S&P Global says the Three Waters reform will change the DNA of local communities. Picture/File
New Zealand’s “three waters” reforms are expected to change the DNA of the country’s local authorities and could have significant implications for the cash flows and balance sheets of some, said rating agency S&P Global.
In 2019, the government announced major reforms of three water services managed by municipalities: drinking water, wastewater and rainwater.
If enacted in their current state, the reforms will see the creation of four Water Service Entities (WSEs) that will operate and be responsible for water services across the country, beginning in FY2025.
S&P said the creation of WSEs could relieve local councils of all water-related activities, including water fees and charges, operating and capital expenditure, assets and liabilities – including debt.
“New Zealand’s Three Waters reforms are set to change the DNA of the country’s local council sector by transferring the management of key water services from local councils to new water service entities,” said the agency in a report.
The reforms, due to start in July 2024, will affect the sovereign, local councils and the New Zealand Local Government Funding Agency (LGFA), according to the report.
But S&P said “a large information vacuum” currently limits its ability to accurately reflect proposed reforms in its credit ratings.
Key information that would help S&P’s assessment included clarity on the future course of action, he said, such as which water-related activities should be transferred – the three waters – drinking water, waste water and stormwater – or a subset.
“Given the inherent difficulties of dividing stormwater assets, some stakeholders suggest that the reforms could exclude some or all stormwater utilities,” S&P said.
Financial aspects of the reforms – for example whether councils will receive payments in return for transferring their assets to WSEs and what the amount of those payments will be, whether council debt will be novated to WSEs or whether debt will remain on councils’ balance sheets until they decide to pay it back, and how the amount of the debt will be calculated – were also in the “information vacuum”.
S&P said some clarity was needed on the timeline for implementing the reforms.
For many councils, the reforms could have significant implications for their cash flow and balance sheets, the agency said.
S&P estimated that between one-third and one-half of the sector’s debt and a large portion of revenues were water-related.
“The financial impact will vary from council to council, with many better off in the immediate future, while others may be worse off.
“The long-term effect on budgets and debt ratios is difficult to determine at this stage due to lack of information.”
S&P outlined some hypothetical rating actions it might take as a result of the reforms.
One would raise a rating if reforms significantly improved a council’s fiscal performance, such as reducing deficits after capital account and structurally reducing its debt-to-operating revenue ratio.
Another would be to lower a rating if reforms weaken a council’s fiscal performance, such as widening deficits after capital account and increasing its debt-to-operating revenue ratio.
“This could happen if a council has limited water-related debt and a high proportion of its revenue comes from water-related activities,” he said.
S&P said it could assert a rating if the reforms had no material effect on a board’s credit metrics.
“This could happen if the reforms result in little financial change, or if we believe the council remains exposed to water-related activities carried out by the WSEs.
“The latter may mean that we continue to include water-related activities in our credit assessment,” he said.
At this stage, S&P considered the Three Waters reforms unlikely to affect New Zealand’s sovereign credit quality.
“Based on our criteria, we can assess that the new WSEs pose potential liability risks to the New Zealand sovereign, particularly if they are established under New Zealand law and benefit from Crown liquidity facilities.
“However, there should be sufficient margin in the ‘AA+’ sovereign rating of foreign currencies to absorb an increase in contingent liabilities, for now.”
The implications for LGFA credit quality will depend on several factors yet to be determined.
One factor would be the mechanism by which the councils’ current water-related debts were either transferred or repaid to the LGFA and the timeframe within which this occurs.
S&P noted that the reforms follow the National Party’s “Three Waters Review” in 2017, which looked at ways to improve the regulation and supply of the Three Waters.
The review came alongside the Havelock North inquiry into a water contamination incident in 2016, when 4,500 people in the town became seriously ill from drinking contaminated water.