Financial reports

There are now two reports on the financial state of the Kaipara District Council.  There is the Financial Health and Sustainability Audit of Kaipara District Council by PJ Associates which can be found here.  There is also the report on Kaipara District's performance 2011 by Larry Mitchell which can be seen here.

Larry Mitchell report

Chief Executive's Report 24 August 2011

Excerpts from the Larry Mitchell report of February 2011

PJ Associates Report



Before tackling the report itself I will look at the comments of the Chief Executive in the Chief Executive's Report of 24 August 2011.  These comments explain the background to the report.  Note that my commentary is in blue.

1.6 Council Financial Health – Report from Larry Mitchell

Chief Executive's Report 24 August 2011 
At the time Council requested an independent financial review and chose Philip Jones to do that review I had just commissioned Larry Mitchell to provide an update of his May 2009 report on Council’s financial performance. However, now that Philip Jones has completed his review and Council has received the report it is appropriate that Council see this report. A copy is circulated separately with the Chief Executive’s Report.

Re: the May 2009 report of Larry Mitchell

Was it made available to ratepayers?

Was it made available to the Mayor and the Deputy Mayor?

Was it made available to the Finance portfolio holder?

Was it made available to other Councillors?

Did Council authorise the commissioning of the first report?

Who paid the fee for the report and was this authorised by Council?

If the report was not made available to Councillors what was the purpose of the report?

Did the report recommend careful financial management of the EcoCare debt?

Did Council take any steps as a result of the report?

 Re:  the February 2011 report of Larry Mitchell

Did Council authorise the commissioning of this second report?

Who paid the fee for the report and was this authorised by Council?

What was the purpose of the report?

When Councillors decided to commission the PJ Associates review why did the Chief Executive not tell Councillors about the second report of Larry Mitchell that he had just been commissioned?

The report was received by the Chief Executive in February 2011 and kept secret and not disclosed to Council until 24 August 2011.  Why was the report not disclosed to the Mayor, the Deputy Mayor, the finance portfolio holder and the other Councillors.immediately it was received?

In February 2011 when the report was available Council was in the draft annual plan process, considering the expenditure for the next rating year.  This information in the Mitchell report was absolutely vital to the consideration of the financial future of Council and yet the Chief Executive chose to keep it secret.  Both Councillors and ratepayers desperately needed the information contained in the report so that they could make informed decisions.  All the financial information in the annual plan is therefore completely incorrect because the report was not made available.  What were the Chief Executive's reasons for not disclosing the report?

Did the Chief Executive keep the report secret during the draft annual plan stage because he did not want Council or the ratepayers to know of the financial crisis facing Council?

Why was it not appropriate for Council to see the report in February when it could have taken some action in the annual plan based on the information in the report, but now it is "appropriate" for the report to be made publicly available.  Is that because the cat is now out of the bag (with the release of the PJ Associates report) and the secret was getting too big to keep?

While the Larry Mitchell report does not delve into the operational structures that the Philip Jones Report process covered it comes up with similar findings and provides a more strategic view as well as providing comparisons. This along with the Larry Mitchell League Table Report previously provided to Council and which ranked Kaipara well, provides good information on the Council’s financial performance and how it ranks against other Councils.

Basically the Larry Mitchell report says that Council is financially healthy with caveats around the Mangawhai Community Wastewater Scheme. The subject of these caveats has been known to Council since the inception of the wastewater project and reinforce that it will need careful financial management. Council has already dealt with this and is putting in place strong processes for managing its debt. These include:

1. Appointment of independent treasury advisors.

2. Robust review of the assumptions behind the Mangawhai Community Wastewater Scheme financial model for inclusion in the Draft 2012/22 Long Term Plan for public consultation.

3. Review of Council Policies with draft Long Term Plan including borrowing and financing policies.

The statement that the Council is "financially healthy with caveats...." is just rubbish.  It is like saying that I am rich if it weren't for the million dollars that I owe the bank, Or the patient is perfectly healthy except for a chronic heart condition that will kill him at any moment.  Larry Mitchell wrote the report and I suspect he totally disagrees with the Chief Executive's spin.

