The Realities of Council Debt Settings
“A think piece covering the dilemmas of excessive Council debt, leading to discussion of alternative means of New Zealand Local Government funding …for is the question of Council Debt not central to all LTP process?
The prominence within Council debt management processes … ranking first of all financial management matters,* suggests that the fullest appreciation, scrutiny and understanding of a Council’s debt position is the most important of issues now facing New Zealand Councils.
* Note: the cprlifesaver site https://cprlifesaver.co.nz/comparative/ specifically the data-set of “debt ratios” outnumbers all of the other financial ratio metrics. Council debt issues remain the most prominent of all financial matters within public discussions.
This paper-dissertation, accompanies and explains the cprlifesaver “Debt” segment measures and ratios of the site’s “Comparative” sections.
Authors Note: I apologise for the length of this paper but such is often the way in dealing in simple terms-with complexities. Included in this primer are explanations of standard well understood concepts and techniques. Experienced practitioners familiar with these can elect to skip lightly over them.
A balanced scrutiny of Council debt is important. It is not merely a pointy heads chatter contained in a bubble-or a forensic-clinical evaluation of the financial consequences of Council debt.
The egalitarian nature of the subject is due to its widespread influence over all Council activities.
The economic well-being objective, (the most influential of the four) must directly address the issues of debt, because any discussion of economics, introduces other-call them sociological or community consequences-for example, the affordability of debt, debt servicing, issues relating to a ratepayer’s ability to pay … which within a comprehensive Council debt assessment need to be factored into the picture.
All of the three other well-beings are going nowhere without consideration of economic constraints where arguably the most important of these is funding … using debt.
This brief paper addresses some of the wider implications of Council debt.
Note: while the cprlifesaver site-its Comparative Section- focusses on the mechanics of debt ratio financial analysis, many others such as Council demographics, density factors, expenditure mixes etc- well over 100 statistically based financial measures-ratios are reported on the site!
Each Council, will regularly, as part of its normal rolling annual, triennial and 10 year long-term planning cycles, set its targets for funding-debt raising, principally the funding for long life asset and other proposed significant capital expenditures.
On such occasions as these, the full significance of key strategic financial planning decision-making, will include consideration of all of the fundamental issues associated with debt.
Either from a zero based budgetary or a cost-plus setting, all Council plans need to build these forward projections, within boundaries of feasibility and sustainability.
Any plan that has not evolved this way or has at least been stress tested using the feasibility and sustainability cprlifesaver metrics or their equivalent may be questionable.
Note: Incidentally, within NZLG financial planning circles, recent enquiries indicate that there do not exist any equivalent alternatives for the cprlifesaverfinancial measures and ratios (“all of em” … not just for debt).
Answers to the many other typical and pervasive financial posers including rating, capex, depreciation, expenditure levels and so on … can be addressed with the use of relevant evidence- ased and statistically sound measures … enter the cprlifesaver “measures and ratios” of the site’s Comparative section.
Long Term Financial Plans … Council LTPs
The LTP financial planning process is a “no brainer candidate” for use of the IP of cprlifesaver. LTP’s invariably commence their analysis of a Council’s position by posing the axiomatic question of …
“What is our Council’s optimum, prudent and sustainable debt level, sufficient to fund our proposed expenditure plans, while still staying within all legislated and prudential and covenanted debt management boundaries?”.
This question is pivotal, it is the essential catchall factor … as all possible iterations of LTP models are confined – within funding-debt boundaries!
The essential nature of debt holds true under all planning conditions. It might have been thought that at present, with historically low interest rates prevailing, Council Debt as aan issue will have suddenly become of lesser importance.
Not so, when contemporaneously Council debt levels have “exploded”. They have quintupled from an historically and generally accepted maximum of $700 per ratepayer to over $4000 per ratepayer, all within the last decade. While interest rates may be low the nominal debt numbers-definitely are not
In addition, continuing limitations on Council funding- particularly the realpolitick pressures of funding deriving from already maxed out property rates- just add to the difficulties.
