Part 3: Trends in financial information in the LTCCPs

Matters arising from the 2009-19 long-term council community plans.

3.1
In this Part, we discuss the main financial trends projected in the 2009-19 LTCCPs. We discuss:

3.2
This Part primarily focuses on the trends emerging from the combined data drawn from the LTCCPs of all 85 local authorities. However, it is important to remain aware of the broad and varying range of circumstances, contexts, and community preferences that affect each individual local authority and the decisions that it makes, particularly for forecast rate levels and use of debt.

Summary of our findings

3.3
Total rates are forecast to increase during the 2009-19 period. However, local authorities appear to be holding rates at the same proportion of total income as they forecast in the 2006-16 LTCCPs.

3.4
The 2009-19 LTCCPs show increasing debt. Local authorities are planning to have much higher debt levels, and pay more to service those debts, so they can develop and maintain their infrastructure.

Department of Internal Affairs' financial analysis of the 2009-19 LTCCPs

3.5
In 2009, the Department collated and analysed the financial information included in local authorities' 2009-19 Statements of Proposal. In May 2009, the Department presented the Minister of Local Government with the results of this high-level analysis (which included its observations on non-financial matters). The Department then analysed the financial information included in the final 2009-19 LTCCPs. The findings from all the Department's analysis of, and observations on, the 2009-19 LTCCPs were made publicly available as part of the Local Government Information Series.6

3.6
The Department also made the financial information it used available to us for further analysis. The Department's review provides extensive information. Therefore, we do not intend to revisit the Department's work. Instead, we encourage readers to access the Department's analysis and use it to complement our analysis and observations.

3.7
Our financial overview focuses on trends in local authorities' financial forecasts, proposed rate levels, and the effect of their proposed use of increased debt. We focus on these matters because we consider that these were the most significant matters arising from the Department's analysis and our audits of the 2009-19 LTCCPs.

Summary of trends in the financial forecasts

3.8
The following is our summary of significant trends in the financial forecasts presented in the final 2009-19 LTCCPs:

  • total rates income is forecast to increase from $3.9 billion in 2008/097 to $6.5 billion in 2018/19 (up 68%);
  • local authorities expect to collect $4 billion in development contributions and $11.2 billion in subsidies during the 10-year period8 of the 2009-19 LTCCPs, reflecting 3% and 9% of total income respectively;
  • surpluses are forecast to increase from $3.2 billion in 2009/10 to $4.6 billion in 2018/19 (up 44%);
  • overall (from 2009/10 to 2018/19), equity increases by more than 36% to $127.5 billion;9
  • investment in property, plant, and equipment is forecast to increase to $131.1 billion in 2018/19, an increase of 38% from 2009/10 estimates;
  • debt increases from $5.9 billion (estimated in the 2008/09 annual plans) to $10.8 billion (up 82%) in 2018/19;
  • total interest expense incurred during the period of the 2009-19 LTCCPs is $6.7 billion, with the interest expense forecast for 2018/19 being 91% higher than in 2009/10, reflecting the increase in debt; and
  • capital expenditure is forecast to be $31.4 billion in the 10 years from 2009/10 to 2018/19, and the annual depreciation expense is forecast to be 56% higher in 2018/19 than in 2009/10, reflecting this additional capital expenditure and periodic asset revaluations.

Forecast increases in rate levels

3.9
The LTCCPs show that total rates are forecast to continue to increase during the 2009-19 period. The lowest levels of rate increases occur mainly towards the end of the 10-year period. However, local authorities appear to be holding rates at the same proportion of total income as they forecast in the 2006-16 LTCCPs. The proportion of rates to total income was 59%10 at the end of the 2006-16 LTCCPs and is 58% at the end of the 2009-19 LTCCPs.

3.10
In the 2009-19 period, the year-on-year increase in total rates range from 4.04% for the lowest increase to 7.2% for the highest increase. This shows that rates, at the overall consolidated sector level, are forecast to increase by more than the anticipated increase in the Consumer Price Index (the CPI).11 We note that within the sector, some local authorities have made a policy decision to cap rate increases at, or below, CPI levels.