Note the comment:

The subject of these caveats has been known to Council since the inception of the wastewater project and reinforce that it will need careful financial management. Council has already dealt with this and is putting in place strong processes for managing its debt.

Hello?  If the Chief Executive knew about the caveats at the inception - some  four or five years ago - why has he and his Council done absolutely nothing in that time to address the problems that he was clearly well aware of?

Why was there not "careful financial management" for all of those four or five years?  Why did he ignore the problems and do nothing knowing that there were all those caveats and concerns about EcoCare?

The secret report of Larry Mitchell of May 2009 would have had some strong warnings about the EcoCare debt.  Why were those warnings ignored by the Chief Executive?

Why did he not disclose the second Mitchell report in February 2011 so that urgent "strong processes" could now be well underway?

Why did the Chief Executive sit and fiddle while Kaipara was financially destroyed?

I need to draw your attention to Larry Mitchell’s strong advice about ring fencing the “Mangawhai Wastewater” debt. He is strongly opposed to any element of this or its servicing being spread across the district. This is something Council will have to carefully consider when reviewing its policies as part of the Long Term Plan process.

Of course the Mangawhai debt has to be ring-fenced.  If that does not happen then it blows all the benchmarks of prudent financial management out of the water.  By ring-fencing the Mangawhai debt everyone can pretend that all those principles of prudence can be met.  If the Mangawhai debt is added to the core debt then Council is well and truly a cot-case.  So quarantine the thousand or so ratepayers on the EcoCare Scheme off from the rest of Kaipara and everything will be fine.  The only problem is that there is no way that those Mangawhai ratepayers will be able to meet the rates necessary to pay off the interest, the overheads, and the $53 million principal of the EcoCare debt  They will become the most indebted people in the country, rates-wise.  Properties in the EcoCare area will be impossible to sell and Council will have effectively created a ghetto of unsaleable houses with a debt that is simply unsustainable.

No doubt the experts are well aware of this problem and are working overtime to try and hatch a plan to raise a general rate over the whole of Kaipara that will be secretly used to fund EcoCare.  The truth is that at the end of the day ratepayers will have to foot the bill for the financial botch-up of the Tiller-McKerchar Council, regardless of how the new rates are going to be dressed up.  That is unless ratepayers can bring a case against the Chief Executive, the Mayor and Councillors for breach of their statutory duty of care. Now there's an interesting thought.......



(These exerpts show how desperate the Council's financial situation is.  The author suggests that the only way that council can survive financially is to ring-fence the Mangawhai Debt.  Those in Mangawhai who are connected to Ecocare should read this with absolute trepidation,)

 Note:  Bold emphasis is by the author.  Light blue highlighting is by Legal Eagle.

18 February 2011

Best endeavours have been exercised in the preparation of this report. Areas mentioned where other content has not been included leaves gaps in the analysis and require completion as soon as possible (when current performance data becomes available). The commentary of this report on the ‘EcoCare’ project is totally reliant for its completeness and accuracy upon representations of others. The effective mandated segmentation of ‘EcoCare’ debt as detailed in the KDC borrowing management policies is absolutely crucial to the KDC’s financial position and to any assurances provided within this report. The same is true of ‘EcoCare’ financial viability, including adequate provisioning of bad and doubtful debts.

On the other hand this report raises some serious questions that deserve comprehensive independent consideration including that of elected members. All will be faced with the many challenges referred to in some detail within the report.


Measure: Debt per Ratepayer ... self-explanatory ... Note; „Debt‟ is defined as all council liabilities-debt measured as total current plus term liabilities (external debt obligations to all third parties).

Current: A score of $ 6,667, (2008 totalled a mere $2,652 debt per ratepayer) and rankings of 1st of 10 and 4th of 36. This is a very high relative debt level reflecting the bringing to account on the KDC balance sheet of the Mangawhai (EcoCare) debt. This debt totalled an additional $56 M in the year to June 2010. A separate section of this report covers the implications of this situation. In brief, the added debt is to be treated in all respects as belonging to the Mangawhai-EcoCare zone with no prospect that it will spread district wide. The separate reportage of this study distinguishes Mangawhai‟s (quarantined) debt as do the borrowing management policies. These policies reinforce this position (of segmented-performing debt) and data is provided (next graph) of KDC core debt excluding Mangawhai to give the clear factual debt picture with and without the influence of each debt component.