The Debt Dilemma
Council Debt will continue to remain the principal issue and constraint within any Council’s LTP and logically also for its capital expenditure budget. Hence, Debt’s ongoing and fundamental importance for all Council long term plans*.
* Developing the tools to deal with comprehensive-defensible Council financial planning challenges is the prime motivation for the effort taken to develop the analytical and forensic debt management statistical and other ratios of the cprlifesaver site!
There is much though in the Council funding process, often developed incrementally (last year plus inflation), that barely “fits where it touches”. Older cost plus LTP’s have rarely been stress tested with financial-debt analysis.
Such plans as these generally skip over issues of testing using such parameters as the “what ifs”, the “boundaries-limits” and of “best practice”.
LTP’s lacking structure-such as a failure to work the numbers within tested-feasible boundaries- generally consist of a patchwork of policies and practicessitting uncomfortably alongside competing and some incompatible objectives and constraints. Questions of affordability and sustainability the hallmarks of comprehensive-defensible Council financial planningjust never get asked in many existing LTP environments.
Another catch-up for LTP best practice has emerged. Council debt management, since the 2009 Local Government Act (LGA) financial management amendments, has become more complicated and the issues of debt, more pressing now a decade later.
The old cost plus or cherry picking of good ideas within LTP debt structuring, now require different techniques. These include asset management plan integration, treasury management, debenture deed compliance, audit coverage of the debt ratios and so on … and … in the nick of time “a life-saver” … use of the IP of the cprlifersaver!
The pace of change and growing complexity of Council debt management properly describes- the debt dilemma for Councils.
Life has gotten complex
Our standards of living and expectations of public services have lately increased enormously. In our rapidly expanding and increasingly complex national economy, Councils whilst grappling with population growth, sustainability and factors such as the effects of climate change and automation, have had added to these, complications and competing demands for added Council services.
These new or enhanced existing Council services all must be factored into the mix of workable projected LTP’s. And the pivotal questions of permissible-feasible debt levels remain… lurking beneath all LTP decisions do they not?… hardly a place for the largely untested LTP of just ten years ago.
It is axiomatic that major expenditure budgets are coupled to steadily rising borrowing levels that are subject to limiting constraints.
There are currently huge demands for catch-up (backlog) and new project (essential) capital expenditures. LTP’s designed to meet these demands involve some more radical funding platforms and schemes such is the pressure of the CAPEX planned where traditional NZ Local Government funding sources are “maxed out”.
Note: The sooner the Shand Report (2008) -Council funding alternatives-is dusted off and its key recommendations implemented … the better we all will be.
“The Cavalry”… in the form of sanctioned approvals of new forms of financing of LTP’s has yet to arrive.
Much of “The Reality” of Debt issue is that Councils, for the present, just have to-make do and work with what we have got. Many Councils labour but continue to strive to achieve best practice, despite the many challenges. The tools of the cprlifesaver are purpose- designed to support the emerging policies and process.
Councils also continue to lobby and where possible, explore alternatives to bank lending, to date with only limited application.
For instance, with the use of state backed special purpose public funding vehicles for major infrastructural capital projects can be cost-shared with Central Government. The recently established agencies- the Local Government Funding Agency and the emergence of State affiliated organisations- such as The Super Fund all bode well as likely sources of long-term infrastructure (LTP) spending.
Sound and sustainable Council long run financial decision-making under present conditions, is still a tall order in spite of these hopeful signs. Given the many parlous and unsatisfactory circumstances currently being faced by Councils for the funding of their LTP’s … though we must play what is currently in front of us … “the Cavalry had better be mighty quick about it”.
In this high-pressure arena, the dilemma includes facing numerous, mandated rules-debt limits-to be juggled and complied with.
These include those that accompany the legislation and the regulations-imposed statutory (though appropriate prudential) debt limits that constrain their freedom to operate when making LTP funding decisions.
