The tidal wave of debt

By Geoff Cumming

As home owners get an early warning of this year's rate increases, Geoff Cumming discovers that the true cost of paying off council debt will be much higher

Auckland Council alone will owe $13.1 billion by 2022. Photo / File
Auckland Council alone will owe $13.1 billion by 2022. Photo / File

If the hike in your rates bill seems less of a leap this year, enjoy it while you can. After a decade of rate increases averaging 7 per cent a year, councils - cowed into submission by ratepayers and the Government - are making do with increases around 2 per cent to 4 per cent, closer to the rate of inflation.

But it's the calm before the storm. Councils are either racking up debt or delaying replacement of assets until they burst. As the Auditor-General's Office warned in a 2012 report, "sweating" the assets raises the risk of failure with big consequences for communities.

Collectively, councils will owe $19 billion by 2022 (the end of the current long-term-planning phase) and most will rely heavily on generations of ratepayers to pay it back. Leading the charge is Auckland Council, which alone will owe $13.1 billion - a trebling of debt in a decade. But wait, there's more. Auckland has identified a $12 billion gap (on top of $56 billion already earmarked) in funding over the next 30 years for transport projects to ease congestion and allow for burgeoning population growth.

Then there's the $10 billion needed to fix stormwater pollution and cater for more people ...

Mayor Len Brown is responding to these astronomical sums with a low rates strategy. His rate rises in the first term were all below the average 4.9 per cent signalled in the council's long-term plan and for 2014/15 he's seeking an additional 2.5 per cent. Already, the council is feeling the squeeze from lower-than-expected rates income.

Though the 10-year plan earmarks some rates funding for the $2.8 billion City Rail Link and $3.6 billion is allocated for stormwater and wastewater works, big ticket items not yet on the books include an airport rail link and additional harbour crossing - and anyone stuck in traffic knows transport improvements are needed sooner rather than later.

Down in Christchurch, a half-billion-dollar hole in the council's earthquake rebuild budget threatens further tortuous progress. High-growth councils including Auckland, Tauranga, Hamilton and Queenstown are flirting with debt levels that worry some analysts - and risk running foul of new Government-imposed debt ratio limits.

Small rural councils face a similar headache but with different drivers: many are losing population (to Auckland, mostly) and those left are generally ageing or on low incomes. But they face raising debt to replace creaking infrastructure and meet tougher standards for water supply and wastewater systems - work sorely needed to reduce pollution.

Everyone agrees rates alone can't cope with these snowballing demands, some of it a legacy of underfunding in tough economic times for asset replacement and future growth. And there's only so much borrowing before it impacts noticeably on rates. But the Government plans to make it even harder for councils by restricting their use of development levies - charges developers pay for the cost of extending council infrastructure and services - to raise revenue.

Auckland Council is banking on $2 billion in income from development charges in the 10 years to 2022 (with annual income rising from $48.5 million to $242.5 million). But if the draft reforms proceed, the council claims it will be $480 million out of pocket for community infrastructure, requiring an 8.5 per cent rise in the average rates bill by 2021/22.

What's being done about it?

The Government's response has been to place councils in a fiscal straitjacket with a suite of reforms aimed at keeping costs down and avoiding rates "surprises". Something has to give and Local Government NZ is embarking on a review of financing to find alternatives to rates and existing user-charges. Councils are also due this year to overhaul long-term plans, forecasting budgets for 2015-25 (the debt levels highlighted are estimates for 2012-22). Auckland Mayor Len Brown, who lobbied for the financing review, is billing Auckland's 10-year plan update as the city's "most important debate in 50 or 60 years".

Brown wants the council to pare back spending in the long-term plan review. He also wants Aucklanders to use the process to make a stark choice between slow growth dependent on rates and fuel charges or "new revenue streams so we can build assets in 10-15 years instead of 50".

"The choice will be stark - it will be pace or no pace. If Aucklanders say 'yes, we want that money to get us there', I think there's a reasonable chance we'll get in place a funding stream to make that happen."

