Article: Property Investment

Credit Ratings And Self-Congratulations with Frank NewmanCredit Ratings And Self-Congratulations with Frank Newman

A recent reaffirmation of the Whangarei District Council’s AA credit rating by Standard & Poors (S&P) has been trumpeted by the Council as good news. Mayor Mai said, “It was enormously satisfying to get this level of recognition from an independent, internationally recognised agency. Their praise is not just for the way we handle money.  It is also for a range of measures we have taken to improve our operation and results for our customers… we are on a roll.”

The Mayor is being too self-congratulatory. It is good news, for those who lend money to the council, but it’s ratepayers who have paid the price.

WDC’s debt problems started as far back as 2002. That year coincided with the election of a succession of spendthrift councils and changes to the Local Government Act that mandated local councils to spend on all manner of community “well-beings”.

As a result council debt accelerated at the pace of a Formula 1 car. The consequences had become evident by 2012, and were quantified by local government economist Larry Mitchell who ranked the WDC 62 out of 67 councils and placed it on “red alert” because of its poor financial performance.  Council’s public response was to criticise Mr Mitchell and stop subscribing to his research! Privately council staff went looking for new ways to pay for their spending. At about this time S&P downgraded the council’s credit rating to AA-.

For the record, a credit rating measures the risk of an organisation defaulting on its debt repayment and interest obligations within the next five years. It exists for the sole benefit of money lenders, not ratepayers. Rating agencies typically give local government the highest credit rating because when they get into financial strife they can rate their way out of trouble, which is exactly what the WDC did, and is doing.

In the 2015 year it increased rates by 9%, and its long-term plan has rates increasing an average 4.8% a year through to 2025. The compounding effect means by 2025 ratepayers will pay 67% more than they were 10 years earlier; an annual increase double the expected growth in household income over that time.

The WDC has also engaged in a significant sell-off of its property investment portfolio. That money went into a reserve tagged for new property reinvestment - as required by council policy. But not for long. Instead of borrowing from external parties, councillors raided the $28 million reserve to fund spending.

And they have done the same with a $32 million reserve to fund water infrastructure. That reserve was built up from surpluses in the water rates account. Just over $18 million of the “reserve” is earmarked for the upgrade of the water treatment plant at Whau Valley. It is not clear what the remaining $13.7 million is for and why it has been collected. What is clear is that the surplus is now being used to fund council’s general spending.

By dipping into reserves, the council has got its hands on $67 million that would otherwise have been borrowed from money lenders and show up in the accounts as public debt. WDC staff and some councillors conveniently ignore this “internal debt” figure when reporting its debt ratios - using the external debt figure of $162m only, instead of the total debt figure of $229m. In my view that significantly understates the council’s debt position and is grossly misleading to say the least.

The graph shows the rapid escalation in total debt from 2002 to the present day.

It shows that until 2012, debt was financed largely from external sources (merchant banks essentially). In 2012 the council discovered a new revenue steam in the form of funds held in reserve.

The effect is that money that should have been used for community purposes hasn’t; money that should have been reinvested in investment property hasn’t; and more money has been collected from water users than is needed to reticulate the water and maintain the infrastructure.

By switching from external (public) to internal debt to finance its funding shortfall since 2012 the WDC has held its external debt at around $160 million, and comforted the people at Standard & Poors who in May 2016 reinstated the WDC’s AA credit rating.

The fact that the credit rating agency says the WDC is not likely to default on its debt within the next five years should be no comfort whatsoever to ratepayers. Council staff and politicians are being less than honest to suggest otherwise. The credit rating says nothing about expected rate increases within the next five years which is the real test of a council’s ability to manage its finances.

Frank Newman is the principal of Newman Property Consultancy. He is the author of numerous books on investment matters. For questions or comment about this article contact .(JavaScript must be enabled to view this email address)

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