In addition, Councils are required to adhere to well defined and customary accounting borrowing limits. These are expressed in metric terms mostly as coefficients-such as debt per ratepayer ratios-related to bases-such as property rates collected or as a proportions of total Council revenues. These benchmarks have been developed for and are tailor to the Local Government sector and as time has passed, they have developed into accepted best practice benchmarks.
Note: The cprlifesaver debt moduledata sets of this kind cover all statutory debt limits and include other debt metrics of similar Councils measured on a like with like basis-providing finer judgments and relevance of the comparative data. The five cprlifesaver Groups of debt metrics arebased, for example on scales of population and ratepayer numbers. The Groups are City, Metro, Provincial, Rural and Unitary.
There are a number of underlying considerations, using first order generally accepted principleswhich set outguidelines relevant to all Council debt planning. Together with the LGA legal requirements of Council debt all Council LTP’s-it goes without saying?-must incorporate and adhere to these boundaries and rules.
These are the accounting standards-part of the GAAP-accounting requirements and rules-modified for Council scenarios and include the following:
- The carrying depreciated value of Council tangible assets- their “values” representing unexpired or yet to be expensed costs- should have a defined relationship to the debt used to finance their acquisition.
- Thejustification for this rule is based on the notion of the preservation of inter-generational equity. For example, debt matched to asset values allows for funding over a longer period of time whereas funding from rates would unfairly impose future costs on current ratepayers.
- Long term debt should bear some appropriate, prudent and sustainable relationship to Council’s debt servicing capacity.
- Debt should be set by taking into account the remaining useful lives of the assets that are being financed. This accords with the accounting requirement to match unexpired asset costs with asset-driven future revenues.
- Council’s carrying value of its assets, representing unamortised costs, at their least must ultimately be capable of a set off with the future cash flows and revenues derived from the asset’s use.
- Expected revenues must accrue from the assets future use, sufficient to cover both surpluses –and debt servicing. This accords with the accounting requirement to properly value assets according to their value in use and revenue generating capacity.
- Legal LGA requirements now reinforce basic best practice debt limiting (maxima) rules. These define the interrelationship of asset values, depreciation reserves, debt servicing including interest and asset associated debt funding levels (maxima).
- All of these boundaries within the LTP structure, are closely controlled according to legally mandated financial planning policy settings. These include the debt ratios and prudential limits of Council Treasury Management policies- LGA 2002 as amended to 2019 … at Ss. 101 to 104. Theyare integral to all financial planning.
- Note: These legal rules are the very same financial measures to be found throughout the cprlifesaver site’s extensive “Comparative” debt module toolbox.
In accordance and in compliance with these policies, a Council’s debt will be expressed in the LTP within a range of values and will comprise the total of consolidated-group Council Total debt. Limits, specifying debt maxima and minima applying over the whole term of the planning horizon will be noted and implemented.
And the good news, these days,-a far cry from a smorgasbord of varied debt management practices which pertained before the local government sector financial management reforms of 2009 were introduced- is that now, we have been provided with a set of standardised prescribed, customised and representative debt measures to guide our financial decision-making. LGA 2002 S.101 (A), Financial Strategy at S. (3)(b) (i) … “quantified limits on borrowing”.
The merit and the representative nature of the debt benchmark measures lies in the fact that all of the measures use NZ local government-relevant specific markers-that is, widely accepted bases for debt setting, adapted to local acceptable best practice.
We now for Council LTP’s use a common set of markers- signposts*, such as Council revenues, rates, expenditures, asset values and the like.
Note: * This sector consistency- of Council TLA practice-is another “Big Up” for … Comparative financial analysis (the “C” of CPR) … as is totally adopted within the cprlifesaver IP … its measures and ratios of the Comparative Section (below).
These mandated measures, expressed as the maxima of Council debt benchmarks, are a recent and welcome addition adding to the discipline of setting Council debt levels.
Their introduction has created a uniform and comparable framework over all Councils. This has also set boundaries for debt-related financial planning … where no formal process of debt setting had previously existed.
