Big rises in water charges and council credit downgrades

Wellington City Council is expected to be the first local authority in the spotlight as credit rating agency S&P Global warns today of the likelihood of council rating downgrades around the country.

Late last week, Wellington officials provided information to S&P to inform its review. “We’ll be expecting to hold further discussions with S&P in the next week or two about any conclusions they reach on our revised rating,” says city council chief financial officer Andrea Reeves.

After several years in which the capital’s failing water and wastewater networks have made headlines, Reeves acknowledges the need for dramatic change – and that comes at a cost.

“The Council has previously expressed the need for transformational change in governance, asset ownership, funding and management to lift the city’s Three Waters network performance to the level appropriate for a modern, inclusive, and environmentally sustainable city,” she says.

Wellington and Marlborough are both awaiting ratings reviews this month. Both were placed on negative outlooks last year; Marlborough has already suffered one downgrade and would hope to avoid a second; Wellington will be anticipating its review more worriedly.

Christchurch, Dunedin and Nelson city councils are also undergoing pre-Christmas ratings reviews, though all three were on stable outlook last year, so downgrades would be more of a surprise.

A lower credit rating means paying higher interest rates on debt. Typically dropping one notch might mean paying an extra 0.05 percent interest – increasing the rate Wellington pays the Local Government Funding Agency to 6.75 percent on much of its borrowing.

Wellington’s gross debt was forecast to hit $1.47 billion this year – and similar to home-owners’ mortgages, some of that will be locked in at lower interest rates; some will be paying higher rates already.

The council’s forecast annual interest payments have already leapt from $41m to $61m, and will rise still further – especially if its credit rating is downgraded.

“Inflation and interest rates are significantly higher than expected,” the council warned in its 2023/24 annual plan. “This is increasing the cost of Council services and we are having to manage these pressures while maintaining levels of service, delivering city development projects and producing an annual budget.”

Councils that fought to retain control of their water assets have got their way – now they’re discovering the price their communities will pay for it.

Waimakariri District, one of the councils that led opposition to the previous government’s water reforms, now faces a credit rating review in January. And Whangārei District Council was downgraded in August.

Credit outlook worsening for councils

In an attempt to move Three Waters debt off its balance sheet, Wellington City Council is using a new infrastructure financing model to raise up $400m to build a new sludge minimisation facility at its Moa Point wastewater treatment plant.

These are the sorts of solutions that the incoming government is asking councils to investigate, as it restores drinking water, wastewater and stormwater assets to direct council control – with the associated costs, revenues and debt liabilities that entails.

National’s infrastructure spokesperson Chris Bishop has told Newsroom he prefers a council-controlled organisation model, in which the country’s 67 councils place their water assets in a ratepayer-owned company.

That organisation could be solely owned by one council like Auckland’s Watercare. Or it could be owned by a grouping of several councils, perhaps neighbouring, perhaps not.

“Many mayors up and down the country are forecasting double digit rates increases. Hamilton City is, and we have been very transparent about that. If councils are deferring capital spend, because ratepayers can’t afford it, then they are not building the infrastructure our country so clearly needs.”

Paula Southgate, Hamilton mayor

One thing that’s critical, in cities like Wellington, is that the assets be moved off the council balance sheet, Bishop said last month. That’s a continuation of the Labour Government’s stance on financial separation, to free up both councils and water entities to borrow to renew their infrastructure.

But this morning, S&P Global Ratings has thrown a dampener on National’s hopes of achieving balance sheet separation through such an arrangement.

“We would likely view a council-controlled organisation where there is a high degree of political control or ownership, alongside a high level of indebtedness, as either part of its parent council’s tax-supported debt or at least a material contingent liability,” writes senior analyst Martin Foo in the agency’s New Zealand Local Government Outlook 2024.

“It is likely to result in our S&P rating being downgraded which in turn will result in a higher cost of funding for Council… The rates increase required to fund the investment would simply be unaffordable for our community.“

Campbell Barry, Hutt City mayor

That’s because if costs blew out in drinking water networks or the wastewater treatment ended up in the poo, and the organisation wasn’t able to pay its debts, lenders would be reasonably confident the council would bail it out.

