No bailing out water, says minister

The Government has responded for the first time to pleas to guarantee councils’ water infrastructure debts, so locals can finance the required upgrades and renewals.

With the repeal of the previous government’s Three Waters reforms and National’s promise to leave the infrastructure in the direct ownership and control of local communities, it’s finally dawning on councillors just how expensive this will be for ratepayers and local users.

In the past, councils have failed to invest in water and wastewater infrastructure because it’s out of sight and out of mind, when ratepayers’ money can instead be spent on more sexy projects like parks and sports arenas.

New Local Government Minister Simeon Brown tells Newsroom: “One of the criticisms in the past has been too often funding which has been paid for water infrastructure is being used for other purposes.”

Brown says the Government is working at pace on implementing its Local Water Done Well policy, ensuring that councils are able to set up financially sustainable models for delivering the three waters services – drinking water, wastewater and stormwaters.

What does “financially independent and sustainable” entail? To Brown, it means neither the councils nor the Government would be called on to inject additional funds, or bail out a water provider if it’s failing to deliver.

The minister says he’ll be announcing the Government’s plans in coming weeks. Those would include supporting councils to set up, in most cases, council-controlled organisations that would be able to make the long-term investments needed. These will generally be owned by a grouping of several councils.

Brown says he wants to provide certainty to councils. There will need to be law changes to enable councils to create council-owned companies – and to protect both ratepayers and taxpayers from unexpected additional shocks beyond the significant anticipated hikes in user charges.

Could the Government legislate to say that councils may not provide a financial backstop (that is, financing or grants or bailouts) for water providers? “That’s the direction we’re going in,” Brown says.

They’re exploring that option, and testing it against financial agencies’ rules.

The situation for Auckland’s big Watercare council-controlled organisation is different. It can’t credibly achieve balance sheet declaration from the council. Instead Brown has been advised to look at other options to allow it to borrow more – which is what its chief executive Dave Chambers called for, in a Newsroom interview late last year.

“We’re discussing it with the mayor and with the councillors, who are the owners of Watercare, Brown says. “Ultimately, Auckland Council is the owner, they are the ones who need to be putting forward what the financial sustainable model is for Watercare – not Watercare putting it forward.”

So is he seeking a solution where neither councils nor the Government find themselves in hock for a bailout? “Absolutely. The reality is, this is about ensuring we have financially sustainable and financially independent entities. And we want to ensure that councils have ownership of those assets, and that they put forward financially sustainable models.”

Of course, the previous Government talked down any explicit or implicit guarantee of the debts of the new water services entities it was establishing – but ratings agencies like S&P Global weren’t convinced. They said the water entities could get good interest rates on their borrowing, but only because lenders believed the Government would bail them out if necessary.

The same may be true of the new Government’s council-owned companies – lenders will assume they are too big and too critical for any government to allow them to fail.

The previous government said it would not guarantee the debt of the water entities, but it did quietly write in a liquidity facility like the Local Government Funding Agency’s one.

This Government could do the same. A liquidity facility is different from a guarantee – it is a backstop financing arrangement where the provider agrees for the other party to draw down upon it subject to a few conditions, including a fixed timeframe.

A guarantee, though, would be more watertight and stronger, usually with no strings attached.

Council debt to climb as Government debt flattens

The Local Government Funding Agency was established in 2011 to raise debt on behalf of councils, on terms that are more favourable to them than if they raised the debt directly.

In its briefing to Brown, as incoming minister, it says there are currently 31 shareholders, comprising the New Zealand Government at 20 percent and 30 councils at 80 percent of the paid-up capital.

There is no requirement for the Government to guarantee debt. However, it does provide the liquidity facility to the Authority of $1.5 billion. This facility has never been drawn on.

The recent growth in local government debt tends to have been driven by those councils with higher-than-average growth, such as those in Auckland, Waikato, and the Bay of Plenty.

Councils’ gross debt has doubled in the past eight years to about $27 billion, and is projected to rise $10 billion more in the next eight years.

The briefing says the biggest challenge facing the local government sector is the need for additional infrastructure – growth-related, public transport, and water quality improvement – that has been historically provided either solely by local government or jointly with central government.

Fast-growing councils like Auckland, Tauranga, Hamilton, Waikato District, Queenstown Lakes and Wellington are constrained financially from providing more infrastructure due to concerns over credit ratings and long payback periods on infrastructure investment that is debt-funded upfront.

“A number of the high-growth councils do not have the revenue to take on additional debt to fund the infrastructure, remain compliant with Local Government Funding Agency financial covenants, and maintain credit ratings above A+,” the briefing says. “This can also disincentivise councils to invest in growth infrastructure.”

The briefing cites Auckland Council’s initial refusal to approve the residential development of Drury as it did not have the $1 billion needed to fund transport, water, and community facilities infrastructure within its long-term plan.

Or Tauranga City Council turning to $175m of Infrastructure Finance Fund financing for the Western Bay of Plenty Transport System Plan and considering applying for $151m of additional financing for its Civic precinct, to avoid traditional borrowing.

Alternative forms of financing come with complications. For instance, private sector developers in public-private partnerships or special purpose vehicles will have to pay much higher rates on their borrowing than Government. This is passed on to residents or users of the infrastructure.

And despite these contortions, these non-traditional financing solutions are still unlikely to separate the assets (and debt) from council balance sheets.

“Hard choices will need to be made on what infrastructure the public sector invests in, given affordability issues and financing constraints,” the briefing warns.

The Local Government Funding Agency, with its AAA credit rating, can raise debt at lower costs than is possible from either the banking system or capital markets. That means councils can spend more money on the actual assets their communities need, and fritter away less in interest payments.

The briefing says there’s widespread agreement within the local authority sector that high-quality drinking water, wastewater and stormwater services are critical to the health and success of communities.

The Funding Agency would potentially be in a stronger position to lend to the National Government’s proposed council-owned companies than to the Labour Government’s 10 big water services entities.

But there will be strings attached: “We note it is likely most lenders would prefer volumetric water charging and for security to be offered to lenders.”