Part 1: Financial results and trends
1.1
In this Part, we consider the financial results for local authorities for 2016/17. We are interested in how local authorities performed compared to what they planned and budgeted for and whether they prudently managed their debt.
1.2
In completing our analysis, we wanted to answer the following questions:
- Are local authorities maintaining their budget commitments to invest in their assets?
- Are local authorities adequately reinvesting in their assets?
- Did local authorities spend what they planned to on their operations?
- Did local authorities collect the revenue they expected to?
- Did local authorities prudently manage their debt?
1.3
Except for Auckland Council, we have used parent-only results. We analysed the group results for Auckland Council because it produces a group budget in its long-term plan and we wanted to compare the actual 2016/17 information with the budget.
Are local authorities maintaining their budget commitments to invest in their assets?
1.4
Most local authorities did not spend as much on their assets as they had planned. In 2016/17, local authorities' capital expenditure was $3.8 billion, which was about 78% of the $4.8 billion budgeted.1,2 Although this is an improvement on the 2015/16 results, where local authorities spent about 70% of what they budgeted, local authorities continue to spend less on their assets than they had planned. We have observed and reported on this in previous years.
1.5
As Figure 1 shows, since 2012/13, most local authorities have spent less than 80% of their capital expenditure budget.
Figure 1
Local authorities categorised by actual capital expenditure as a percentage of their budgeted capital expenditure, 2012/13 to 2016/17
1.6
Auckland Council had the largest variance to budget ($403 million), spending 79% of the $1.9 billion budgeted. Auckland Council reported that this is mainly because of project delays and deferrals. Project delays primarily occur when a project's planning and design phase takes longer than expected. Many other local authorities that underspent on their capital expenditure reported similar reasons to Auckland Council.
1.7
The financial information alone does not tell us whether the ongoing underspending affects the quality of local authorities' service delivery. We comment further on this point in paragraphs 7.49-7.52, noting that underspending can be because of budgeting inaccuracies as well as, or instead of, performance issues.
Do these capital expenditure trends differ for major infrastructural assets?
1.8
Local authorities are responsible for owning and managing the following main groups of infrastructure assets:
- water supply;
- sewerage;
- stormwater drainage;
- flood protection; and
- roading and footpaths.
1.9
As in previous years, we collected and analysed the capital expenditure information that was disclosed in the funding impact statements for 2016/17. Capital expenditure has to be disclosed in one of the following three categories:
- expenditure for new assets to meet additional demand;
- expenditure to improve levels of service; and
- expenditure to replace or renew existing assets.
1.10
As shown in Figure 2, spending remains generally below budget, which is consistent with our previous findings.3 This is especially the case for the water supply and flood protection infrastructure assets. The flood protection underspending is affected by the results from Christchurch City Council. Its original 2015-25 long-term plan budget was substantially reduced for the 2016/17 annual plan because of revised timelines for post-earthquake flood protection works.
1.11
As we have reported in the past, if local authorities continue to underinvest in their assets they might not be able to maintain service levels in the future. We comment further on this point in paragraphs 7.49-7.52.
1.12
Figure 2 shows three areas where the actual spending was significantly greater than budgeted. In each of these areas, one local authority spent significantly more than it budgeted, heavily influencing the results. Christchurch City Council spent about $114 million more on sewerage (renewal and replacement) and $40 million more on stormwater drainage (renewal and replacement) than budgeted. Both of these were to complete earthquake-recovery work.
1.13
Auckland Council spent $23 million more on stormwater drainage (additional demand) than budgeted. This was because projects progressed ahead of schedule. If we exclude the significant additional spending by Christchurch City Council and Auckland Council, the actual spending against budget for these three areas would be between 93% and 108% of what was budgeted.
Figure 2
Core activity funding impact statements – total actual capital expenditure and variances to budgeted capital expenditure
| Capital expenditure types | Additional demand | Improve level of service | Renewal and replacement | |
|---|---|---|---|---|
| Water supply | Actual capital expenditure | $117.9m | $117.1m | $149.0m |
| % of budget spent | 86% | 74% | 65% | |
| Sewerage | Actual capital expenditure | $178.2m | $111.5m | $393.6m |
| % of budget spent | 69% | 88% | 131% | |
| Stormwater drainage | Actual capital expenditure | $85.1m | $63.5m | $132.4m |
| % of budget spent | 139% | 108% | 146% | |
| Flood protection | Actual capital expenditure | $6.8m | $40.3m | $15.5m |
| % of budget spent | 58% | 98% | 30% | |
| Roading and footpaths | Actual capital expenditure | $106.4m | $313.2m | $825.3m |
| % of budget spent | 66% | 92% | 111% | |
Are local authorities adequately reinvesting in their assets?
1.14
In previous years, we have outlined our concern that local authorities might not be adequately reinvesting in their assets.4 After our analysis of the 2016/17 results, those concerns remain.
1.15
To consider how local authorities are reinvesting in their assets, we compared renewal and replacement capital expenditure to depreciation. We consider depreciation to be the best estimate of what portion of the asset was used during the financial year (see Figure 3).