What are the alternatives?

Fuel charges are about as far as the Government is prepared to go. Options such as giving councils a slice of income tax or GST (or at least letting them keep the GST on rates) have all been explored and rejected as too difficult, though they are common enough overseas.

Peter McKinlay, a public policy consultant who works with councils, says Auckland could always look at selling down port or airport shares to raise cash.

Brown's favoured options include a transport levy on rates, roading network charges (such as congestion charges for using arterial roads at peak times or motorway tolls and tolls for new roads) and using Public Private Partnerships (PPPs) where, in theory, the private sector funds the development and then reaps a profit before handing it back to the council.

Brown has revived a "consensus building group" he appointed last year to fine-tune these options. Trouble is, the Government has consistently opposed road charges while PPPs have proved a road to ruin for too many public bodies, here and in Australia. Unveiling Auckland's new electric trains last week, Transport Minister Gerry Brownlee confirmed his opposition to tolls, charges or a regional fuel tax as an unfair burden on motorists.

What's wrong with PPPs?

Some roading PPPs in Australia have succeeded but, too often, proponents over-estimate usage, charges escalate and they rebound on the public body. No one wants another Kaipara where a poorly governed council embarked on a PPP to fund a new sewerage system for fast-growing Mangawhai. Council debt blew out to $80m and (partly because PPPs keep the debt off the council's books) the first ratepayers knew about it was when a 31 per cent rates demand landed.

Urban planner, blogger and former regional councillor Joel Cayford says Treasury regards PPPs as "innovative" but Mangawhai's scheme was so "off-balance sheet" that even the Auditor-General's Office missed the early warning signs. "The checks and balances are pretty minimal," says Cayford. He says the sewerage scheme was predicated on high growth, with developers promising intensive subdivision. But the property boom fizzled and the council was, at best, out of its depth. Cayford warns that Auckland's long-term balance sheets also assume high growth - risking revenue problems if growth slows or if interest rates go sky-high.

So borrowing's not so bad then?

Councils argue raising debt to finance major long-life assets such as roads and water pipes is fine because repayments can be spread over the generations who will use them. But interest on borrowing soon filters on to rates bills - and many ratepayers are already struggling with big increases. Too much debt can shackle future generations and the risks include higher interest rates, declining migration and ageing population.

Local government experts including McKinlay argue that residents might accept rates rises if councils did better at explaining the need for them and bringing ratepayers on board. He cites an Australian council which gained approval for 10 per cent rates rises in seven consecutive years. McKinlay says tighter Government requirements have reduced councils' flexibility - they need freedom to be more creative.

What are the constraints?

In the past decade, high rates rises generated a ratepayer backlash and election upheavals. Train-wreck debt blowouts such as Kaipara and Queenstown didn't help councils' reputation for fiscal discipline. A 2007 rates inquiry concluded most councils gave good value for money and could in fact borrow more to ease the burden on ratepayers. But 2008 and the global financial crisis ushered in a National-Act Government with an agenda to minimise council costs and spending.

Reforms that kick in this year include benchmarking rates and debt against affordability, financial transparency and restrictions on development levies. Debt repayments, including interest, must not exceed 10 per cent of operating revenue for small councils and 15 per cent for fast-growing councils. Auckland's ratio will reach 13.6 per cent in 2021, leaving little wriggle room for further borrowing.

Where does this leave councils?

Local Government NZ president Lawrence Yule says rural councils such as Wairarapa face real problems upgrading wastewater systems and water supply for small, scattered settlements. While there's scope to share services, many have a shrinking rating base as the population drifts north. Yule says council debt is still within accepted norms and property rates are not yet a broken model "but it's doubtful rates will be able to cut it, going forward".

Many assets built in the 1960s are due for replacement; the agency's review will pinpoint future infrastructure costs and the cost drivers. "We are just trying to signal that current realities with rates are quite constraining compared to the infrastructure costs councils face."

