If councils win fight to retain Three Waters, how much more will they have to raise rates?

January 1, 2023 Stan

Summer Newsroom

We continue our 12 questions about Three Waters. If the assets remain on council balance sheets, communities will pay the price – quite literally.

Keeping water infrastructure on the balance sheet would mean some councils need to more carefully prioritise when specific infrastructure spending occurs.

The key is to have good long-term infrastructure strategies, so that capital expenditure is well planned over a long time period.

Currently there are some short-term challenges as New Zealand has under-invested in infrastructure over the past 30 years. But with good planning, this infrastructure deficit can probably be addressed over time – that comes back to the challenge of the right political incentives.

WHO PAYS FOR THREE WATERS?
* Paying for Three Waters: the local pūkeko v the imported partridge
* Who would actually manage the borrowing for Three Waters infrastructure?
* Three Waters’ magical kete with room to borrow more and more
* On the 4th day of Christmas, what’s so good about four water corporations?
* Achieving the gold standard of balance sheet separation
* Driving through water reforms in new special purpose vehicles
* Govt sticks resolutely to ‘bottom line’ of balance sheet separation – but why?

If every council is trying to boost its re-election chances by diverting water network depreciation capital to new civic buildings and monuments, or by cutting rates, then the out-of-sight infrastructure underneath the ground will continue to suffer.

Newsroom has gone to ratings agencies S&P, Fitch and Moody’s and to three top independent experts to discuss the impact on ratepayers, taxpayers, and on those consumers whose water charges will pay for the highly leveraged borrowing of the four new water corporations – or whose rates will pay for councils to do the investment.

They are legal expert Josh Cairns; finance advisor Bevan Wallace; and infrastructure consultant Amelia East.

“The constraint is not how much could they borrow, but how much will ratepayers allow them to borrow, and that explains why there are local authorities out there with zero debt but crumbling pipes.”
– Amelia East, HKA NZ

“Council indebtedness occurs on a spectrum, one that is heavily tilted towards balance sheet conservatism outside of the cities, so on paper, councils probably have a fair amount of financial headroom,” says HKA New Zealand head Amelia East.

“The constraint is not how much could they borrow, but how much will ratepayers allow them to borrow, and that explains why there are local authorities out there with zero debt but crumbling pipes.

“New regulatory standards will bind councils’ (and ratepayers’) hands to some degree, but we really are courting the same funding challenges if significant reform of some kind or other doesn’t alter the water status quo.”

“Councils should rightly be constrained on new investment such that they do not embark upon vanity projects,”
– Bevan Wallace, Morgan Wallace Ltd

Bevan Wallace agrees. Managing assets, he says, is not a constraint on councils – it is an obligation.

What ratepayers demand they are managed efficiently, and that the costs are allocated fairly through direct fees for service, rates or taxes.

“Councils should rightly be constrained on new investment such that they do not embark upon vanity projects,” he says.

“Where maintenance is required to ensure minimum service delivery standards are met they should be able to recover such costs through appropriate levies either on users, ratepayers or even taxpayers depending upon who is making the demands.”

“This could become more of an issue for higher-growth councils over time, particularly if further development of water infrastructure is needed to meet water standards or likewise with other local infrastructure.”
– Paul Norris, Fitch Ratings

While councils have financial headroom now, that may soon tighten. Paul Norris from Fitch Ratings says the company doesn’t expect the eight councils it rates to be “materially constrained” by debt ceilings or their current rate increase plans over the ratings agency’s projections period, which are currently out to 2026.

“That said, this could become more of an issue for higher-growth councils over time, particularly if further development of water infrastructure is needed to meet water standards or likewise with other local infrastructure,” he says. “We would expect rates would need to go up in such cases to keep in step with higher capital spending demands but we don’t see this as a significant issue for most councils for now.”

In July, Fitch affirmed Queenstown Lakes District Council at its AA- rating, with a stable outlook. If anything, Three Waters might strengthen Queenstown’s debt position, the agency said.

“The reforms aim to transfer councils’ water assets and associated debt, revenue and expenditure to newly created independent water entities from July 2024,” it said. “We believe Queenstown Lakes District Council will maintain sufficient stability and flexibility in its revenue and expenditure, in line with its risk profile, and that the reforms may improve its debt sustainability.”

It’s also affirmed ratings for Waikato, Waipā, Rotorua, Ashburton, Timaru and Invercargill – though, always with the caveat: “There is insufficient clarity at this time to determine the precise impact on debt metrics.”

This month, ratings agencies will be closely scrutinising the water services implementation bill, and the bill establishing an economic regulator to oversee how the new Three Waters incorporations charge for their services.

Their assessment of the models will help answer the question of how New Zealand can afford to pay the projected $185 billion price to fix and maintain its run-down water infrastructure over the next 30 years.

The cost of borrowing to pay for infrastructure is already putting council credit ratings under pressure: Wellington City Council has been placed on a negative outlook, and Marlborough District Council has been downgraded. When ratings go down, interest rates go up – which means increased liability for ratepayers. This will affect the four new water entities even more, because of their size.

The new bills will help answer the questions of how separate the new entities’ balance sheets are from councils, and from central government, which has agreed to a backstop liquidity facility.

That, in turn, will influence the credit ratings for the new entities, and for the 67 councils that nominally own them, and potentially even for the New Zealand government’s sovereign rating.

“The question is, does the bill give us the information we needed?” asks Anthony Walker, director of sovereign and international public finance at S&P Global. “Or is there more financial and transition unit information coming next year, which may be the information we need to wait for?”