The newly established Local Government Funding Agency (LGFA) has been handed an AA+ credit rating by both Fitch Ratings and Standard & Poor's (S&P), the same rating the two credit rating agencies have on the New Zealand government's debt.
Aside from the AA+ long-term local currency rating, both Fitch and S&P have given the LGFA a long-term foreign currency rating of AA and Fitch a short-term foreign and local currency rating, used on the likes of commercial paper debt issues, of F1. The outlook on the long-term ratings is stable. See definitions of Fitch's ratings here, definitions of S&P's ratings here, and see credit ratings explained here.
"The ratings reflect the strong underlying asset quality of LGFA's shareholders composed of regional and territorial councils (local councils) and which is supported by a Joint and Several Liability (JSL) guarantee," Fitch says.
"The ratings also consider the strong links of the vehicle with the New Zealand sovereign offsetting Fitch's concern about its lack of track record. The ratings and outlooks mirrors those of the New Zealand sovereign."
The LGFA was created by Parliament passing the Local Government Borrowing Act in September. As well as establishing the LGFA, this legislation, overseen by former ACT Party MP and Minister of Local Government Rodney Hide, lifts a previous prohibition on local government bodies borrowing overseas. Philip Combes, currently head of the NZDMO, will become the LGFA's chief executive in the New Year and former BT Funds Management chief executive Craig Stobo is its chairman.
Central government stake & NZDMO role
The LGFA is 20% owned by the central government, with the remaining 80% initially held by 18 local councils including the Auckland Council, Christchurch City Council, Whangarei District Council, Western BOP, Tauranga City Council, Hamilton City Council, Wellington Regional Council, Wellington City Council, and Tasman District Council. The LGFA's debt isn't guaranteed by the government but Fitch views its support as "exceptionally" strong.
"The government will provide a liquidity facility of up to NZ$1 billion through its treasury vehicle, the Debt Management Office (DMO) and will execute the funding and investing functions, and act as the sole swap counter party," Fitch notes.
S&P says its ratings reflect its view of the LGFA's "extremely high" likelihood of extraordinary support from the New Zealand government, arising from its "integral" links to the New Zealand government, combined with its "very important" role under S&P's government related entity criteria.
"The ratings on LGFA also reflect the organisation's strong stand-alone credit profile, arising from its sole role of providing debt finance to the New Zealand local and regional government sector, the sound aggregate credit quality of that sector, and the LGFA's prudent liquidity policies," S&P says.
"These strengths are moderated by the organisation's wholesale funding profile and our expectation that risk-weighted capitalisation will progressively decline from initially strong levels as lending increases against a backdrop of a small capital base." See S&P's full report here.
'Limited' borrowing options
The LGFA will issue local government bonds to investors and on-lend the funds raised to participating local authorities to help meet their funding needs. This pooled approach will help local authorities borrow money at lower interest rates than they currently can, Hide has said, noting industry body Local Government New Zealand estimated the LGFA will save councils about NZ$25 million annually through scale and by obtaining a strong credit rating at or near the highest possible AAA rating. The S&P and Fitch AA+ ratings are both firm's second highest.
Current long-term council plans suggest local authority debt will double over the next five years to more than NZ$11 billion. Local authorities say their debt funding options have previously been limited to the domestic banks, private placements and wholesale bond issues to domestic institutional investors and, to a lesser extent, retail bond issues to domestic retail investors. The LGFA will raise debt in local and foreign currency in both domestic and overseas markets.
Fitch notes that all principal shareholders and borrowers with more than NZ$20 million of loans will need to enter into a JSL guarantee, except the government. Under this guarantee, a security trustee can, on behalf of the bond holders, call on the guarantors directly following a payment default by the LGFA.
"The JSL is on demand and can be called without board and court order. Each guarantor is liable on a pro-rata basis according to its prior year's rate revenues. The LGFA's debt is expected to increase on the basis of the vehicle participants' large funding needs and additional local councils joining either as shareholders or borrowers," says Fitch.
Potential for concentration of risk around Auckland
Fitch says although there could be a potential concentration of risk from the recently established Auckland Council "super city", which also plans to tap overseas debt through its own borrowing programme, the Auckland Council's borrowing through the LGFA will be capped at 60% of the exposure in the first three years and 40% thereafter.
"Fitch considers the asset quality of the shareholders and borrowers as strong, especially the larger local councils. Given the LGFA's nature, its asset pool is expected to be concentrated on individual names," says Fitch.
"Asset quality is supported by each local council's ability to have a charge in respect of unpaid rates, which provides recourse to the underlying rateable properties. In addition, the local council's secured creditors, which include the security trustee and the LGFA, can through a debenture trustee appoint a receiver should a local council default."
"The receiver has the power to assess and collect a rate from ratepayers to repay the bond holders. Fitch believes the LGFA has sufficient liquidity as it will hold 10% of its assets in liquid form and will benefit from a liquidity facility of up to NZ$1 billion provided by the NZDMO."
Govt can lend to the LGFA
Meanwhile, S&P says its view of an "extremely high" likelihood of extraordinary government support is based on its assessment of the LGFA's: very important role given it's expected to become the main funding source for the local government sector.
"Additionally, LGFA provides several benefits to the central government, including the deepening of the New Zealand capital markets and an additional source of liquidity for New Zealand banks, as well as providing greater efficiency at the local government level," says S&P.
S&P also points out that the LGFA's legislation lets the government lend it money if it's in the public interest to do so or if it is necessary to meet a temporary shortfall.
(Update adds details of S&P rating).