That’s a two-edged sword: it gives the council-controlled organisation access to lower interest rates like those paid by its parent council or councils, but it ensures the organisation’s debt is also loaded onto the council’s balance sheet.

Population with access to safe drinking water

It’s a problem, when some councils are nearing their hard debt limit of 280 percent of rates income.

“Councils face a trilemma of meeting higher water investment needs, reining in growing debt burdens, and keeping a lid on unpopular rates hikes,” the report says “And proposals to simply shift council debt ‘off balance sheet’ while maintaining council control of related assets, don’t always stack up.”

One solution, to avoid councils being saddled with the water organisations’ debt on their balance sheets, would be to follow the lead of the previous Government.

S&P Global’s report says a clause like section 166 of Labour’s Water Services Entities Act 2022, expressly prohibiting councils from providing water organisations with any financial support, loan or bailout, could reassure the ratings agency that the council and the water organisation’s balance sheets were genuinely separate.

“To be able to give you a really good answer, I really need to have the government actually be formed, and clearly tell us what they’re planning to do.”

Vince Cocurullo, Whangārei mayor

But that’s a big call too, when New Zealand’s water quality is poor. S&P says almost a quarter of New Zealanders receive drinking water that fails to comply with national standards. Several councils are forced to issue long-term “boil water” and “do not use” advisories as a result.

And nearly a quarter (73) of council-owned wastewater treatment plants operate on expired consents. The average age of pipelines is about 33-37 years. “Councillors often choose to ‘sweat’ invisible, underground assets in favour of spending on popular above-ground facilities.”

At some councils, asset replacement investment falls short of depreciation. This renewals gap is particularly big for stormwater, S&P says. And the shortfall is worsened by recent upward revaluations of infrastructure assets, and damage wrought by Cyclone Gabrielle.

So what does it all mean? The S&P report says New Zealand councils are highly leveraged, compared to overseas municipalities, and their debt is still rising.

In the absence of new policy to alleviate fiscal imbalances and restrain growth in debt, it says, the ratings agency may reflect the increased sectorwide risk by revising downwards its assessment for the entire local government sector.

Ahead of January’s rating review, Waimakariri mayor Dan Gordon says the council has just had S&P visit, and he’s confident its credit rating will remain high.

Gordon is also co-chair of the Communities 4 Local Democracy grouping that opposed Labour’s Three Waters reforms. If council-controlled organisations don’t provide the mechanism to achieve balance sheet separation, he says, then the issue of S&P rating downgrades is likely to affect smaller or more indebted councils.

“That said, an AA to AA- or A is still as strong or stronger than major trading banks to raise debt.”

The other co-chair, Manawatū mayor Helen Worboys, says balance sheet separation is critical for highly-indebted councils like hers – but she believes it can be easily achieved as long as no single council controls more than 49 percent of a new regional water entity.

“All councils have borrowing limits,” she says. “Some like us have reached the limit. Currently council-controlled organisations come within those limits and unless we can remove this requirement and achieve balance sheet separation then we achieve nothing.”

She says Manawatū’s water infrastructure is in good condition, but it’s come at a cost. Feilding’s urban rates are the second-highest in New Zealand.

“We have invested and maintained good three waters infrastructure and we want to retain ownership and local decision-making on the future of our assets, albeit via a council-controlled organisation model. Not all communities are in this position unfortunately.”

Others mayors are far more dubious that simply moving assets to arms-length council-controlled organisations will provide them the solution they need to the mountain of water infrastructure investment in their path.

Hamilton was the most recent city to be placed on a negative credit outlook, during the election campaign. Mayor Paula Southgate says she is neither surprised nor shocked by S&P’s warning this week, but remains very concerned.

“You know I have been saying for several years that there is no easy fix to New Zealand’s water issues and that there is a tsunami of costs on the way to address issues around infrastructure – not just water.”

The Infrastructure Commission has said the costs that lie ahead for water are huge. “I have been part of conversations since 2017 across two different governments, and it is wildly frustrating that we are still talking but not yet doing much to address the fundamental issues. That must change.”