Local body financial commentator Larry Mitchell - about to release his annual "league tables" of council financial performance - says significant debt rises have a big impact on his rankings. Mitchell says several councils are approaching prudent borrowing limits, with debt per ratepayer at over $10,000. Many also have a "huge gap" in their financial reporting - with asset maintenance and renewal costs not appearing on their balance sheets.

Northern councils red-flagged by Mitchell this year include Western Bay of Plenty, Hamilton, Rotorua, Kawerau and Kaipara. Local Government NZ disputes his methodology (and harrumphs at comparing councils) and he concedes his rankings tend to favour no-frills, low-debt councils. But Local Government Funding Agency figures confirm that Hamilton, Tauranga, Western BOP and Rotorua are dicing with high net debt/total revenue ratios which make lenders nervous (and can lead to higher interest charges) - though the agency stresses none are in breach of its criteria.

Isn't Auckland a special case?

Auckland's operating revenues mean it will always have enough to repay loans and fund depreciation, says chief finance officer Andrew McKenzie. The council is rated safer than the bank by ratings agencies - though that's because it can rate the socks off people if it has to. Rates make up only 43 per cent of council revenues (some councils depend on rates for 70 per cent to 80 per cent of income). It rakes in millions each year in separately-levied water and wastewater charges, building consents, parking charges and fines, and dividends from its airport and port ownerships.

But it is already approaching the Government's borrowing limits and its strategy assumes continued high population growth and manageable interest rates.

Shouldn't Aucklanders just accept higher rates?

After the last decade - but largely because of skyrocketing property values - any relief is welcome respite for lower income-earners and homeowners with huge mortgages. But it's arguable the mayor is creating a bigger rates headache down the line by not building up reserves for future projects.

The current 10-year plan flagged rates rises averaging 4.9 per cent until 2022 - the lower rises we've seen mean a shortfall in rates revenue.

For 2015/16, the council needs to find savings of $30 million to achieve a 4.9 per cent rate increase.

Current projections show the annual revenue shortfall rising to $119 million in 2022.

Last year, Brown's consensus-building group found that an annual 0.5 per cent to 0.6 per cent increase in rates would raise $7.5 million in the first year but the gains would compound to $60 million by year six.

But Brown claims he needs public "buy-in" (through the long-term plan review) before adopting such measures as a transport levy.

"The clear [public] view is that rates around the rate of inflation are reasonable but beyond that they really struggle with it."

Where does this leave the City Rail Link?

Brown wants a start on his "transformational"inner-city underground loop brought forward to 2016.

But the 2012-22 long-term plan earmarks just $83 million from rates for the $2.8 billion project. Quicker funding from the Government [$1.2 billion is sought] depends on a big boost in suburban rail patronage from electrification.

Other assumptions in the LTP include $129 million raised from development levies and $344 million from "alternative funding sources".

However, the Government's reforms have cast considerable doubt on the amount that can be raised in developer contributions (at least upfront), while National's wariness of congestion charges means such alternatives as these may be years away.

Aucklanders dig deeper to pay council

Auckland's soaring property market means rates bills are no longer a flash in the pan. When water and wastewater charges are thrown in, the average homeowner in Auckland now pays $3000 a year to council, about $60 a week, and many households pay upwards of $4000.

In its first three years, the single Auckland Council officially raised total rates income by 3.9 per cent, 3.4 per cent and 2.9 per cent. For 2014/15, Mayor Brown is seeking an additional 2.5 per cent (though 3.5 per cent more from the residential sector as part of his policy to reduce the "differential" charge on commercial ratepayers - who this year will pay no extra).

But the double whammy of the introduction of a single rating system and property revaluations in 2011 have made the official rates rise meaningless for many: in high-demand areas where property values rose above the norm, double-digit increases are the reality. Rates on an average Kingsland villa (2011 valuation $750,000) increased 60 per cent in the first three years of the single council, from $1800 to $2900 (excluding water bills). The council eased the "transition" with a three-year phase-in, capping increases at 10 per cent. It concludes in 2014/15 - just in time for this year's revaluation to kick-in - powered by an even hotter property market.

- NZ Herald

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