TL;DR: Ratings agency Standard & Poor’s is pushing back hard at suggestions from Local Government Minister Simeon Brown and Mayor Wayne Brown that carving Watercare out of Auckland Council can be done easily and cheaply without clear guarantees on the new Watercare bonds from the Government or Auckland Council.
Industry sources have told me Watercare would get a BBB+ or A- credit rating at best under the proposed structure, even with a ‘nod and a wink’ from the Crown that it would rescue Auckland’s water network if push came to shove. This means the Government and Council are loading up an extra 50 to 100 basis points in borrowing costs onto the nation’s key infrastructure provider in the economy’s growth engine.
Over many billions of dollars of borrowing, the costs would mount up to tens of millions of dollars a year and the unnecessarily low credit rating would also restrict Watercare’s ultimate scale of the borrowing because fund managers don’t have much room for BBB bonds. They will happily fund billions of AA bonds that the Council could issue, let alone the AA+ bonds the Government could sell.
To add to the financial pain, those costs are essentially unnecessary insurance premia to pay for the short-term and very political figleafs of keeping high credit ratings for the Council and Government themselves for now, and politicians being able to disavow responsibility for high water charges increases in future.
In my view, that’s an expensive and unnecessary ‘nod and a wink’ that delays and restricts the amount of house-building needed to cope with previous fast population growth, let alone likely growth. The Government and Council would be achieve a lot more in a shorter period and with much less cost by simply borrowing off their own balance sheets. At worst, Auckland might lose a notch on its credit rating and increase its borrowing costs by 5-10 basis points, which would add about $2 million a year in interest costs.
Messrs Brown and Brown are choosing political figleafs now in exchange for loading up tens of millions in extra interest costs on Auckland ratepayers, while also delaying and downsizing the amount of house-building possible in future decades. It is the exact opposite of the Government’s stated aims of controlling inflation in basic living costs and ‘Going For Growth’ on housebuilding.
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Brown figleaves to cost Aucklanders tens of millions
The much-trumpeted deal to carve Watercare out of Auckland Council and soften this year’s water charges hike from 25.8% to 7.2% risks costing Aucklanders tens of millions of dollars a year extra in interest costs over the longer run, all to allow the Government and Council to say publicly they aren’t guaranteeing the debt and allow politicians to disavow responsibility for new and/or higher water charges.
The deeper failure is that these extra costs will have been paid unnecessarily, especially from a taxpayers’ point of view. That’s because in reality, the Government would be forced bail out Watercare anyway. As it stands, the key ratings agency Standard & Poor’s is already pushing back at the vagueness of the Government’s position behind Watercare, saying that without a proper assurance the new carved-off Watercare would have a much lower credit rating than the Council’s AA rating and the Crown’s AA+ rating.
Sources close to the process have confirmed Watercare might get a BBB+ rating or A- rating at the very best, even with a ‘nod and a wink’ from the Government. That would impose an extra borrowing cost over and above regular Government AA+ bonds or Auckland Council AA bonds of at least 50 to 100 basis points.
Local Government Minister Simeon Brown and Auckland Mayor Wayne Brown trumpeted their deal on Sunday to carve Watercare’s assets out of Auckland Council as a win-win-win for ratepayers, taxpayers and the growth aspirations for Aotearoa’s biggest city and its economic (and housing) growth engine.
They said it would break the shackles on Auckland’s borrowing limits, dramatically reduce this year’s water charges increase and mean the Council and taxpayers would not have to guarantee Watercare’s bonds. It was also seen as a template for other councils to do the same thing. What’s not to like?
The trouble is that combination of lower water charges inflation, more borrowing and no formal guarantees of ratepayer or taxpayer bailouts is an impossible trinity without some sort of implicit reassurance or comfort for ratings agencies and bond investors given by the Goverment that means there is effectively a guarantee anyway.
The real problem is this ‘nod and a wink’ from minister of the day is not being clarified and won’t be clear until legislation is written later in the year.
Strategic ambiguities abound
I asked Simeon Brown’s office, Wayne Brown’s office and Standard & Poor’s for clarity on what form the guarantee or assurance would take.
The Browns said in their announcement on Sunday that: “International credit ratings agency S&P Global Ratings has determined the model would mean Watercare’s borrowing is considered separate from Auckland Council for credit rating purposes.”
Simeon Brown went further in a news conference (bolding mine):
“What has been tested with S&P is effectively a model whereby the council remains the owner, the council continues to control Watercare through appointments and setting the statement of intent and direction, but the council is no longer able to provide financial support to Watercare.
“Watercare will be legislated as having responsibility for delivering water and wastewater to Aucklanders rather than Auckland council and the Crown will also be legislating that any loans entered into by Watercare must include a disclosure that they’re not guaranteed by the Crown.” Simeon Brown
Really?
Sources close to Auckland Council suggested on Sunday that the lack of a formal guarantee could be replaced by type of ‘nod and wink’, described thus: “Central Government would be under no legal obligation to rescue the entity, but would be able to do so if it chose.”
What might S&P think of not having a guarantee?
I asked and they wrote back with the following (bolding mine):
“Any legislative changes that prohibit Auckland Council from providing financial support to Watercare may greatly limit the risks posed to the council by Watercare from a credit-rating perspective. Doing so, however, means the credit quality of Watercare would likely be much lower than Auckland’s AA rating. An entity such as Watercare can't borrow on terms as competitive as the council can unless it's part of the council or at least backstopped by the council.” S&P spokesman via email
So how much lower would the rating be? Sources familiar with the details of local government credit ratings said a BBB rating was likely with no assurance of Crown support, with a possible one or two extra notches to BBB+ or A- with a ‘nod and a wink.’
So was this the only choice for Auckland Council, Watercare and the Government?
There’s been a lot of chatter about how there was no way for Auckland Council or Watercare to borrow more because the Council was up against its debt ceiling of 280% of revenues. I’m told that’s not true because Watercare could have borrowed more through the Local Government Funding Agency (LGFA), but only if Auckland Council agreed to a one-notch credit rating downgrade.
S&P made clear that such a downgrade would only increase the Council’s costs by 5-10 basis points or less than $2 million per year. In previous years council officials have warned a downgrade for Auckland Council would force a sovereign downgrade, but S&P and others have rejected that.
In eseence, Brown and Brown are choosing an option that avoids rating downgrades that might prove politically embarrassing or increase mortgage borrowing costs nationally (but only marginally). They are also able to distance themselves from decisions made by Watercare and other water providers to increase and/or impose water charges.
Ka kite ano
Bernard
A nod and a wink that will unnecessarily cost Aucklanders tens of millions per year