Auckland Council nears borrowing cap via LGFA as local authorities flock to cheap debt

Tuesday 28th June 2016

Auckland Council is nearing the limit on what it can borrow through the Local Government Funding Agency as low interest rates encourage local authorities to take on low-cost debt.

Auckland Council yesterday deferred a bond sale, citing market volatility that has followed the UK's decision to exit the European Union. The LGFA has a covenant on the net debt-to-revenue ratio for the council of 250 percent, which it says is consistent with an A+ credit rating from Standard & Poor's.

Auckland Council's debt ratio currently exceeds 200 percent and is forecast to rise, says Andrew Michl, LGFA's manager of credit and client relations.

"Their 10-year plan is consistent with remaining compliant with LGFA covenants, we don't have any concerns about them breaching the covenants - however, it's fair to say they are financially constrained," Michl said. "If you look at their 10-year plan, they list the projects they would like to do and say 'we don't have the balance sheet capacity to do everything we would like to do'. That's why you're seeing a bit of tension between the council and government on the issues around growth."

The LGFA also has a balance sheet ceiling on the amount it can lend to Auckland Council specifically - 40 percent of its assets - and the council is currently sitting at 33 percent.

The agency has lent $6.4 billion to councils as of June 2016, up $1.4 billion from a year earlier, while total council debt is forecast to be around $14 billion, up from $13.1 billion in 2015.

Michl said the growth in debt was important for the economy, and it was important to be aware of infrastructure timing when looking at debt numbers. The biggest benefits of raising debt through the LGFA was for councils that didn't have their own credit rating as some larger councils were already issuing bonds directly to the market, Michl said.

Falling interest rates have helped reduce interest costs for councils. The yield on the LGFA's 2019 bonds has tumbled from a peak of 5.25 percent in October 2013 to between 2.5 and 2.75 percent recently.

"If you look at 2019 yields, they've almost halved now," Michl said. "That's a positive for councils in terms of their financing costs, especially for Auckland Council which is using something like 16 percent of its rates to service debt - lower interest rates are going to have a material effect."

LGFA has a target spread of 50 basis points above central government bonds, but the average right now is higher, with its 2027 bond yield gap at 105 basis points. That yield gap creates more demand amongst investors, Michl said. About 28 percent of the bonds are owned by offshore investors, many of whom would have previously held government bonds but can get better returns on LGFA bonds of the same credit rating.

BusinessDesk.co.nz

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