The Kākā by Bernard Hickey
S&P slams new Govt's council finance vacuum

S&P slams new Govt's council finance vacuum

Ratings agency puts 15 councils on review for downgrade, blaming uncertainty over new Government's financial support after Three Waters repeal; Councils forced to ramp up rates increases
Wellington Water workers attempt to resolve a burst water main. Councils are facing continuing uncertainty over how to pay to repair and expand infrastructure. The Wellington Regional Council was one of those downgraded. File Photo: Lynn Grieveson / The Kākā

TL;DR: Ratings agency Standard & Poor’s has downgraded the outlooks for the debt issued by 15 councils, immediately increasing borrowing costs and forcing rates increases that will further inflate living costs and keep pressure on the Reserve Bank to keep mortgage rates high.

S&P blamed the new Government’s decision to repeal Three Waters and the resulting uncertainty about how councils would pay to repair and expand infrastructure needed to cope with 1.5-2% per year population growth enabled over the last 20 years by both parties running the Beehive. High population growth boosts GST and income tax receipts for central Government, but loads up massive infrastructure costs for councils, who don’t get a share of GST or income tax, unlike in other countries. The population grew 2.8% last year, the fastest rate since 1947.

The new National-ACT-NZ First Government’s decision to cancel Three Waters and freeze new capital grants to councils without any extra revenue support has essentially robbed Peter to pay Paul, leaving ratepayers stuck with double-digit rates increases that are keeping inflation and mortgage rates up. The new Government’s moves to freeze centralised spending has instead pushed the costs and blame out to councils. S&P’s ratings actions have effectively called bullshit on the Government’s repeal of Three Waters and the RMA without ready replacements. (Paying subscribers can see more below the paywall fold and in the podcast above. I’ll open it up later if we get over the 50 likes mark.)

Elsewhere in the news in Aotearoa-NZ’s political economy this morning:

  • Grant Robertson announced yesterday he would retire next month as a Labour list MP to become vice-chancellor of the University of Otago. Porirua MP Barbara Edmonds, a former tax lawyer, will become Labour’s Finance Spokeswoman.

  • Members of the Independent Hearings Panel setting the agenda for Wellington’s housing own more than $7 million worth of property in the city, with five of the six properties not declared in the panel’s published conflicts-of-interest register and within Mt Victoria and Te Aro, where the panel recommended tougher rules limiting densification, BusinessDesk-$$$’s Murray Jones and Dileepa Fonseka report this morning.

  • Waka Kotahi-NZTA has advised the Government that delivering the roads and public transport National campaigned on could end up costing more than twice as much as the party said it would, opening up a potential fiscal hole of $24 billion, NZ Herald-$$$’s Jenee Tibshraeny reports this morning.

  • There was strong demand from potential buyers of a long-term lease to run the Port of Auckland and leave the land in the hands of Auckland Council, BusinessDesk-$$$’s Oliver Lewis reports this morning.

  • Finance Minister Nicola Willis is open to the Wellington Port being part-privatised to pay for new port facilities to keep the Cook Strait ferries operation running, NZ Herald’s Thomas Coughlan reported yesterday.

  • ELE Group, the Auckland labour hire firm that collapsed before Christmas and left 1,000 migrant workers stranded without work, income or the ability to work easily for anyone else, owes creditors $12 million, including more than $4 million to migrant workers, 1News’ Corazon Miller reported last night from the first receivers’ report.

  • The United States has warned China it will take action if China tries to ease its industrial overcapacity problem by dumping goods on international markets, two American officials told the FT-$$$ yesterday.

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S&P calls bullshit on new Govt’s water financing vacuum

The new National-ACT-NZ First Government has talked repeatedly in its first 100 days about fiscal discipline and the need for ‘grown-up’ conversations about ‘hard decisions’ on Government spending, arguing it needed to focus on bringing down the cost of living for home owners facing high mortgage costs and rates bills.

But its spending freezes and a rash of repeals under Parliamentary urgency of key planning and financing arrangements for council investment in infrastructure has only opened up a capital spending vacuum that is forcing councils to fill the holes with double-digit rates increases.

