Councils could breach ‘idiotic’ debt cap
A new report shows Covid-19 will play havoc with local body balance sheets as councils reliant on tourism and hospitality see their revenue streams dry up and their ability to borrow sink along with it
Auckland Council is negotiating with credit agencies to raise its debt ceiling so that it can weather the "mother of all recessions".
Mayor Phil Goff told Newsroom he was talking to ratings agencies about ways the city could temporarily raise its debt cap without triggering a ratings downgrade that would have flow-on effects for other councils.
Even if a downgrade was averted, all council balance sheets could be badly stung by a lower rates take, less revenue from assets like airports, and fewer fees collected through parking or community services.
Self-imposed 'debt ceilings' are adding to that problem and mean the councils' ability to borrow will decline as revenues dry up.
Council debt caps will shrink by $2 for every $1 high-growth councils lose in rates. Because borrowing limits are capped at 250 percent of revenue.
"I have no idea why that debt cap is where it is at anyway...it makes no sense to me. I think it's idiotic.
Five councils would breach their debt caps under one economic scenario generated by an analysis of the situation by Internal Affairs' Local Government Covid-19 Response Unit.
The unit is a joint initiative of DIA, Local Government New Zealand, Society of Local Government Managers, and the National Emergency Management Agency.
LGNZ president Dave Cull said the unit's report was "gritty" and "sobering" reading for every council across the country.
"Whatever the critics might say, there's not a lot of fat in many council budgets. A huge amount of it, especially in growth councils, has to go into renewing or installing new infrastructure.
"Otherwise you get into the situation where you just can't have housing development because you haven't got roads or pipes."
Sense Partners Economist Shamubeel Eaqub said there was a simple solution to averting a debt ceiling breach during the "mother of all recessions" - central government cash.
Council revenues would rise if they were given more money via a Government grant. They could then borrow more off the back of that and never breach their debt ceilings.
"I have no idea why that debt cap is where it is at anyway ...it makes no sense to me. I think it's idiotic.
"Essentially the current rules stop you from being able to invest in the future at a time when interest rates are very low [and] the private sector investment cycle is in a slump."
'There's no better time to invest'
Goff said Auckland Council was bracing itself for a "significant" hit to its revenue.
"The revenue loss will come largely from non-rates sources.
"You've got things like Auckland International Airport dividend. It should normally be $60 million. In the next few years it'll be zero."
The report says the councils most exposed to financial stress were those that relied on a broad range of funding sources. Rates are predicted to be easier to collect during a Covid-19 downturn than other revenue.
Auckland is at the top of that list with its fee income just 24 percent less than the money it takes in from rates.
The report predicts declines in this revenue will come from a slowdown in building activity, a reduction in fees collected from the hospitality sector, and the closure of community services like swimming pools.
Goff said the funding crunch had led to the dismissal of 1100 temporary contractors two weeks into lockdown.
It had also come at a time when his council had a rare opportunity to invest in infrastructure.
"There's no better time to invest in infrastructure than when the pressure and the heat goes out of the market.
"[Previously] we've been fighting against the market when there's been an 8 percent per annum rise in construction costs," he said.
"That [rise] will diminish because some of the demand will go out of the market."
LGNZ's Cull noted that for years councils had been encouraged to find revenue streams that weren't rates.
Now those that relied on non-rates funding streams would be badly affected by Covid-19.
The report says reduced revenues could place critical infrastructure investments in areas like housing and water assets at risk.
For high-growth councils, developer contributions make up a big chunk of their income.
Using the financial crisis as a guide, the report predicts these will decline as well, which could further delay investments in housing infrastructure, much as it did during the GFC.
Hamilton has started to refund its building and resource consents and defer the payment of developer contributions. The city's mayor Paula Southgate said the council was just starting to reach its financial targets when Covid-19 hit.
"We are now under pressure to find ways to move business ahead within some really turbulent economic times.
"We're not alone."
The tourism councils
Councils in areas that have experienced a tourism boom are among the worst-affected.
Not only are many heavily exposed to tourism-related investments, but they will face a major contraction in their local economies.
Some made big commitments to invest in infrastructure to support growth during a major tourism boom.