1.16
Comparing renewal and replacement capital expenditure to depreciation shows that, for most local authorities, asset reinvestment was less than 100% of depreciation. These results might indicate that the quality of the assets is deteriorating. If nothing changes, the cost of maintaining service levels might fall on future generations.
1.17
Since 2013/14, there has been an increase in the number of local authorities with expenditure on renewals and replacement that is more than 100% of depreciation. This increase is largely because some local authorities are completing large, one-off renewal projects.
1.18
In the last year, there was no change in the number of local authorities (28) whose renewal and replacement capital expenditure was less than 60% of depreciation. Fewer local authorities are within the reasonable achievement range of between 60% and 100% of depreciation. However, there are only three local authorities whose renewal and replacement capital expenditure has been consistently more than 100% of depreciation in each year since 2012/13. We remain concerned that local authorities are not adequately investing in their assets.
Figure 3
Local authoriries categorised by renewal and replacement capital expenditure as a percentage of depreciation, 2012/13 to 2016/17
1.19
This calculation (expenditure on asset renewals and replacements compared to depreciation) indicates only whether the expenditure is enough to maintain existing assets. We urge individual local authorities to continue considering whether they are adequately maintaining their assets. They need to take into account their circumstances and look at this calculation in more detail to provide assurance to their communities. We comment further on this point in paragraphs 7.49-7.52.
Did local authorities spend what they planned to on their operations?
1.20
In 2016/17, total operating expenditure for local authorities was $10.6 billion. This was 5.8% more than the $10 billion that was budgeted and $100 million more than the operating expenditure in 2015/16. Fifty-seven local authorities spent more than they had budgeted. Five local authorities spent 25% more than they had budgeted.
1.21
From our analysis, there were no consistent reasons why expenditure was higher than budgeted.
1.22
Christchurch City Council had the largest variance to budget, with operating expenditure that was $157 million more than the $715 million budgeted. Of this variance, $56 million related to projects that were treated as operational but had originally, and reasonably, been budgeted as capital expenditure. An additional $46 million related to losses on the disposal of assets. Items such as disposals of assets can be difficult to budget for or control. The remainder of the variance is made up of several minor factors.
1.23
The two largest percentage increases in operational expenditure from budget were Hurunui District Council ($23 million or 61% more than budget) and Kaikōura District Council ($15 million or 165% more than budget). Both local authorities incurred more expenditure as a result of the November 2016 earthquake. The expenditure related to emergency repair and recovery expenditure and the impairment of assets damaged in the earthquake.
Did local authorities collect the revenue they expected to?
1.24
In 2016/17, local authorities received more revenue than they budgeted for. For key revenue sources such as rates and subsidies and grants, local authorities received what they expected. However, for development and financial contributions and user charges, they received more revenue than expected.
1.25
In 2016/17, local authorities recorded operational revenue of $12.1 billion. This was 12.5% more than the $10.8 billion that was budgeted and about $1 billion more than revenue recorded in 2015/16. Sixty-six local authorities recorded more revenue than budgeted, with seven local authorities recording over 25% more revenue than budgeted.
1.26
As shown in Figure 4, "rates" remained the main source of revenue, at 47% of total revenue. Revenue from rates was also similar to what was budgeted. Local authorities recorded significantly more revenue from "development and financial contributions" and "other operating revenue".
Figure 4
Local authorities' operating revenue, by type
| Key revenue sources | 2016/17 actual revenue amount $ million | 2016/17 budgeted revenue amount $ million | Percentage over budget |
|---|---|---|---|
| Rates | 5,653 | 5,638 | 0.3% |
| Subsidies and grants | 1,414 | 1,364 | 3.7% |
| Development and financial contributions | 381 | 288 | 32.5% |
| Other operating revenue | 4,685 | 3,491 | 34.2% |
1.27
Development and financial contributions depend on the growth in a city, district, or region and are, as a result, difficult to budget for.
1.28
Other operating revenue is made up of:
- investments, such as interest and dividend income;
- user charges, which are fees local authorities charge for a variety of activities, including building and resource consent processes, dog licensing, and food premises licensing;
- vested assets, which represent the value of assets donated by others to local authorities (this is a non-cash revenue source); and
- fair value gains on financial assets and liabilities, and other assets such as investment property (this is a non-cash revenue source).
1.29
Factors outside a local authority's control, such as changes to growth, interest rates, or the property market, can significantly influence revenue sources. Auckland Council had the largest dollar variance to budget, receiving $516 million more revenue than the $4 billion that was budgeted.5 Of this variance, $459 million was from the net movement in the fair value of financial assets and financial liabilities, and more vested assets received than expected.
1.30
Many of the local authorities that recorded significant increases in revenue were also affected by fair value movements and received higher than expected vested assets.