Now the real grown-up in the conversation, ratings agency Standard & Poor’s, has criticised the Government’s withdrawal of centralised direction and capital support in a 12-page research note and a three-page summary backing up its announcement yesterday that downgraded the outlook on the credit ratings for debt issued by 15 councils and two council-controlled organisations. The summary note was titled: Credit FAQ: NZ’s Policy Shift To Weaken The Institutional Setting On Local Councils and the full note was titled: NZ councils’ extremely predictable and supportive institutional settings are at risk.

S&P said in the research note:

Rising infrastructure budgets and responsibilities are putting growing pressure on the New Zealand local government sector'sfinances. The councils' own-sourced revenues and grants from the New Zealand government (Crown) are not rising enough to adequately cover this additional spending. This is widening revenue and expenditure mismatches, as seen with large deficits and rising debt levels compared with similar systems.

“We believe these imbalances will persist for longer than we expected. This is because of rising inflation and infrastructure budgets, and given the new National Party-led coalition government's promise to repeal existing water reform legislation by Feb. 23, 2024. These reforms were aimed at removing water-related operating and infrastructure responsibilities from councils.” S&P research note.

S&P pointed to “widening revenue and expenditure mismatches, with large cash deficits and rising debt levels compared with similar subnational government systems in other countries.”

“Further, policy uncertainty is elevated given the weakening of financial outcomes and a shift in political support for key reforms (particularly related to water services and infrastructure) that were partly designed to alleviate financial pressures on the sector.

“If the trend continues, it could undermine the strong credit quality of the sector.

“The final design of the new National Party-led government's reform will be vital to address the rising revenue and expenditure mismatches across the sector. Reforms will also be important to curtail the upward trajectory of the sector's debt levels as a proportion of operating revenues.

“In addition, uncertainty is elevated given the shift in political support for key sector reforms, including water reform and the Resource Management Act (RMA). The former government's water legislation was developed after many years of reviews and working groups, and the sudden reversal makes it difficult for councils to prepare their upcoming ten-year long-term plans. Policy uncertainty could weigh on our view of the system's predictability compared to other highly rated systems internationally.

“We could revise our assessment of New Zealand's institutional framework to stable if we observed greater policy stability that could narrow the sector's revenue and expenditure mismatches, leading to a sustainable reduction in sectorwide debt. This could occur if proposed local government reforms or upcoming budget planning markedly improves councils' financial positions. “S&P research note.

Ratingsdirect Institutionalframeworkassessmentnewzealandcouncilsextremelypredictableandsupportiveinstitutionalsettingsareatrisk 57402904 Feb 19 2024
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‘We don’t think you’re serious about addressing the deficit’

S&P was particularly blunt when talking about the new Government’s true appetite to help councils and solve persistent deficits after capital spending (bolding mine):

“The New Zealand central and local government appears to be a unwilling to address the growing imbalance between revenue growth and rising expenditure for the local government sector. Despite local governments having strong revenue and expenditure autonomy, they have much larger deficits and higher debt than we forecast.

“Many councils are reluctant to substantially raise general property rates more than inflation to fund rising expenditure. This is despite rates being set by individual local governments and not being limited by Crown policies. Large rate increases in recent years have been cannibalized by high inflation, and rising interest expenses and infrastructure spending. Because of this, deficits have widened across the sector. We estimate the after-capital account deficit across the sector grew to be 16% of total revenues in 2023, and total debt rose to 184% of operating revenues.

“The New Zealand Productivity Commission1 estimates that local government property rates are roughly the same proportion of GDP today as they were more than 100 years ago. In contrast, the Crown's taxation has more than tripled over this period. Many councils prefer to accumulate debt to fund most of their infrastructure rather than fund it via cash flows, and they have limited ability to raise revenues outside of property rates.” S&P credit FAQ

Ratingsdirect Newzealandspolicyshifttoweakentheinstitutionalsettingonlocalcouncils 57402952 Feb 19 2024
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‘Delays and uncertainty plague council planning’

S&P pointed in particular to a directive from Local Government Minister Simeon Brown to councils that they must include water activities in all future budgets.

