Source: Auckland Council
Why does Auckland Council enter into interest rate hedging contracts?
Interest rate hedging gives the council certainty about how much it is going to pay in interest over time. This enables the council to plan for the future and be confident that it can provide essential services regardless of changes to interest rates.
Over the life of the hedging agreements there may be times where the council theoretically “loses” due to interest rate changes. It also theoretically might make gains. However, these are not “real” losses or gains—they are reported as an accounting convention to reflect changes in interest rates (in this case mainly due to the sharp fall in interest rates that has resulted from COVID-19.)
This is analogous to a private homeowner taking out a fixed-rate mortgage to provide certainty over future mortgage payments. If, after fixing a mortgage rate, interest rates decrease, the homeowner will not suffer an actual loss but will continue to pay the agreed fixed rate. Likewise, they won’t “gain” anything if interest rates increase, but will continue to pay the fixed rate.
Why has the council posted losses from interest rate hedges?
The focus for council in hedging is not on maximising potential financial gain by speculating on uncertain future interest rate fluctuations, but in safeguarding ratepayers’ money and ensuring there is no risk of actual financial loss, now or in the future. This protects the council’s ability to provide the essential services and infrastructure investment that Aucklanders rely on.
If the council did not follow its current, prudent approach to interest rate hedging, even a 1 per cent increase in interest rates would result in additional interest costs of around $100 million to ratepayers—to balance the operating budget the council would then need to increase rates by around 6 per cent or cut other costs or services.
What is Auckland Council’s policy on interest rate hedging?
Council has a diversified portfolio approach to debt management and interest rate exposure risk. This approach is standard practice for any corporate of this size in New Zealand and internationally.
The policy on hedging and interest rate exposure risk is clear, prudent, and available on the council website.
Council’s policy is supported explicitly by global ratings agencies. On 29 September 2020 Standard & Poor’s affirmed the councils ‘AA’ long-term and ‘A-1+’ short-term issuer credit ratings. This means the council has one of the highest credit ratings in New Zealand, second only to central government.
S&P writes that risk from council debt is “well managed by the [financial management] team and the council hedges all of its foreign-exchange and most of its interest-rate exposure.”
Decisions on hedging strategy are made by the council’s Treasury Management Steering Group (TMSG), which is comprised of senior finance officers and CFOs from across the Council Group as well as experts from the private sector.
The TMSG carries out the council’s treasury activities in accordance with the council’s Treasury Management Policy, as required by the Local Government Act 2002.