Queenstown Lakes District mayor Jim Boult said he had seen projections that the district's economy could contract by 40 percent and experience unemployment rates of 25-30 percent.
"We had a growing GDP. We had a growing population. A reasonably high net worth base among our residents - and had the lowest unemployment rate.
"Now we're going to go to probably the highest amount of unemployment in New Zealand and experience some real social issues because people won't have money to live."
On top of that, the tourism-related revenue brought in by the council was "very significant". It included the Shotover Jet concession, dividends from the district's airport, and other hospitality-related fees.
"For example, table and chair revenue from restaurants operating on the sidewalk will disappear for the next 12 months at least," Boult said.
"Leases on wharf concessions, various other concessions for tourism businesses, all of those will take a massive hit."
The report says Queenstown Lakes district was also likely to suffer a major lockdown-related downturn because 60 percent of its GDP was tied up in "non-essential" services.
Boult said the district felt the pressure from residents to keep potential rates rises low.
However, with a big decline in its non-rates revenue, the council would need to pass on an increase of some kind.
"We have been disadvantaged by the fact that we were proactive in looking at different revenue streams."
'We don't have the money. They don't have the money'
The councils with the highest levels of debt are all shareholders in the Local Government Financing Authority, which is able to pool risk across its members and allow them to borrow at low interest rates.
Debt covenants are part of that borrowing arrangement. LGFA councils are bound to a net debt to revenue ratio of 250 percent. However, the report says that can be increased through a shareholder vote between all of its member councils and the Government.
Auckland Council has a credit rating from Standard and Poors that before March this year was based on a debt ceiling of 270 percent gross debt to revenue. Breaching this would have seen its credit rating downgraded with implications for the borrowing costs of other councils. In March, the council's finance committee was told S&P had removed the explicit reference to 270 percent in its Auckland Council rating conditions.
Yet in both scenarios tested out in the report - one for a sustained 15 percent reduction in income and the other for a 20 percent one - Auckland council breached LGFA debt covenants.
Those covenants have been heavily criticised by people like Tauranga mayor Tenby Powell who told Newsroom high-growth councils should have debt caps of 400-450 percent of revenue.
Goff said this was something the council was trying to address through direct negotiation with ratings agencies.
However, any temporary increase would not be the one Powell wanted.
"We are negotiating with the credit rating agencies for a temporary lifting of that debt cap," Goff said.
"We could look at a double digit figure, probably [a] low double digit figure."
"As long as the credit rating agencies appreciated what the situation was...that this was something temporary...and that you were taking reasonable action to remediate the problem."
However, Eaqub questioned whether a ratings downgrade meant as much as it once did where borrowing costs were concerned.
"What's the problem?
"Do we really think the Reserve Bank is going to stop buying local government bonds even if there's a credit downgrade?
"Does anybody seriously think interest rates are going to rise anytime soon?"
There were also other ways to raise the debt cap or keep it stable in the face of declining revenues.
One was to focus on reducing the rates burden without cutting into a council's debt headroom, he said.
That meant deferring rates rather than trying to pass on zero-rates rises.
Increases should be lower than planned, but not so much lower that it damaged the ability of councils to borrow.
Eaqub said if councils gave hardship refunds to those genuinely unable to afford their rates then that would keep its paper revenue line intact.
So, a council would have the same headroom to borrow while reducing the rates burden for people who were struggling to pay their bills.
However, the best way to shore up council borrowing headroom was for the Government to step in and simply give councils more money.
"[That way] they don't necessarily have to grow the cap because they can add things [revenue] to their balance sheet."
Hamilton's Southgate said full funding for projects was something her council had raised many times with the Government.
She, like other local body politicians, has pinned some of her budget-balancing hopes on the Government's "shovel-ready" project fund.
Economic development Minister Phil Twyford told her and other mayors in the region that if they wanted Government funding, councils needed to invest in projects rather than trying to reduce rates.
"He basically was telling us that if Government was going to use its balance sheet to help parts of New Zealand recover from Covid, then local councils had to play their part.
"And in his personal view, taking a one-time hit to rates is not a useful investment. That's something councillors will have to consider," she said.
"They [Government] can't fund everything. We can't fund everything. So this will all come down to working out priorities."
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