Rate capping forces local council debt rethink

By David Donaldson

August 1, 2016

The local government sector in Victoria is going through a period of fast change.

Councils are unlike the other tiers of government in that they don’t experience the natural political cycles as Labor and the Coalition switch places

It’s more sporadic. The last round of big reforms happened in 1994 when Jeff Kennett’s government forced a round of amalgamations and made significant efforts to convince councils to rid themselves of debt.

Two decades on, the sector is going through another period of upheaval, thinks Municipal Association of Victoria CEO Rob Spence.

Like their state and Commonwealth counterparts, councils are rushing to catch up on technological disruption. Spence — who was previously CEO at Footscray and Brimbank councils — is seeing “blooms of innovation” happening. It’s a good sector for trying out new things, he reckons — unlike other tiers of government “you don’t have to have 50 people sign off on a letter”.

Brimbank is working on a single database to cover all client interactions. Spence names Boroondara as doing interesting things on digital transformation; Wyndham on planning.

Rate capping

Councils are also taking new approaches to funding infrastructure and are reconsidering a deeply ingrained culture of aversion to debt.

The catalyst has been the introduction of rate capping, which prevents local government areas raising rates by more than the amount decided by the minister (unless they can make a convincing case otherwise). This year it’s 2.5%.

Unsurprisingly, there’s been pushback, with complaints the state is simultaneously preventing councils raising revenue and giving them a greater share of the cost of delivering services. Councils are required to deliver some services by law, so 20-25% of costs are locked in, reducing the amount that can be cut to balance the books.

A lot of councils are concerned about suddenly being unable to vary their rates when needed. A recent parliamentary report found that the process for getting permission to raise rates by more than CPI was “onerous” and could cost each council that applied around $250,000. That’s a lot — especially for small rural councils.

Accessing the bond market

Despite these concerns it’s not all bad, thinks Spence. It’s prompted a rethink of how councils finance themselves.

Victorian local government areas have, for the most part, very low debt — many would argue unnecessarily low, given their ability to borrow cheaply. A disinclination for debt entrenched by Kennett — he gave certificates to councils that paid theirs off in full — has persisted to this day, Spence argues.

At the moment there isn’t a clear line of guidance on the appropriate level of debt for councils, as the Essential Services Commission, which deals with council finance issues, hasn’t issued any advice. The parliamentary inquiry recommended the ESC clarify its position.

An interesting development is that Victorian councils, which have traditionally relied on banks for finance, have recently begun to access the bond market.

Although individual councils’ borrowing needs are too small for capital markets, a new organisation, set up by the MAV with the Commonwealth Bank and NAB, allows local governments to band together to borrow at a lower rate than is available through the banks.

The key driver behind the establishment of the Local Government Funding Vehicle was to bring down the cost of borrowing. Not only is debt cheaper on the capital markets, but when they do borrow from banks, competition means councils get a lower rate there, too. And while it’s new to Australia, it’s a tried and true mechanism at the local government level in other countries.

“Councils are high grade credit quality borrowers but each one doesn’t have the scale to required to access capital markets itself,” explains Commonwealth Bank’s Rob Kenna.

“NAB and CBA have partnered with MAV to develop a vehicle for councils in Victoria to aggregate borrowing in a single vehicle we can market to institutional the investor universe in Australian dollars,” he told The Mandarin.

“We have already done that in three tranches. It’s helped councils manage their own access to debt and access institutional markets themselves.”

Spence estimates around half of Victoria’s councils have made use of the vehicle to access funds. Many of these are large outer-urban councils trying to stay ahead of the infrastructure and service curve as they experience high rates of growth. And the other half? “Mainly a lack of requirement for borrowing” he responds.

A changing approach to finance

In the past councils tended to raise funds for infrastructure before proceeding with construction. This could mean juggling several tens of debt products with rolling deadlines. Borrowing a larger amount of money in one transaction on the bond market offers a simpler financing mechanism with less administration.

They’re making it easier to borrow over longer periods. The three tranches so far have offered bonds at five, seven and recently 10 years. Rather than rolling over debt every six months, these longer term options require less ongoing work.

It’s all part of the broader sweep of changes in the sector. “We’re seeing very rapid moves to digital transformation, we’re seeing reconsideration of debt relative to raising cash upfront and building,” Spence explains. “We’re seeing quite a shift in how councils work.”

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