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S&P yesterday issued a negative financial outlook revision on the Dunedin City Council, raising concerns over its ability to meet financial targets outlined in its recently completed long-term plan.
The decision follows last week's confirmation the Office of the Auditor-general is to investigate the council's subsidiary Delta over its Central Otago land purchases in 2008 and 2009.
S&P yesterday confirmed the DCC group credit rating would remain at AA long term and A-1+ in the short term and put Dunedin on negative credit watch.
There was a one-in-three chance of a downgrade within the next two years.
S&P credit analyst Anthony Walker said the finding could put "further downward pressure" on future ratings.
Dunedin Mayor Dave Cull said in a statement the council was up to the challenge of continued financial belt-tightening.
It was not a downgrade, but the agency had made it clear the council needed to follow through with its tough financial targets, Mr Cull said.
Prospective lenders gauge their interest rates on the risks outlined by any, or all, of the three major rating agencies, S&P, Moodys and Fitch.
The decision "has not come as a surprise, given council debt levels, but it ensures we are even more firmly focused on achieving or improving the forecasts in our long-term plan", Mr Cull said.
The revised S&P outlook was not expected to increase the council's borrowing costs, he said.
While a downgrade to an A rating could prompt increased interest of 25 basis points, or a quarter of a percent, financial service sources believe the council could face up to a 10-basis-point rise in interest charges, the equivalent of a 10c per $100 borrowed on renegotiated or new borrowings.
Overall council debt stands at more than $616 million.
In its long-term plan, adopted in June, the council approved an increase in the city's debt by $59.6 million during 2012-13, largely to pay for the upgrades of the Dunedin Centre, Tahuna wastewater plant, Toitu Otago Settlers Museum and Logan Park redevelopment.
All the loans were expected to be borrowed from Dunedin City Treasury at 7% interest.
During 2012-13, about $17 million of debt would be repaid, leaving the council's gross debt levels at $274.5 million, but still well above its self-imposed target of $200 million.
Mr Walker said the negative outlook, and possibility of a downgrade, was based on S&P's view Dunedin may not achieve its financial targets outlined in its long-term plan, as its account deficits were not improving as quickly as forecast.
"If this scenario were to materialise, we consider that Dunedin would have limited budgetary flexibility to improve its financial position without deferring asset renewals, which may lead to future infrastructure backlogs," he said.
In budget terms, the council had "limited room to manoeuvre", which was reinforced in the long-term plan, and which includes clear limits on borrowing, Mr Cull said.
"The challenge of servicing debt and maintaining services within rate rise limits of 4% in the coming year and 3% the year after is already recognised.
"Through cost-cutting measures and reduced capital spending, the DCC is already addressing the issues identified by S&P," he said.
Council subsidiary, infrastructure company Delta, bought subdivisions in Luggate in 2008 and Jacks Point near Queenstown in 2009, but the investments became the core of a recent $9 million writedown of investment value, which in turn contributed to Dunedin City Holdings Ltd booking a $5 million loss for the year to June.
Mr Walker said depending on the Auditor-general's investigation, the outcome "may weaken our assessment" of Dunedin's management of its council-controlled companies and "further downward pressure could be placed on the ratings".
On the issue of council subsidiary companies, Mr Cull said recent governance changes meant those companies "are now more accountable".
The council's ratings could be revised back to stable if the council's budgetary performance strengthens as it forecasts, specifically if the council achieves after-capital account deficits of about 2% of consolidated operating revenues in 2014 and beyond, while maintaining its budgetary flexibility, and a stable political setting, Mr Walker said.
Council chief executive Paul Orders said in the statement he was confident staff would deliver a draft budget for 2013-14 within the long-term plan limits, based on finding "significant savings and operational efficiencies".
Last month's annual report figures, on the council and its companies, revealed debt had risen to $616 million for the year to June, including more than $216 million in core debt, including the Toitu Settlers Museum, Tahuna and Town Hall projects. Overall debt included $146.6 million now held by Dunedin Venues Ltd against Forsyth Barr Stadium.
While S&P had a "very positive view" of Dunedin's financial management and the council's "modest contingent liabilities", those strengths were "partially offset" by Dunedin's high debt burden relative to international peers, and its low debt-servicing ratio, Mr Walker said.