Trend: Separate section refers

Finding: Separate section refers Implication: The increase in total KDC debt is very important to explain in understandable terms. There is a danger of treating all KDC debt as comparable, a misinterpretation of this situation as well as increasing the dangerous possibility that the KDC debt policy settings may not provide the necessary safeguards. The separate „EcoCare‟ section of this report refers to the protection-separation of Mangawhai debt that is essential to ensure KDC treats the recently added debt (and debt repayments) correctly in policy terms.


Note: Notional Core KDC debt ... KDC finances without EcoCare. This notional extra debt graph shows the effect of core KDC debt without inclusion of the added EcoCare ($56 M) debt total. The reason for inclusion of this information is to show core debt only levels, compared to the group of ten KaipGp peer Councils. The rankings of this data/graphs are 3 of 10 for the smaller group and 13 of 35 for the larger provincial/rural group. Somewhat surprisingly these scores, even without inclusion of the EcoCare debt are quite high (within the highest third) for both of these two groups. KDC core debt, to be borne by the District ... even without Mangawhai debt will still present its own challenges.

Measure: Capital Creation Current: This measure, graphically demonstrates the significant impact of bringing to account the Mangawhai-EcoCare assets. This capital introduction is the ‘other side of the debt story’. That is, the increased KDC debt is offset by matching (Mangawhai) assets. Note also in terms of KDC‟s ratepayers equity, (the net worth of the KDC) this total, in spite of the added debt in the 2010 year actually shows an increase from $410M to $415M (though still and as explained above this is a low relative ranking at 32 of 36). One additional point. Added assets, for which the KDC becomes responsible, can be a burden even though KDC‟s net worth is improved. This is due to the extra asset maintenance commitments and no doubt substantial added administrative overheads associated with this complex EcoCare project.

Trend: A major change of KDC circumstances

Finding: See above comments and separate analysis section

Implication: Very! Important: The significance of these developments must be fully understood and treated carefully. Future KDC wide projections, together with Mangawhai asset management-depreciation-debt-borrowing polices all must be properly coordinated based on prudent and sustainable financial management practice.

Measure: Debt – Wealth ... this measure relates debt levels to the value of the property base (combined land and capital values). The Mangawhai debt situation (below) refers.

Current: See previous measure commentary

Trend: The direction that this measure is heading is of concern and will take careful handling for all who are faced with financing of the EcoCare scheme. Mangawhai residents and only them! are now faced with an adverse debt-wealth statistic as they are required to meet debt repayment and higher service charges from their lower property values rated against their high level of Mangawhai-EcoCare related debt. They face heavy long term contractual commitments along with their local, current targeted rates payments. The blowout of Sundry Debtors from $1.4m in the last year to $5.0M raises the issue of the sustainability of Mangawhai debt repayments.

Finding: See previous measure commentary

Implication: See previous measure commentary re debt levels. The now very high level of total KDC debt in this relative measurement context of property values places Kaipara in a less favoured position relative to the others. Its ranking now of 10th of 10 in the KaipGp indicates that KDC borrowings are not well supported by its property rating base, particularly in “accepted” Council debt sustainability terms. Once again, these facts emphasize the importance of segregating from other KDC ratepayers the Mangawhai debt as well as a need to develop future KDC debt projections in a long term sustainable fashion. Legal disputes can add to these complexities. Detailed ongoing and independent analysis of this state of affairs will be essential to gain a fully rounded picture prior to taking any further actions. This report refrains from further comment at this stage.


EcoCare ... and other Pressing Financial matters

The significance of EcoCare and the February 2011 Report Limitations
This brief ‘points’ outline, records certain concerns relating to the EcoCare project and adds commentary of a number of other related financial management matters. As mentioned in the introduction to this report, the EcoCare project raises important implications for the financial sustainability of the KDC. This is principally due to the addition, in 2010 of approximately $56 M - $58 M of Council debt, albeit offset and accompanied by about the same value of (now) KDC booked/owned assets

No representations as to the completeness and detailed accuracy of the following observations are given. For adequate assurance on these matters, full and complete representations would be required from the other professionals involved.