Note: these recently introduced uniform and comparable statutory debt ratio measurements are the basis-foundation for all of the cprlifesaver site’s “Comparative” financial assessments … for all 67 NZ TLA’s and Unitarys.
The legislators and local government sector financial people had, before their introduction, debated at length (2010 to 2012) the development of the then proposed debt ratios, both as to their merits and their limitations. Council folk also fully participated in the drafting of the specifics of the measures themselves. A really good case study for the mutual support and cooperation that characterises much of what often happens in NZLG circles.
The next section of this paper is a version amended for the purposes of supporting the November 2019 SOLGM workshops.
It focusses upon LTP related issues of debt. References to the SOLGM workshop environment are incidental and have not appreciably altered the flow of the argumentation. There is some repetition of material from the first half of the paper as the second section is intended to standalone … as an LTP topic.
Long Term Plan references- the www.cprlifesaver.co.nz marketing initiative:
Authors Note: The “Comparative” section of the subscriber partitions of the cprlifesaver website- includes all of the statutory and other LTP measures- in total these number over 100 metrics. They comprise a most informative and useful set of financial and economic ratios and measures that have become a fundamental part of NZ Council financial and LTP planning. This “brief” – an extract of the November 2019 “Council Debt Realities” paper-was included in the full version to achieve a comprehensive coverage of the metrics developed in support of long-term plan (LTP) processes.
It deals principally with debt policy comparisons of the NZ Government and of NZ Councils … and of ratepayer “Affordability” issues.
It is a part of the paper that might be “skipped” by readers more interested solely in the debt questions.
One size does not fit all
In the field of long-term financial planning- “is Jack as good as his master?”
That is, is Council LTP best practice better informed by comparisons with its Central Government cousin?
In making a contrast between the two forms of government, useful comparisons of best practice for each sector are emphasised. Improvements of Council LTP process and policy emerge-as a result.
Councils have different LTP settings due to their differing scale of financial and economic circumstances, a self-evident enough statement though important to recall where within their LTP processes-due to scale differences- “one size… does not fit all”.
Currently, particularly for the many NZ Councils that have, by 2019, reached their debt maxima under the guidelines and statutory debt limits, the related issues referred to in this paper continue to create robust public discussions. kingreform
The subservience of Council’s role to Central Government decrees-that is, their rules setting– creates many less than optimal imposed issues for the Council planner. Councils as a group themselves and when seeking reforms, must directly continue to lobby for improvement of their lot within the Council public debt and more general funding debate.
LTP preparers must in the meantime take up the cudgels and make it all work as will be discussed – and in the face of numerous adversities and continually changing circumstances.
An “unstable” LTP environment?
Most prominent of the issues facing Councils continue to be the inadequacies of their funding sources and financial mechanisms, including of most significance, the creaking inadequacies and structural limitations of funding from property-based rates.
Added to this there exist a wide divergence of individual Council financial circumstances ranging from fiscal conservative low debt levels as found for Rural Councils and extending to high debt, typically urban Councils, whose demands for development and asset creation go hand in hand with higher borrowings.
Council LTP solutions, fit for purpose need to take a horses for courses approach to reflect these size and complexity facts of life.
Note: The cprlifesaver grouping of five classifications of Council size-scale, directly address these differing Council financial circumstances. In addition, the normalisation of the metrics using a per ratepayer base further improves cprlifesaver datavalidity and usefulness.
Councils face stern scrutiny
Councils are these days, subjected to a great deal more detailed scrutiny of their debt policies when compared to Central Government.
The extensive measurement and disclosure tools relating to Council debt are customised for the sector and are highly visible. Their prominence in the public debate and in media coverage exceeds the other. Council debt information has become fully integrated into Council treasury management policies and is widely and publicly aired … while Central Government debt disclosures remain much more opaque and variable.
The practice of setting distinct and separate sector debt ratio rules, results in differing degrees of oversight- a straight jacket for Councils, more an informal reefer jacket for the senior government potentates. More a question of “do as I say, not as I do”.
