On the third day of Christmas, we continue our 12 questions about Three Waters. Compared to existing council debt caps, how can Government reforms give both the water corporations and the councils increased headroom to borrow?
Perhaps the country's biggest financing question is how New Zealand can afford to pay the projected $185 billion price (if overseas consultants are to be believed) to fix and maintain its run-down water infrastructure over the next 30 years.
To continue this season's metaphor, on the third day of Christmas our true love gave to us, three flax kete – and tasked us with borrowing to fill them.
When Kingi Ihaka wrote the Aotearoa version of the carol, The Twelve Days of Christmas, and chose "three flax kits" to illustrate the third day, perhaps it was quiet homage to the tale of Tāne travelling to the heavens to retrieved thee kete: one filled with the knowledge of evil or makutu, one with the knowledge of ritual, memory, and prayer; and one with knowledge that could help mankind.
The promise of the Three Waters reforms, to both enrich the four new water incorporations with sufficient borrowing headroom to bring New Zealand's water infrastructure up to standard, while at the same time leaving councils with the freedom to enrich our communities with new parks and libraries and communities infrastructure – that seems equally magical to many.
WHO PAYS FOR THREE WATERS? 1/ Paying for Three Waters: the local pūkeko v the imported partridge 2/ Who would actually manage the borrowing for Three Waters infrastructure? 3/ Three Waters’ magical kete with room to borrow more and more 4/ On the 4th day of Christmas, what’s so good about four water companies? 5/ Achieving the gold standard of balance sheet separation 6/ Driving through water reforms in new special purpose vehicles 7/ Govt sticks to ‘bottom line’ of balance sheet separation – but why? 8/ If councils retain Three Waters, how much will they have to raise rates? 9/ The silly Ministry of Water Works – and its serious side 10/ On the 10th day of Christmas, should Three Waters become two? 11/ Too big to fail – calls for Govt to guarantee Three Waters debts 12/ Paying for Three Waters: ‘It’s always gonna come back to you in the end’
So 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. They are legal expert Josh Cairns; finance advisor Bevan Wallace; and infrastructure consultant Amelia East.
In comparison to existing council debt caps, how is it that the Government expects both the water entities and councils to be able to magically borrow more once these reforms are implemented?
To be blunt, New Zealanders won't get an accurate assessment of how much the water entities will need to borrow until they have been established, and draw up realistic plans of what infrastructure is required to meet the new water standards. Data needs to be collected not only from councils but from all the privately-run schemes that the new water entities may end up taking over.
And for councils, it's not strictly true that all of them will have increased debt headroom. A small handful have functioning water infrastructure with little or no debt against it; they will lose management of their water assets, as well as losing the revenues they charged on drinking water and wastewater services. These councils will receive one-off payments from the Government's "no worse off" fund – most notably Whangārei, which will receive $90m – but they argue that this doesn't come close to covering lost revenues for the next 30-plus years.
Most councils will shift their debt liabilities to a water entity for cash, improving their balance sheet position when the transition takes effect in July 2024. They will have more room to borrow for other community infrastructure, like parks and libraries.
Paul Norris, director of international public finance for Fitch Ratings, expects some councils may benefit and some may be more constrained under current plans. "This will depend on the impacts on council finances once water-related revenues, expenses, debt and assets are stripped out of councils and the proposed changes wash through, and on support provided by the sovereign," he says.
"An important assumption is that there will be no liability to councils related to the water entities, which we understand would be the case via legislation."
Initially in July 2024, the combined Three Waters debt (councils and new water authorities) will be only a little more than at present. The small increase is mainly because the new entities have to borrow $1.5 billion immediately, to finance the Government's "better off" sweetener and "no worse off" compensation to councils, an attempt to solicit their support for the reforms.
But over time as the entities increase their Three Waters infrastructure spending, and councils use their increased headroom to finance more community assets and public transport projects, the combined level of debt will increase.
Officials say more customers, a larger revenue catchment, balance sheet separation and economic regulation will provide the new water entities with stronger balance sheets and greater flexibility to direct significant investment to where it is needed. This would enable them to finance the required catch-up investment, and respond to short-term shocks like earthquakes, and long-term challenges like climate change.
There is doubt, though, about the official expectation that the new water entities will achieve similar issuer credit ratings to councils' AA ratings. Yes, water entities will achieve higher leverage ratios, enabling them to borrow up to $8b more through to 2031.
But without a Crown guarantee of that debt, finance experts and rating agency S&P predict they would have credit ratings around BBB-, which is the lowest possible investment grade. S&P defines that as: "Adequate capacity to meet financial commitments, but more subject to adverse economic conditions." And that means higher interest payments that will be passed on to customers.
Forecast additional debt capacity for new water entities (nominal $b)
That's forced Finance Minister Grant Robertson to agree to a Crown liquidity facility – an emergency fund entities could borrow from when access to the usual financial markets is constrained. It would be similar to a $1.5b fund made available to the Local Government Funding Agency. Officials say that won't constitute an on-demand source of cash, and would only be available to bail out the entities if they are hit by "extraordinary events" that result in a lack of liquidity. That could be, for example, a temporary dislocation in capital markets.
Even with a proposed liquidity facility, the corporations will struggle to match the AA+ ratings of bigger councils.
Bevan Wallace, executive director of Morgan Wallace, says increased debt will come with a corresponding increase in interest rates paid, unless they have an implicit guarantee from the Crown. "Absent such a guarantee, the ability to borrow is either constrained or penalty interest rates are incurred, much as is the case with borrowings secured on a second mortgage.
"The ultimate borrowing costs will be anchored to the Crown’s cost of borrowing rather than the risk of the entity if such a guarantee is either implicit or explicit."