In discussing and evaluating this project, its important aspects, particularly from a newly elected official’s standpoint relate to its financial sustainability. The project is ‘a fact’ now, it is largely completed, at least for its wastewater component and as designed it is intended to stand on its own feet supported by the Mangawhai zone-area ratepayers. It is they whom alone are benefiting and will continue to benefit from the EcoCare infrastructure. The following brief paragraphs under separate headings refer.

Segmentation of EcoCare debt
So termed policies of “Segmentation of KDC’s Debt” ... contained in the Council’s LGA 2002 S.104 (e) mandated Liability Management Policies, (Borrowing and Management policies) were developed (circa) in 2009. These policies were a response to the danger of Mangawhai debt flowing over into KDC district-wide debt funding and or repayments. It was believed by the then Council that it was vital to confine the debt to the level of the specific area of benefit that is the burden of the Mangawhai debt ... to Mangawhai alone.

All elected members should be familiar with the provisions of these policies. No changes should be made to these policies that would have the effect of letting Mangawhai ‘off the hook’ as they have committed (in a fully enforceable legal sense as well, it is believed) to meeting their financial obligations as they fall due. Greater protection than currently exists for this situation is warranted (if it is possible) and is now discussed further.

Doubly enshrined (constitutional) safeguards for EcoCare debt repayment
‘Nice idea’ but in cold hard legal terms double enshrinement (the protected say 66% majority constitutional) safeguards for the EcoCare debt repayment terms do not exist and cannot be assured or assumed. The Local Government Act does not make provisions for safeguards of this kind that involve greater future certainty for resolutions passed by Councils. A simple majority decision of any (new) Council can have the effect of overturning existing provisions such as the EcoCare borrowing policies. The effects of such a decision would be very harmful to ordinary, at large people and communities of the Kaipara District. It may just have to be sufficient to ensure that any mooted such policy changes are fully understood and debated prior to any changes being decided. Hopefully this report achieves this objective meanwhile.

In spite of all safeguards and in addition to the dangers of policy amendments (above), the reality is that financial failure of Mangawhai’s ratepayers, the personal residents, developers and commercial property owner’s may emerge, (have started), legal actions could bring challenges, (they have already appeared) and bad debts may continue to increase, (as pointed out elsewhere they have, to June 2010 increased in one year by $3.6 M to $5.0 M).

In addition, debt servicing (interest and some principal) costs are rising steeply, up $1 M to $3.8 M in June 2010 and are reportedly increasing in the current year, largely as a result of EcoCare debt. Note also amongst this report’s debt graphs the core KDC debt, (excluding EcoCare) is itself ‘amongst the third highest’ debt level of the KDC peer group of 10 similar Councils. All in all ... ‘hang onto your hats’.

KDC, as already pointed out faces these funding-financing and other future challenges. KDC is not alone in these matters. Many NZ Council’s are facing recessionary times and the enclosed February 2011 Local Government Magazine article at Appendix 5 titled ‘Local authorities balance sheets warn of financial troubles’ identifies over 15% of NZ TLA’s who ‘will struggle’. Faced with these realities, for all of these cases, to manage through the next few years will take excellent governance and management skills. Here are some immediate actions-suggestions to assist.

• Conduct the forensic and recovery processes as detailed in the Appendix 5;

• Ascertain the sensitivities of differing debt and bad debt scenarios and take appropriate actions that will address any difficulties;

• Set in train medium to long term financial sustainability benchmark performance measures and closely monitor these;

• Continue to assess the prospects and implications of local government reorganisations;

• Continue to do what KDC continues to do best ... that is, to gain existing or better levels of subsidy based on reliable focussed local affordability information ... and continue with a no frills, low overheads, low staff levels ‘affordable’ local level of service;

• Consider an improved accounting public disclosure, one that separates the effect of EcoCare from the core KDC finances. This would improve the under-standability of financial statements as well as reinforcing the significance of the policy and other issues affecting EcoCare-KDC financial positions;

• Final note: See below the comparative 2010 ‘Napier City’ average comparative residential rates survey data in the next section ... this shows, at June 2010, NZ TLA wide average rates of $1,638 pa, a 22.7% increase since 2006. Anecdotal evidence suggests that the KDC ‘may’ be at least as good as this average figure, (Rodney’s 2010 rates were over $2,200 pa before it went broke). Further work is necessary to accurately determine this ... and could be used to influence some ‘hearts and minds’ in the District.



