Government officials have admitted in the past month that they can't take over ratepayer debt on New Zealand's water infrastructure in the straightforward transfer that councils feel they had been led to expect.
The 25,000 residents of Kaipara care about council debt more than most. They are still paying the price of a $15 million wastewater treatment plant at Mangawhai where the cost ballooned to a $90m ratepayer debt.
The council was sacked and replaced by commissioners in 2012 but although the disgraced decision-makers have gone, most of the debt remains. For years, locals tightened their belts as their roads deteriorated, their drinking water network and their public gardens were shut down – all to pay down debt to ensure that legacy was not handed to another generation.
"The first thing everybody here focuses on is the debt, not the asset or its functionality, or how many people are connected to water or not." – Dr Jason Smith, Kaipara mayor
It is the mayor of that small district, between Auckland and Whangarei, who is publicly flagging the problem. Dr Jason Smith was alarmed to discover, in a briefing from the council's treasury services provider, that Local Government Funding Agency rules prevent it lending to anybody other than councils. His council had been told that if it opted in to the water reforms, the new northern regional water authority would take over the $52m still outstanding on the wastewater treatment plant.
But it emerges the debt councils have incurred to pay for their drinking water, wastewater and stormwater networks can't be transferred to the Government's four big new regional water authorities. At least, not easily.
Councils are estimated to be in hock for about $10 billion for their Three Waters infrastructure, though that is offset by any monies they have set aside from depreciation to pay for upgrades and maintenance. The idea was that both the debt and the depreciation reserves would transfer to the four new authorities, leaving them liable to take over a smaller net debt sum.
However, PwC partner Alex Wondergem has warned Kaipara Council that overseas investors will not allow the lending, that they have effectively financed, to be transferred to the new authorities with lower credit ratings than the councils.
That is a somewhat simple characterisation of a complex problem, that is now being discussed by the Department of Internal Affairs and Local Government NZ.
"It's not an aspect that the Department of Internal Affairs has a very good handle on, and they have not engaged with the Local Government Funding Agency in any meaningful way," Wondergem said. "The Department of Internal Affairs are relatively ignorant of what some of these challenges are."
With councils expected to confirm their position on the water reforms by the end of this month, Dr Smith said he was alarmed that such a critical question had been left so late.
"It would be good to get some clarity on the issues regarding debt because councils cannot afford to stop undertaking Three Waters capex that is debt-funded ahead of June 2024." – Mark Butcher, Local Government Funding Agency
There are 68 councils that own waters infrastructure: the 67 city and district councils, plus Greater Wellington Regional Council (whose bulk supply networks were entirely forgotten in initial calculations).
Ninety percent of their borrowing is from the Local Government Funding Agency, a statutory body set up in response to council borrowing woes in the 2008 Global Financial Crisis. (Dunedin manages its own borrowing, as does the big Auckland Council for two-thirds of its debt).
The funding agency, in turns, sells bonds to international investors. Those investors are confident to lend the agency money because of its AAA credit rating, underwritten by the Government and 64 of the councils as guarantors.
The Local Government Funding Agency then lends to the councils (whose credit ratings are all A+ or higher) against the surety of their rates revenue. Councils do not borrow against their assets, as it would not be feasible to hand over parks and libraries if they defaulted on their debts.
The problem is, the Funding Agency's rules bar it from lending to anyone other than councils, so the four new water authorities can't just take over the debt. To change those rules would require the agreement of the Government and its 30 council shareholders. But they might be reluctant to agree to guarantee the debts of the new water authorities, which will likely have lower credit ratings and won't themselves be guarantors.
The alternative solution – buying out the councils' net debt – runs into questions about how much that will be. Nobody yet knows. The Government has set aside $500m in its taxpayer-funded "no worse off" fund, but much of that money is already tentatively allocated. It is an uncapped fund, and Internal Affairs may yet have to go back to Finance Minister Grant Robertson asking for billions more.
Alternatively, the balance could be paid for by the four new authorities – but that would quickly cut into their debt headroom to do the very thing for which they are being created: to upgrade New Zealand's often old and poorly maintained water infrastructure.
A Department of Internal Affairs spokesperson acknowledged it would not be possible to take over all ratepayers' water debts. If or when responsibility for water services is transferred from local authorities to water services entities, on June 30, 2024, they would transfer the assets, the revenues and effectively transfer the liabilities, he said.
"We know that there will be a range of financial instruments used by councils," he said. "In some cases, these debt instruments will be able to be transferred or novated to the water services entities and in other cases this may not be feasible."
The department would work with councils and the Funding Agency to understand the mix of liabilities and how best to effect their transfer.
Where debt instruments were not transferred to the new water services entities, the spokesperson said councils would receive cash payments from the new water entities instead. These would be equivalent to the value of any outstanding water debt.
"Councils may choose to pay down debt, or use the payment to fund activities that would otherwise have been debt funded," he said.
It is understood that after an initial discussion early in the reform programme, Internal Affairs didn't talk substantively to the Funding Agency again until last month.
But Mark Butcher, the agency's chief executive, said there were two-and-a half-years before the assets and liabilities were due to be transferred, so that was still plenty of time to work through the transition issues.
"We are very much willing to be part of the process to get the best possible outcome for everyone," he said. "Our key stakeholders are central and local government, our investors and rating agencies so a smooth transition is important but also a process followed where the financial cost of transition is minimised.
"We are the largest lender to the sector with just over $13 billion of loans to councils as at today, and by June 2024 we think we will have between $5b and $7b of Three Waters-related loans to councils. Having one large lender should help the transition process."
Decisions would be needed around repayment, refinancing or transfer of debt if possible, and many of those decisions would be driven by what the new Three Waters regional entities want to do. And they have yet to be established.
"I think that the financial issues are less of an immediate concern and they can be easily resolved within the timelines. The more difficult and pressing issues for central and local government to resolve relate to ownership and governance of the Three Waters entities and whether councils opt in, opt out or have no choice in terms of participating in the Three Waters Reform Programme," he warned.
Some councils were also concerned at being asked to make a decision on the water reforms before knowing the outcomes of the Government's review of the future of local government. "So unfortunately not everything is aligned," he said.
Once the structural issues were sorted in coming months, he said there should be a focus on the debt. "It would be good to get some clarity on the issues regarding debt because councils cannot afford to stop undertaking Three Waters capex that is debt-funded ahead of June 2024."
Financial services consultancy PwC has advised Kaipara and other councils on the Three Waters reforms. "We recommend councils take the time to understand their debt position, including interest rate swap positions, and what portion of this relates to water activity," Alex Wondergem told Newsroom. "There may be complexity in transferring or novating some debt instruments, and in some cases it may be advantageous to councils to retain existing debt.
"We understand Internal Affairs are looking to ensure all debt allocated to Three Waters is accounted for. We encourage councils to ensure they understand the most appropriate solution for their individual situation."
Back in Kaipara, Mayor Jason Smith said the community was acutely aware of how big the district's waters debt was. "Mangawhai wastewater was a coming of age for Kaipara," he said.
"The first thing everybody here focuses on is the debt, not the asset or its functionality, or how many people are connected to water or not. The first thing we focus on is the debt.
"So it was particularly alarming to discover that the first thing we're interested in is the the last thing Internal Affairs is working on."
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