3.11
Overall, total rates are forecast to increase from 53% to 58% as a proportion of total income during the 10 years of the 2009-19 LTCCPs. At a consolidated level, rates increases do not vary much between metropolitan, provincial, rural, and regional local authorities.12 At 2019, the range across these four types of local authorities shows that 55% to 60% of total income is sourced from rates. District councils in provincial locations will obtain 60% of their revenue from rates in 2018/19, 6% higher than in 2009/10. Regional councils will obtain 55% of their revenue from rates in 2018/19, a 9% increase on 2009/10. The increase between 2009/10 and 2018/19 in the proportion of rates to total income ranges from 4% to 9% for the four types of local authorities.

3.12
Overall, the level of total rates as a proportion of total income still varies widely among local authorities. For example, there are several local authorities that have forecast rates to be up to 80% of total income in 2018/19. However, at the other end of the spectrum, there are several local authorities that have forecast rates to be as low as 39% of total income in 2018/19. These differences again emphasise the effect of the widely varying circumstances of local authorities. Those local authorities with lower total rates levels, in most cases, have significant additional sources of income from owning profit-making subsidiaries.

3.13
Given the forecasts for infrastructure renewal, replacement, and development needs in the 2009-19 period, local authorities' funding needs are extensive. Local authorities that are forecasting that they will be holding rates at about the same proportion of total income are moving away from relying on rates to meet growing funding needs. Instead, they are looking to use other sources of funding, particularly debt.

Increasing use of debt

Increasing use of debt is reflected in the 2009-19 LTCCPs

3.14
The 2009-19 LTCCPs are characterised by an increasing use of debt. This trend has been evident throughout the local government sector since 2004. The increase between 2009/10 and 2018/19 is $3.9 billion, a 55% increase to a closing balance of $10.8 billion. In 2015/16, debt is forecast to reach the highest level overall, peaking at $11.2 billion. Rural district councils are planning to reach their peak level of debt a year earlier. The peak occurs later for metropolitan and regional councils. Collectively, they will reach peak levels of debt in 2016/17.

3.15
Although total debt is clearly very significant for local authorities in dollar terms, and the increases are large during the period of the 2009-19 LTCCPs, the effects are not so large when considered in the context of local authorities' overall balance sheets, and annual revenues and expenses. Total property, plant, and equipment purchases forecast for the period of the 2009-19 LTCCPs are $31.4 billion, bringing local authorities' total assets to $131.1 billion in 2018/19. Debt as a percentage of total assets is forecast to move from 7.4% in 2009/10, peak at 9.5% in 2014/15, and fall to 8.3% in 2018/19.

3.16
For regional councils, the increase in debt level is much higher, at 77%. However, we note that most regional councils have very low levels of debt in 2009/10. The increase in debt for rural district councils is much lower, at only 16%, which indicates an ongoing reluctance to use debt as a source of funding. Rural district councils, with smaller communities and less infrastructure, are also less likely to need debt as an additional source of funds.

3.17
The average increase of debt for each rural district council between 2009/10 and 2018/19 is $2.1 million, compared with an average increase of $38.9 million for the provincial district councils, and $45.5 million for all local authorities. The lower levels of debt increase in the rural part of the sector are also likely to be linked to low or negative population growth rates.

3.18
The highest level of annual borrowing is forecast to occur in 2010/11, which aligns with the year of the greatest asset purchases. In 2010/11, $3.7 billion is forecast to be spent on purchasing property, plant, and equipment and $2 billion is borrowed to help fund these purchases. Overall, from 2016/17, local authorities are expected to be in a position where, annually, the level of debt repayment is greater than the amount of new debt being taken on.13

Borrowing costs

3.19
The cost of borrowing to local authorities amounts to $6.7 billion during the 2009-19 period. This reflects a 109% increase in the annual interest expense compared with that estimated in the 2008/09 annual plans. This shows not only that local authorities are forecasting an increase in the amount of debt (55% more in 2018/19 than in 2009/10) but also that they are factoring increased interest rate levels into the expense estimates.

