Three waters reforms pass financial separation test - S&P

The three waters reforms would achieve balance sheet separation and improve some councils' finances, according to analysis that paves the way for the legislation.

To achieve these results, the government will support the new water service entities (WSEs), as part of the changes introduced after feedback from a working group of mayors and iwi.

The reforms came under fire from political opponents when the government said it was pushing ahead before having checked if the changes would affect the proposed new entities' ability to borrow.

Internal Affairs has since sent two scenarios to global ratings agency Standard & Poor's (S&P), to test balance sheet separation and whether the reforms could affect Auckland Council and Wellington City Council's credit ratings under the updated reform model.

Balance sheet separation in the case of the water reforms refers to limiting councils' influence over water assets, which gives the WSEs a stronger credit rating and enables the high levels of borrowing needed to fund the infrastructure improvements the reforms aim for.

Several of the changes made to the reform model since it was introduced increase councils' influence over the assets, which had put this government bottom line in doubt, but S&P has found the reforms would still achieve it.

"We consider the structure proposed in scenario 1 would separate the water-related activities from Auckland when determining Auckland's credit rating under our methodology. Therefore, we exclude the water-related revenues, expenditures, assets and liabilities from Auckland's financial analysis," the ratings agency's report said.

It attributed this to the WSEs' expected credit rating, as well as the high likelihood of support from the government.

This is likely in reference to the "Crown liquidity facility" ministers confirmed the government would provide, an emergency fund entities could borrow from in cases when access to the usual financial markets was constrained.

A Department of Internal Affairs (DIA) spokesperson said the intent was not for an on-demand source of cash, and would be targeted at "extraordinary events that impact a WSE and result in a lack of liquidity. That could be, for example, a temporary dislocation in capital markets".

S&P also said the increased influence of the proposed Regional Representation Groups (RRGs) over the WSEs was offset by the councils not having a majority of representatives on the RRG, mana whenua making up half of RRG members, and the council being legally unable to financially support the WSE.

The analysis assumes WSEs will have BBB- standalone credit profiles and long-term ratings of AA+. The DIA spokesperson said the WSEs' credit ratings would also be assessed again before legislation was passed.

Improved finances for some councils

S&P's report also found Auckland Council would be financially better off, and Wellington's would be unaffected, by transferring the water assets and debt to the WSEs.

Auckland's long-term local and foreign credit rating would improve from AA to AA+ with a stable outlook, and the removal of water-related expenses and revenues from its books would improve its budgetary performance and debt burden assessment.

"This was because the reduction in total expenses (including interest expenses and capital expenditure) outweighed the loss of total revenues," the report said.

Wellington's credit rating, budgetary performance and debt burden would remain unchanged - at AA+ with a stable outlook, although its total debt would be slightly higher at about 198.4 percent of revenue, compared to the 181.1 percent in the base case.

A DIA spokesperson said water assets tended to be more highly leveraged than other council assets, and transferring the assets from council to WSE would usually improve councils' books.

The government's 'no worse off' funding aims to shore up the exceptions - councils with higher water revenues than expenses who would be facing a budget and borrowing capacity hit.

Legislation setting up the WSEs and setting out their roles and responsibilities is expected to be introduced shortly and passed before the end of the year.

A second bill is also set to be introduced before the end of the year.

Local Government Minister Nanaia Mahuta said this was "effectively to bring forward the governance, representation, local voice issues in the first bill - and that was a set of issues that was of most concern to local government".

"Then the functional elements of the water service entities will follow in the second Bill."