1.31
Several local authorities recorded significant revenue as a result of natural disasters, such as earthquakes, flooding, or fire, which were needed and used to cover the cost of the natural disaster, including the reinstatement of damaged assets. For example, Kaikōura District Council received $16.4 million in grant revenue and advances from insurers. This is more than Kaikōura District Council's total budgeted revenue for 2016/17 ($8.8 million).
Did local authorities prudently manage their debt?
1.32
Many local authorities use debt to fund long-life assets. As a general principle, debt should not be used to fund operations. Furthermore, local authorities usually use debt to fund new assets to meet demand or to increase levels of service, rather than to fund renewals.
1.33
However, local authorities can choose to use debt to fund any type of capital expenditure. Because many local authorities do not spend all of their capital expenditure budgets, we are not surprised that local authority debt was less than budgeted.
1.34
Overall, local authorities continue to manage their debt prudently. Fewer local authorities than in previous years face financing costs that are greater than 15% of their rates revenue.6 Only one local authority is breaching its debt-servicing benchmark (see paragraph 1.44).
1.35
Local authorities had $15 billion of debt at 30 June 2017, which was 5% or $0.8 billion less than budgeted, but $1.4 billion more than at 30 June 2016.
1.36
Not all local authorities carry debt. At 30 June 2017, 11 local authorities had no debt. Five of these were regional councils. Ten of these local authorities had budgeted to have no debt.
1.37
Auckland Council recorded the most debt at 30 June 2017 and made up about 55% of total local authority debt. Although Auckland Council had the largest increase in debt of all the local authorities, up $689 million from the previous year, debt was $466 million less than what it had budgeted.
1.38
Despite the large dollar value of Auckland Council's debt, it is operating within the parameters set in its financial strategy and maintains a high credit rating, which has reduced the cost of borrowing.
1.39
The effect of debt on local authorities is best assessed by considering the cost of servicing debt. In our view, managing financing costs that are more than 15% of rates revenue is likely to be difficult and will reduce a local authority's flexibility to respond to unexpected changes.
1.40
However, there is no specific rule on the appropriate level of such costs. It is up to individual local authorities to determine limits that they are comfortable with based on their circumstances and to disclose these in their financial strategies. Local authorities that borrow through the New Zealand Local Government Funding Agency must also comply with a set of financial covenants.
1.41
The proportion of rates revenue used to meet financing costs was 14.1% for 2016/17, which was 0.6% less than budgeted.7 The proportion is more (by 0.4%) than for 2015/16. This shows the importance of local authorities being mindful of the level of debt they hold and ensuring that they have enough forms of revenue to service it.
1.42
Four local authorities had financing costs as a proportion of rates revenue at or above 15% in 2016/17. These four local authorities budgeted for this position. We are pleased to see that this has reduced from last year, when seven local authorities were in this position. There are also two fewer local authorities that budgeted for their financing costs as a proportion of rates revenue to be at or above 15%.
1.43
Local authorities report against prudence benchmarks in keeping with the Local Government (Financial Reporting and Prudence) Regulations 2014. These include three types of benchmarks related to debt:
- debt affordability benchmark;
- debt servicing benchmark; and
- debt control benchmark.
1.44
The four local authorities that had higher financing costs as a proportion of rates revenue all reported that they met their debt affordability and debt control benchmarks in 2016/17. However, one local authority reported that it did not meet its debt servicing benchmark in 2016/17. This local authority needs to carefully monitor and manage this position.
1: This information has been extracted from the statement of cash flows of local authorities. It includes only the cash that local authorities spent on purchasing property, plant, and equipment and intangible assets.
2: When capital expenditure, as reflected in all local authorities' whole-of-council funding impact statements, is compared to budget in those statements, 81% of budgeted capital expenditure has been incurred. We consider that the difference between the 78% and the 81% is because of year-end accruals.
3: When completing the analysis included in Figure 2, we have used the "Year 2" or "2017 forecast" figures included in local authorities' 2015-25 long-term plans. Local authorities are not required to publish revised activity funding impact statements in their annual plans. Although we are using older local authority budget forecasts, we do not consider that this affects our analysis, other than as explained in paragraph 1.10. A local authority will amend its long-term plan if it plans a significant change in level of service or decides to transfer the ownership or control of a strategic asset. As noted in paragraph 7.44, there have been relatively few amendments to 2015-25 long-term plans.
4: See, for example, Office of the Auditor-General (2017), Local government: Results of the 2015/16 audits, pages 10 and 11.
5: We have included the net other gains and share of surplus in associates and joint ventures recognised by Auckland Council in our revenue analysis.
6: We have applied our judgement in using 15% in our analysis. The New Zealand Local Government Funding Agency requires local authorities to have net interest expenditure as a proportion of rates revenue of less than 20% unless they have a long-term credit rating of "A" level or higher. International practice suggests that interest costs to revenue can become challenging for a public entity to manage when they exceed 10%.
7: Finance costs have been drawn from the statements of comprehensive income. It is possible that these figures could include non-cash items. This calculation is an indication only of the pressure that debt can place on a local authority. Other sources of revenue, such as development contributions and user charges, also contribute to meeting the cost of debt.