The Wellington-run authority that borrows on behalf of councils has proposed their debt limit be raised from 2.5 times income to three times income, but some think this won’t be enough, Dileepa Fonseka reports

The Local Government Funding Agency will put a major debt cap increase to a vote next month. The move will likely free up hundreds of millions of dollars for councils deal with many looming infrastructure projects being done in tandem with the Government, along with calls from small businesses desperate for rates freezes and rates holidays. 

Tauranga Mayor Tenby Powell said the change would allow his council to carry out $200m in improvements that would be “inconceivable” if the cap remained unchanged.

“Tauranga is a city that is lacking in thousands of houses. It’s locked up in terms of its roads. The money that we are going to get must be spent on infrastructure,” Powell said.

In a press release on Monday afternoon, LGFA announced it would ask councils to temporarily increase their debt covenants to 300 percent from 250 percent now. This would apply for the financial years ended 2021 and 2022.

From 2023 onwards, that debt cap would decrease by 5 percent every year until it hit 280 percent in 2026. Councils and the Government will vote on the proposal in June.

Ninety percent of council borrowing is done via the LGFA, where councils raise debt under a covenant that limits their borrowings to 250 percent of revenue. 

“The proposed changes have been discussed with S&P Global Ratings Australia Pty Limited, Fitch Australia Pty Limited and LGFA’s Shareholders’ Council,” LGFA said in a statement. 

‘It will never be cheaper’

Council debt caps were heavily criticised years before the Covid-19 pandemic ripped long term plan forecasts to shreds.

Covid-19 only made things worse, with pressure falling on councils to meet zero rates rise pledges or defer rates.

High growth councils like Auckland, Hamilton, and Tauranga found themselves within spitting distance of debt limits as runaway population growth required them to make major upfront investments in infrastructure. 

LGNZ President Dave Cull said his organisation welcomed LGFA’s announcement that the caps would be raised.

“While it’s taken Covid to do this, it’s been talked about as needed – especially for growth councils – for quite some time.”

“If you’re going to be investing in long-term infrastructure this is the perfect time to be borrowing to do it, because it will never be cheaper,” he said.

Debt cap criticism

Council debt caps have attracted a growing chorus of criticism. 

Auckland Mayor Phil Goff said he wanted to renegotiate debt caps upwards temporarily. Powell called for the cap to be increased to 450 percent. Sense Partners economist Shamubeel Eaqub tagged debt ceilings as ‘idiotic’ and said they discouraged investment at a time when it was most needed.

Adding further weight to their views is a report predicting sliding revenues from council services post-Covid, reducing the ability of councils to borrow and spend during a major downturn. This would in turn compound regional economic woes.

In a presentation to investors LGFA said the report forecast a 20 percent decline in revenues across all councils due to Covid-19. 

“In dollar terms this equates to a loss of revenue to the sector of between $355 million and $1.5 billion.”

LGFA’s shareholders largely consist of the councils who borrow money through it. Interest rates are low because councils are able to pool their risk. 80 percent of its shares are owned by 30 councils, 20 percent by Government. 

‘Don’t stop now’

LGFA’s presentation also showed a Reserve Bank initiative to buy local government debt had driven bond yields down. 

And with interest rates at historic lows, some are saying further savings could be made by refinancing existing local Government debt. 

Eaqub said local government bond yields had tracked down from 5 percent to about 1.5 percent today. Many councils still carried debts at those older interest rates.

Local government bond yields have been driven down by the RBNZ. Source: LGFA

High-debt councils like Tauranga were using up to to 13 percent of their rates income to make payments on that debt. If the debt could be refinanced at new low interest rates those costs could be halved.

“A few councils are at that top end of how much debt they have. Because they have high debts relative to incomes a lot of their incomes are used up in interest payments.”

“Being able to refinance at low cost, without penalty, means you free up cashflow.”

Powell is also championing this move and said the only other barrier to his council refinancing were “break fees” attached to some debt. Those would total $70m in the case of his council. He hoped these could be forgiven in light of the Covid-19 crisis. 

“The question I’ve got is why would the Reserve Bank not step in.”

“Carrying the higher local government interest rates so that banks can forgive the break fees.”

Eaqub said the Reserve Bank could buy local government bonds on a large scale to drive down interest costs on this old debt for councils.

“The question is, can they buy sufficient quantities to bring the price down [to a level] that would be as low as the price of new issues?”

Still doesn’t ‘add up’

Eaqub said keeping the debt cap increase temporary would be a safeguard against a future interest rate rises and force councils to prioritise spending, but it could cause problems further down the track.

“If you say that the debt cap is going to come down in the future then it becomes a little bit of an issue because it only gives them that runway for a little bit.”

“And it becomes a constraint later on.”

He said councils would have to gradually increase rates to meet debt obligations as the caps were wound back. 

“It’s fine if we let local government borrow money, but they have even more assets now that they can’t look after with the meagre incomes that they have.”

“The fundamental problem is that local government holds roughly half of the infrastructure assets in New Zealand, but has but a tenth of the income.”

“It just doesn’t add up still.”

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