This distinction between the two, it could be argued, has developed a much closer public scrutiny of the minutiae of local government finances-the “Goldfish Bowl” of rates, rats and rubbish.
Central government finance debates are addressed in a far more lofty, broad brush and rarefied a manner- for instance, via macro-economic analysis of World Bank, OECD and Sovereign Country league tables and within scholarly debates.
A comparison of local government debt management circumstances with those of their Lords and Masters within Central Government is both sobering and lop sided. This disparity … particularly of their relative-comparative freedom of actions- is reflected in Council LTPs, more so recently, as a result of changes to Council’s statutory purposes for its imposed-mandated “well-beings”.
As will be demonstrated, in spite of their different debt management and supervisory standards, both forms of Government share many common factors that influence and benefit their long-term planning processes.
Common LTP factors
Both Councils and Central Government, in developing their LTP’s are bound to consider similar community-wide objectives. These are reflected in Council LTP’s as prescribed and as set down within the “Purpose” clauses expressed as the four well-beings– LGA 2002 S.10 “Purpose of Local Government”.
Central government operates within more stable LTP circumstances than does the local government sector. Councils must continually deal with the outcomes arising from non- negotiable legislative change. The fundamental cornerstone … LGA Section 10 Purpose is the classic case in point.
S.10 has, over the last decade, become something of a political football as it has changed (twice) from its no frills version to the current four expansive and varied well-beings.
Unsurprisingly, as a consequence of the legislative change, LTP practitioners are faced periodically, following a change of government-with the prospect of the challenge and the inconvenience of having to make significant LTP process and planning framework changes … a regular and inconvenient shift of their goalposts. Something of an anathema to good long-term planning process.
To comply with the prevailing “Purpose” section, Council plans must be conducted within a more flexible and variable framework, one responsive both to changing policy and operating circumstances as well as reflecting the fundamental changes of “purpose”.
The current dilemma concerning the push for adequate Local Government funding, has become even more demanding as a result of these recently re-introduced and wide-ranging changed agenda items. They generally require increased rather than decreased expenditure.
Note:A flexibility is built into the cprlifesaver datasets, as all of its metrics cover a wide longitudinal “time” scale-over the current and last five year period- as well as providing fourteen variable significant expenditure options-double this number by adding the per ratepayer view of the data.
The fluid S.10 agenda requires changes to debt financing policies and involves much wider-four well-being- responsibilities. This places increasingly greater financial stress upon Councils while as well taxing the flexibility of their LTP frameworks.
Proposed amendments to The Budget Responsibility Rules of the Public Finance Act- provisions permitting increased Central Government debt- will, when implemented, depart from the existing flat Public Debt protocol of 20% of GDP … altered to a range of between 15 and 25%.This, by way of contrast, is far less a complicated matter to implement than are the wholesale sudden policy shifts demanded of-“sprung on”- Councils.
It is also significant that the 2019 Government budget has been placed onto a well-being footing, aligning both sectors to meet wider-more “societal”- objectives. Councils and Central Government have long faced roughly common objectives such as these, now their common purpose has been made “official”.
A rock and a hard place
Councils, because they are subject to more rigid and imposed debt boundaries via existing legislation, must act in compliance with very prescriptive legislated debt ratio disciplines.
In meeting the expanded debt responsibility demands as imposed by Central Government, Council flexibility for their operations and policies is challenged. This, in spite of the fact that Council’s ability to plan for themselves and to freely set their plans autonomously, is largely placed outside of their control.
An inevitable competing tension arises from these two factors. Given this major caveat, the two forms of government face an assortment of comparable though often very differing degrees of challenge in meeting their plan and budget objectives.
Comparable and non-Comparable LTP goals
LTP common and competing objectives of Central and Local Government are of the following kinds.
- The Budget Responsibility Rules (2019) as agreed to by the Coalition Government, are now comparable with the settings of LGA 2002 S. 104 A … which place prudential limits upon Local Government debt maxima.