3.20
For all local authorities, interest expense as a proportion of total expenditure is 8.0% and as a proportion of total income is 7.0%. Interest expense is forecast to increase from 9.7% of rates revenue in 2009/10 to 11.8% in 2018/19. We do not consider that this level of interest expense for the sector is high or poses a likely risk of compromising the prudence with which local authorities are managing community assets. At these levels, interest expense is well within the standard policy limits usually set by the sector.

Implications of increasing debt on financial prudence

3.21
The debt levels included in local authorities' forecasts were (with the exception of Dunedin City Council) aligned with the borrowing limits established in their liability management policies. However, a number of local authorities increased their borrowing limits as part of the changes made to the LTCCPs through the consultation process. This reflects that local authorities are identifying the need, and increasing their preparedness, to take on greater levels of debt.

3.22
In general, where local authorities have specified their debt limits, interest expense is often limited to 20% of operating revenue and debt is often limited to 250% of operating revenue. These limits are established by each individual local authority. There are no limits established in legislation and prudence needs to be assessed in the context of the individual circumstances of each local authority.

Some examples of the effect of debt on financial prudence

3.23
During the 2009-19 LTCCP audits, we carefully considered each local authority's forecast debt levels and the effect of these debt levels on financial prudence.14 Local authorities and auditors had to place greater emphasis on assessing risk related to financial prudence because of the recessionary environment.

3.24
In two cases – Tauranga City Council and Queenstown Lakes District Council – our consideration, in conjunction with the financial position of the local authority, resulted in our issuing qualified audit opinions. Those qualified audit opinions alerted the reader of the LTCCP about prudence issues primarily related to the level of debt forecast in the LTCCP.

Tauranga City Council

3.25
As a result of Tauranga City Council's consultation process, the draft financial forecasts were revised and the audit qualification that was issued on the Council's Statement of Proposal was removed for the final LTCCP. The Council's forecast debt levels remain high, peaking in 2011/12 at 13% of total assets and falling to 7.4% in 2018/19. In the 2009-19 period, interest is 16% of total expenditure, 10% of total income, and 21% of rates revenue. The extent of the city's growth and the resulting need to develop new infrastructure significantly affect the Council's borrowing needs.

Queenstown-Lakes District Council

3.26
Queenstown-Lakes District Council was unable to resolve its funding issues, and we maintained the audit qualification on the Statement of Proposal for the final LTCCP. The Council is affected by the need for significant infrastructure renewal and new development to respond to the district's growth. The Council signalled in its LTCCP that it did not have enough funding sources available to it to fund the capital expenditure needed for the 2009-19 period. The financial projections in the Council's LTCCP reflect the borrowing needed to match the capital programme. However, the Council has clearly stated that the debt level is not a realistic proposition, and that it will review the funding strategy and capital programme before starting the 2012-22 LTCCP process.

3.27
In the Council's final LTCCP, interest is 14% of total expenditure for the 2009-19 period, 11% of total income, and 22% of rates revenue. The Council's debt as a proportion of total assets is expected to continue to grow during the 10-year period. At 2009/10, it is 12.4% and reaches 23.5% by 2018/19. Although debt repayments occur in the 2009-19 period, the net borrowing position is forecast to peak in 2013/14 when the net debt position increases by $67 million.

3.28
The amount of debt repayments consistently increases from 2015/16 onwards, but the Council remains a net borrower through to the end of 2018/19. The interest expense as a proportion of rates reaches its highest level of 29.5% in 2018/19. These ratios are significantly above the levels generally seen in the sector.

Causes for the growing use of debt funding

3.29
Local authorities use debt as a funding source for acquiring long-life assets, which helps to provide equity between generations of ratepayers. Generally, local authorities should not use debt to fund operational expenditure. A review of the consolidated cash flow statements of local authorities as presented in the LTCCPs shows that, in 2009/10, debt will fund 57.4% of asset purchases. This falls to 27.2% by 2018/19.

3.30
This shows the reducing proportion of asset purchases funded through debt towards the end of the LTCCP period. The reduction occurs in the context of a minimal decrease in the actual dollar value of asset purchases occurring each year. This reinforces the general preference indicated by local authorities to use debt funding as a last resort rather than to routinely fund asset purchases.