Policy uncertainty has caused reporting delays. The Crown government has announced an extension to the June 30, 2024, statutory deadline for the adoption of upcoming long-term plans. This followed a direction for all councils to include water activities in all future budgets. However, current legislation requires local governments to remove all water-related activities from financial statements starting from the 2026 fiscal year. We expect the Crown to repeal this legislation by Feb. 23, 2024.

Nevertheless, this has caused a period of heightened uncertainty for councils. The ongoing shortage of auditors has affected many organizations' ability to prepare audited financial statements. Consequently, legislation was passed in 2020 extending statutory reporting timeframes by two months for Crown entities, local authorities, and council-controlled organizations with June 30 balance dates.

Ready. Fire. Aim. Downgrade. Then higher borrowing costs. And rates.

S&P was particularly scathing about the Government’s repealing of Three Waters without a replacement.

“There is little information on how Local Water Done Well will operate or the timeline for its implementation. We only know that the Crown expects to pass relevant legislation by mid-2025. Implementation could drag the process on for another couple of years, given the complexity of the issue and the public consultation processes. During this period, fiscal conditions for the local councils could continue to deteriorate, and policy uncertainty may continue. This would increase credit risks.

“Recent announcements on Local Water Done Well signal that councils may have to devise plans to meet the new, stricter, water standards, under the supervision of a new water infrastructure regulator. The councils would also have the option to form regional council-controlled organizations (CCOs) for water delivery. These CCOs would presumably differ from Labour's proposed water services entities. They could be voluntary and more tightly controlled by councils because of the removal of the co-governance requirement with local mana whenua.” S&P note.

S&P also made plain that it would not accept the Government’s view that new voluntary water CCOs could be formed without either council or Government guarantees. It also pointed out that lower ratings would increase council borrowing costs, but would ironically improve the profitability of the Local Government Funding Agency (LGFA), which is the Crown-controlled agency that borrows on behalf of councils.

As we previously highlighted, we would likely view a CCO (with either a high degree of political control or concentrated ownership, alongside a high level of indebtedness) as part of its parent council's tax-supported debt or at least a contingent liability of the council

If the ratings on local councils fall, those councils may pay higher credit margins to the LGFA under current arrangements. This could slightly boost the profitability of the LGFA.

Here come the rate rises, which also hold up mortgage rates

Meanwhile, BusinessDesk-$$$’s Oliver Lewis reported this morning that Auckland Council’s Watercare is set to increase water charges by 25.8% from July 1 because of the Government’s funding and planning freeze linked to the repeals of the RMA and Three Waters. The report cited comments in Long Term Plan documents due to go out to the public for consultation from February 28.

“This shortfall in debt funding makes it necessary to increase prices by significantly more than previously signalled.” Significantly, the LTP consultation document also said: “The council expects that 100% of growth costs will be recovered from developers over the LTP period." The direction for new growth infrastructure to pay for itself has already been met with criticism on social media platform LinkedIn, including from one developer who said they would have to hike house prices by about $6,000 to cover what they said would equate to an extra $4600 charge per home. BusinessDesk-$$$’s Oliver Lewis

Rising rates, fees and charges are a major factor holding up domestic services inflation and core inflation, which Reserve Bank Governor Adrian Orr said last week was still too high. Councils have announced double-digit rates increases in recent weeks, blaming the new Government’s withholding of capital grants and revenue support.

Charts of the day

‘Lazy’ youth working at higher rates than ever

Cartoons of the day

Fragility gaslighting

Sharon Murdoch via The Post-$$$ and X

Dunedin bound

Rod Emmerson via NZ Herald-$$$ and X

Timeline cleansing nature pic of the day

‘Finger bitin’ good’

E.E. Grieveson for The Kākā

Ka kite ano



The Commission is being abolished by the new Government.

The Kākā by Bernard Hickey
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