- Both levels of government are comparable in that they act as “taxing” or “rating” authorities, both are subject to similar disciplines, that is, limits imposed by the democratic process on the tax-property rate- paying public accompanied by direct or de facto political consultation processes.
- Both forms of Government are also faced with public scrutiny when setting their debt levels. Both have to take into account factors that are common to their life in a goldfish bowl– their common public scrutiny environments.
- All forms of Government source their funding from the public via coercive taxes and rates. Both sectors therefore share public accountabilities and as a result, the scrutiny of their financial policy disciplines are roughly comparable.
- The major difference occurs when it comes to formal protocols for debt, as Local Government “takes their orders” … Central Government “dishes them out”!
- Debt restrictions, due to their mandated nature, are particularly vexatious for Councils where these limits are imposed with little wriggle room. When compared to looser Central Government debt boundaries, it is a case of “what is good for the goose” is less so… “for the gander”.
- Central Government is subject to scrutiny of its budgets and is often taken to task using comparisons from other jurisdictions such as the OECD and World Bank and other agencies.
- Both the Public the Media and private agents zealously track and compare Country’s national finances, much less so for Councils. These commentaries take account of all demographic, welfare and poverty statistics rated alongside national debt benchmarks which invariably are tested alongside a country’s GDP.
- Councils face modest, less informal scrutiny for consultation disciplines upon their financial plans. This informality is outweighed though by Council’s more rigorous imposed debt maxima management policies.
- Council financial and debt boundaries are inter alia set out at LGA Ss. 83 to 85. Central Government has no such prescriptive directives. The oversight of the Council provisions does not include the requirement to meet any external non-banking Agency approvals or external -OECD type-benchmark debt policies.
- This exemption also applies to Councils for the use of any rigid “acceptable level” criteria relating to the level of Council rates and charges … on any affordability basis.
- Council affordability questions currently are not integral to Council LTP processes, quite a contrast to public expectations and Central Government affordability criteria, for example use of graduated taxation scaling according to personal income bands.
- Council rate rebate processes given on affordability grounds note, occur outside and are completely separate from the LTP. Central Government funds these welfare and affordability benefits.
- In practice, Councils are focussed upon balancing their own budgets. Ratepayer affordability is largely ignored apart from the usual well publicised Rates annual % increase limitation generally … as an electoral promise.
- Councils are governed by their LGA S.100 provision which requires a “balancing” of their budgets, a contrast with Central Governments who as a matter of course, whenever they choose may run budget deficits-or surpluses.
- Central Government by continually having to submit to external agency-imposed overview – is obligated to continually affirm its wider political support from their elector-stakeholders by justifying boundaries for their expenditure and taxation policies. Councils escape this more hands-on level of supervision.
- The role of the State Treasury, given all of its resources and duties of public finance surveillance, adds a layer of overview to Central Government’s budget settings also. Note, these include factoring into budgets, matters of affordability often as measured by social indices.
- The political democratic process and the demands of widely and highly publicised debate, provides the impetus and responses relating to taxpayer approval of the affordability of their plans. No comparable process currently accompanies Council LTP affordability.
- Council’s financial policies, that is, the moderation of their debt levels are left to Joe and Josephine Public to judge. The public though are ill-equipped to independently and at arms-length, being capable of building their case and effectively consulting with and promoting their opinions … more by merely writing letters to their local Press editors.
- Rates revolts occur only rarely … with little other than local effect. The current Council LTP environment for some critical factors is ill-defined and unconstrained.
- As a result, in the absence of any process within an LTP cycle for consideration of a ratepayer’s ability to pay, any comprehensive structured moderation of the affordability of Council plans, by default, lies solely with Council LTP people.
- Further legislation to address this matter by incorporating affordability and Rate increase criteria within Council LTP’s would come as no surprise.
Note: The extensive cprlifesaver “Affordability” economic measures and data information is designed to assist in meeting these “Ability to Pay” information needs.
Author: Larry Mitchell – November 2019Phone 0274 792328 Larry@kauriglen.co.nz