3.31
It appears that part of the reason for the reduction in the proportion of debt funding used towards the end of the 2009-19 LTCCP period relates to the increased levels of monetary assets held by local authorities. Monetary assets are 22% higher in 2018/19 than in 2009/10. The build-up of monetary assets probably reflects the build-up of funds from rates as a result of "funding of depreciation". These funds are collected and then become available for asset renewals and debt repayment.

3.32
Asset purchases use 49% of operating cash flows in 2009/10, but this drops to 29% at the end of the 2009-19 LTCCP period. As noted above, the levels of debt funding also begin to drop during that time (debt to asset ratios peak at 9.5% in 2014/15 and fall to 8.3% in 2018/19). This seems to support the observation that debt is mainly being used to fund specific projects that are needed in the earlier part of the LTCCP period. This is further supported by evidence that, towards the end of the LTCCP period, the net debt position each year shows that repayments are greater than the level of new debt.

3.33
The specific, one-off peak in asset purchases during the 2009-19 period is strongly related to water supply upgrade projects. These projects are often part of work that local authorities are carrying out to comply with the requirements of the revised Drinking Water Standards. Other contributors are previously deferred renewal and growth-related infrastructure development projects, and community facility projects (such as building and upgrading facilities for the 2011 Rugby World Cup).

3.34
There remains a risk that the reason these debt trends reduce towards the end of the LTCCP period is that the LTCCP forecasts become increasingly inaccurate towards the end of the LTCCP period. Although the later years of the forecasts will always tend to be less accurate, known projects, such as the water and facilities projects, in the earlier part of the LTCCP period also explain the trend of reducing debt. When the LTCCPs were completed, the revised Drinking Water Standards were a significant one-off infrastructure upgrade required by legislation. We would expect such a legislative requirement to create an expenditure peak because it is not cyclical expenditure.

3.35
The improvements in long-term planning that have occurred in the sector are also bringing to light, for many local authorities, where assets have been inadequately managed in the past. As a result, some local authorities are addressing deferred capital projects. This is also contributing to a non-cyclical peak in the 2009-19 planning period.

Some examples of the effects of specific projects on debt

3.36
The 2009-19 LTCCPs provide a number of notable examples of specific projects that affect the debt situation for individual local authorities. Grey District Council and Dunedin City Council have significant major projects that they are funding by debt.

Grey District Council

3.37
Grey District Council received a non-standard audit opinion (an emphasis of matter paragraph) highlighting the disclosures the Council made about its financial strategy. The disclosures focus on the Council's financial strategy and its decision not to fully fund depreciation throughout the LTCCP period because of the Council's decision to prioritise maintaining levels of service and to have rate increases no greater than the rate of inflation.15

3.38
Although the ratios of interest expense to expenditure, income, and rates are similar to the trends throughout the sector, we note that the Council has moved from a position of very low use of debt financing in the recent past. During the period of the Council's 2009-19 LTCCP, debt is forecast to increase by 115% and interest expense by 184% – both well above the increases seen in the sector as a whole.

3.39
The Council has disclosed that the most significant implication of this strategy of not fully funding depreciation is that it will not have funds available for future asset replacements. Therefore, when such replacements are necessary, increasing the use of debt could become unsustainable. The only alternative then is to increase rates very significantly. Even though it can see the implications, the Council was not prepared to increase its forecast rates or debt position to higher levels.

3.40
The Council's current significant capital expenditure project is the sewerage stormwater separation project. The Council has not made any allowance in its LTCCP for upgrades to water supplies needed to meet the revised Drinking Water Standards, because it considered the cost of the required upgrades unaffordable for the community. This approach will mean levels of service for this community will not increase in line with others around the country, because the Council's water supplies will not be upgraded.

Dunedin City Council

3.41
Another interesting example is Dunedin City Council, which has been significantly affected by its involvement in building a new stadium. To construct this facility, the Council had to take on significant levels of debt during the 2007-11 period. The Council's level of debt is expected to increase by 226% between 2006/07 and 2010/11, with interest expenses forecast to increase by 254% from 2006/07 to 2013/14, when interest costs are forecast to peak.

