to the large tourism sector, which mitigates idiosyncratic risk.

Rotorua's debt/current revenue ratio and proportion of short-term debt is high relative to that of its peer group, but is supported by the council's good financial flexibility, including predictable revenues and access to funding from the New Zealand Local Government Funding Authority (LGFA). Rotorua is committed to reducing debt levels, and forecast levels have declined between the 2012-2022 and 2015-2025 long-term plans. Fitch calculates a peak debt/current revenue ratio of 175% at FYE20 before declining to 112% by FYE25. Net overall risk ratios are in line with highly rated international peers as Rotorua has minimal contingent liabilities or guarantees, which Fitch includes in these ratios.

Strong capex management is important for Rotorua to achieve its financial projections. The council is forecasting NZD320m in capex over the 10 years to FY25, which equals 85% of the amount of projected capex contained in Rotorua's long-term service plans for its infrastructure assets. Mitigating the risk of a higher-than-expected future capex, is Rotorua's historic performance. The council has operated at 74% of its infrastructure service plans over the six years to FY14 as a result of projects being completed below budget, assets lasting longer than scheduled and decisions made not to proceed with certain projects.

RATING SENSITIVITIES

Rotorua's ratings could come under pressure if its budgetary performance was to deteriorate unexpectedly, and the debt/current balance was above 10 years for a prolonged period. Weakening fiscal discipline and a failure to control capex resulting in debt/current revenue ratios approaching 200% would cause negative rating action.

Positive rating action would require Rotorua to sustain high current margins in excess of 20% and debt/current revenue ratio that is moving towards 125%. The council would need to demonstrate a sustained outperformance in its margins relative to less leveraged peers, given its high relative debt levels.