“It doesn’t matter how New Zealanders pay, via rates or via levies set by other entities, all councils and their ratepayers have huge costs to tackle – insurmountable costs in many instances. Fundamental change is required to bring about efficiency and shared costs. What that looks like is anyone’s guess now.”

Paula Southgate, Hamilton

Southgate says she was no fan of the Labour Government’s previous proposal for four entities. “But we need to have our eyes wide open and face the hard facts about funding the future. Our current local government funding arrangements do not work.

“It doesn’t matter how New Zealanders pay, via rates or via levies set by other entities, all councils and their ratepayers have huge costs to tackle – insurmountable costs in many instances. Fundamental change is required to bring about efficiency and shared costs. What that looks like is anyone’s guess now.”

If councils must willingly cooperate to create CCOs to share services, she says, when will this happen? How will it happen? “Many Councils are debt heavy and up against their debt ceiling. If we keep Three Waters, how do we raise more funds? What funding roles will central Government have? What is the most cost-effective way to borrow?

Councils’ primary funding source is rates, and inflation, increased interest rates and cost increases are hitting hard. “Many mayors up and down the country are forecasting double digit rates increases. Hamilton City is, and we have been very transparent about that.

“If councils are deferring capital spend, because ratepayers can’t afford it, then they are not building the infrastructure our country so clearly needs. This compounds the situation.

“Here in Hamilton we are funding core water infrastructure, and our water treatment is up to standard. So in many ways, we are in a better position than most. But the reality is that we cannot afford to provide services to many parts of the city and that is constraining our ability to enable homes and industry to be built. In a housing crisis, that’s hardly sustainable either.”

Another council to recently be placed on a negative credit rating outlook is Hutt City. It has recently been investing heavily in its water assets in the expectation that the debt incurred would sit with Labour’s new Wellington regional water entity; now its ratepayers face ongoing liability for that debt.

Mayor Campbell Barry says if the water assets are left on the city’s balance sheet, the council’s S&P rating is likely to be downgraded, which will result in a higher cost of funding.

Early indications are that rates rises will be at least 10 percent per annum for the 10 years of the council’s long-term plan, with higher increases in the earlier years of the plan. “The rates increase required to fund the investment would simply be unaffordable for our community.”

The incoming government’s model must provide for balance sheet separation. “I haven’t seen anything in National’s model that would solve the balance sheet separation, so I would agree with S&P’s position. If the new government agrees that this is an absolute bottom line, then that’s a good thing.”

Barry says the government must provide support to ensure any new water enterprise has the financial backstop so that lending is available and at an affordable rate. “This may need to take the form of a Crown guarantee or equivalent, to enable the establishment of the entities and the investment programme.

He says any new Three Waters solution must also ensure that councils’ credit quality is not unfavourably impacted. For example, the S&P report warns that the large investment required in water assets could be a contingent financial liability on council balance sheets.

But in Whangārei, which owns its water assets without any debt, new mayor Vince Cocurullo is upbeat about National’s plans. Yes, the district council’s credit rating was downgraded in August, but he thinks that should be the end of it. He doesn’t expect any further downgrade.

National has said it will be up to councils whether they move their water assets into a council company, and whether they team up with other councils to achieve economies of scale.

Cocurullo says there’s little benefit for Whangārei in moving its assets to a council company – he’d prefer to keep the council running the drinking water, wastewater and stormwaters directly.

“What a council-controlled organisation does is create a division between the entity and the ratepayers,” he argues. “So when we plan for growth, we’ve got no control over which parts of our district get investment in drinking water or sewerage.”

He acknowledges that neighbouring Far North and Kaipara district councils face far greater challenges to pay for their water infrastructure. In his view, the Government should help them out.

Whangārei would be open to a shared services arrangement, he says, allowing the bigger district to perhaps contract its water management services to the smaller ones – but he doesn’t want any change in the asset ownership.

There’s one thing, though, on which Cocurullo and the other mayors all agree: “To be able to give you a really good answer,” he says, “I really need to have the government actually be formed, and clearly tell us what they’re planning to do.”

City and district council credit downgrades