3.42
As well as the stadium project, the Council also has other capital projects (such as the central city redevelopment and development of a secondary sewerage treatment system) in progress during the 2009-19 LTCCP period. As a result, the Council is expecting to breach a number of its own liability management policy limits in the mid-years of the 2009-19 LTCCP period, when the debt levels are at their highest.

3.43
The Council provides a robust explanation of its financial position in the financial overview section of its LTCCP. This includes a "warning" to the community that significant rate increases will be required to bring the ratios back within the policy limits.16 Given the financial position that the Council is in, it is clear that there is little scope for any unexpected core infrastructure capital projects to be accommodated within the 2009-19 LTCCP period or the years immediately following.

Our observations

3.44
The examples of Grey District Council and Dunedin City Council provided above show the pressures – into the medium to long term – that can result from using debt as a funding source. These examples also show that, for most local authorities, it is essential to use debt to develop infrastructure. The examples of Tauranga City Council and Queenstown-Lakes District Council show the cases where financial prudence issues are apparent in the more immediate future. These examples show that the challenges related to financial prudence are likely to become more widespread.

3.45
The cost of infrastructure assets is the main cause of increasing debt levels. We also note that, despite the increased use of debt and the continuing trend of year-on-year rate increases, some local authorities are still having to defer capital expenditure. Some local authorities are managing this by agreeing with the community to reduce some levels of service, while others are maintaining levels of service but extending maintenance periods to limit the costs incurred.

3.46
We consider that, for some essential infrastructure, reducing levels of service or extending maintenance periods is probably not viable in the long term. For good asset management, local authorities should follow renewal and maintenance plans that are optimal for the community. If good asset management practices are not followed, some risk arises that essential services will operate below the community's expectation in the future.

3.47
We also note that, where local authorities have capped rates increases at or below the CPI, debt becomes necessary if levels of service are to be maintained. This is because costs continue to increase over time. Local authorities will not be able to continue to deliver levels of service that meet the communities' expectations if debt is not used as a funding source.

3.48
There appears to be an effective self-imposed limit to the level of rates, which is shown by the ratio of rates as a proportion of total income staying relatively stable. Currently, local authorities do not seek more than about 60% of annual income (funding needs) directly from ratepayers except in rare situations. It appears that, once this level is reached, most local authorities move to other sources of income to fill the funding gap to maintain levels of service.

6: The Department's report, Observations and Trends from 2009/19 Long-Term Council Community Plans, was published as part of the Local Government Information Series (LGIS 2009/15) and is available at www.localcouncils.govt.nz.

7: The 2008/09 rates information was collated from the 2008/09 annual plans of all local authorities. The 2009-19 LTCCPs were not required to include comparative information for the 2008/09 year, so this was not included in many instances. The increase in rates between 2009/10 and 2018/19 is $2.4 billion (58%).

8: All other opening figures are 2009/10 figures from 2009-19 LTCCPs.

9: Balances for equity and property, plant, and equipment are both affected by the revaluation of property, plant, and equipment.

10: Matters arising from the 2006-16 Long-Term Council Community Plans, page 27, paragraph 3.21.

11: Increases in rates are often compared with the movement in the CPI. The CPI is heavily weighted to household goods, such as food and alcoholic beverages. No specific local government index has been established at present. However, the Producer Price Index and the subgroup of the Capital Goods Index for pipelines and transport ways may be better indicators. These have increased significantly more than the CPI in recent years.

12: The Department's analysis used these four types of local authorities. We do not use these categories in other Parts of this report, but found the Department's approach useful for our financial review.

13: For example, in 2018/19 local authorities plan to borrow $858 million and repay just over $1 billion, resulting in a net debt decrease of just over $200 million, compared to the net debt increase in 2009/10 of $1.5 billion, which is the year where the net debt increase is the highest in the 2009-19 period.

14: Section 101(1) of the Act requires local authorities to manage their activities prudently.

15: Grey District Council, Long-Term Council Community Plan, Volume 1, page 22.

16: Dunedin City Council, Community Plan 2009/10 – 2018/19, Volume One, pages 20-23.

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