The policy will allow councils to create their own water CCOs to run water services either for a single council or for many councils. These CCOs will be able to borrow the equivalent of up to five times their revenue from the LGFA at relatively low rates.
Certain high-growth councils are also to be given the right to have their debt caps lifted to 3.5 times revenue from about 2.8-2.85 times revenue for most large councils now.
The policy has reignited a tortured debate about balance sheet separation and whether water entities needed to be set up in such a way as to have completely distinct balance sheets from the councils that owned them. Labour’s Three Waters policy, which was to set up 10 balance-sheet-separated water entities, was built around the principle, with the Government arguing it was essential to ensure council credit ratings were not dragged down by water entity borrowings.
Balance sheet separation is ultimately in the eye of the beholder, in this case, international credit ratings agencies like S&P.
“There is a possibility that the credit ratings agencies will look at this and they will say that a water CCO that is guaranteed by parent council will reflect some if not all of that onto our assessment of that council when we are doing their credit rating,” Butcher said.
He said: “If you don’t have balance sheet separation, part of the burden of the CCO could fall back on your balance sheet as a contingent liability.”
Butcher said if a council owned 100% of a CCO “then it’s more likely it would be incorporated into [the council’s] balance sheet”. CCOs owned by multiple councils would be “less likely”.
He said there was the “possibility” that one or more councils “will have a slightly lower credit rating than they would if they had a completely separate remote water entirety”.
However, he added that regardless of their credit ratings, councils and water CCOs would be able to continue to borrow from the LGFA and that there was little difference in borrowing cost was marginal.
A leak in Wellington. RNZ / Jemima Huston
“If a council had an AA credit rating, they could borrow at 5.45% if they had one credit rating less they could borrow at 4.55% from us,” he said.
Labour’s scheme was predicated on balance sheet separation, but it came at the cost of local control and co-governance with Māori, which frustrated councils who complained that they were losing control of their assets. This plan means there will be a greater degree of local control, but it also comes with the possibility of higher borrowing costs, which could mean higher rates and water bills.
There is also significant disagreement between the Government and Labour about the amount of borrowing required, with modelling commissioned when Labour was in Government warning the bill could be as high as $185 billion over 30 years. The new Government has disputed that figure saying as much as $100b of it was inflated.
The exact way water CCO leverage will be measured is still being worked on between the LGFA and the Department of Internal Affairs.
Water companies and ratings agencies overseas often use funds from operations (FFO) to total debt ratios as their preferred metric. FFO to debt is a more common metric used by utility companies to measure their ability to service debt. It is also the most common measure used by regulators such as the UK regulator (Ofwat).
By contrast, net debt-to-revenue ratios provide an indication of leverage but not the ability to service debt.
Butcher said the LGFA will be cautious about allowing every council to lift its debt-to-revenue cap, despite the new rules.
“Not every council will be able to be eligible for additional borrowing. Councils will have to remain acting prudent from a financial perspective too. We don’t want a council gearing up and putting it into projects that might not be growth-orientated,” he said.
Ratings agencies have already weighed in on the changes with S&P Global Ratings issuing a bulletin on Monday which dealt separately with the decision to lend to water CCOs and to lift council borrowing caps. That bulletin warned the changes could “weaken” LGFA’s loan asset quality “if it starts lending to highly indebted water CCOs”.
The agency said allowing councils to lift their borrowing would “be negative for credit quality across the sector, which is already highly indebted by international standards”.
Thomas Coughlan is Deputy Political Editor and covers politics from Parliament. He has worked for the Herald since 2021 and has worked in the press gallery since 2018.