 Legal Eagle has put together a series of articles that summarise the issues raised by the PJ Associates report. 


1.  Benchmarks of prudence and segmented loans

2.  EcoCare and segmented debt

3.  Some serious questions

4.  Where were the auditors?


1.  Benchmarks of prudence and segmented loans

[This article has been prepared with assistance from a Paper by Larry Mitchell entitled Debt Maxima for NZLG which can be found here.] 

There are no laws relating to how much a council can borrow but there are a set of benchmarks that have been generally adopted for prudent financial management practice in New Zealand local government.   These are called benchmarks, debt maxima, or parameters.

The fundamental question to be asked when applying these benchmarks is:

‘Given the exercise of financial management prudence, what is the maximum level of debt that (this Council) can sustain?’

The two vital considerations are therefore prudence and sustainability which go hand in hand.  Sustainability is in essence a consideration of what ratepayers can afford to pay.  A council therefore has to consider what amount of debt its ratepayers can sustain whilst adhering to the principles of financial management prudence.

Some of the benchmarks that have been adopted are set out below: 

+  Debt per capita should not exclude $750 per resident

Debt per ratepayer should not exceed $1,500 per ratepayer

+  Annual council income to debt ratio should never be less than 1:1 and generally higher

+  Annual interest on council debt will never exceed 20% of total annual general rating revenue.

Pressure to increase debt
The problem is that over the last 5 years or so there has been an increasing pressure on councils’ debt levels.  This is due to natural growth but also to such things as more stringent standards of environmental and public health, which require upgrades of existing facilities, roading developments and water and wastewater improvements.

Local authorities are increasingly under pressure to raise more debt than is considered prudent under the accepted benchmarks.  The benchmarks are under threat, and financial experts are looking for ways of increasing debt without infringing the benchmarks of prudence.

One solution that has obtained the endorsement of the experts is the concept of segmented debt.

Segmented debt
If a council raises a specific debt for a particular project which will raise its own income and self-service its own debt then this may be treated in the accounts as a segmented debt.  This means that it can be ring-fenced or quarantined from council’s core debts, so that the core debt still complies with the debt benchmarks.

To qualify as a segmented debt the debt has to meet two basic requirements.  Firstly the Circumstances must be appropriate.  This means that there has to be a clear, separate debt to a third party, and that debt must be attributable to a specific asset or development.  The asset or development must also have a revenue stream that is separate and quantifiable, and that revenue must be available to council for funding the costs and debt servicing of the asset or the development. 

Secondly there has to be Certainty.  This means, to select a few of the considerations:

 +  The certainty that the circumstances mentioned above will continue to prevail.

+  The need for accurate budgeting, testing and verification to prove the accuracy and reasonableness of the parameters set by the financial models.

+  The ability of the affected community to meet the repayments of the segmented debt as well as other operating costs.

+  The certainty of the availability of the funding mechanism (rates and development contributions), and that this income stream will be sufficient to produce the required revenues. 

Unless these two requirements of Circumstances and Certainty are met it would not be considered prudent to treat a debt as segmented.

Next:  EcoCare and segmented debt.  (coming soon)


2.  EcoCare and segmented debt

In the case of EcoCare it is now apparent that the Circumstances and Certainty test mentioned above were not applied with sufficient accuracy or rigour when it was decided to ring-fence the EcoCare debt as segmented debt.

At the time that Council decided to go ahead with the EcoCare Scheme there was considerable opposition from concerned residents spearheaded by Councillor Bruce Rogan. They voiced concerns over the design model – whether such an expensive project was desirable - and the accuracy of the financial models and the sustainability of those models.

However, it appears that Council was blinded by the advice that it received from its advisers and its consultants and largely disregarded the concerns expressed by ratepayers.

P J Associates report
The recent report from PJ Associates (here) offers some criticisms of the EcoCare Debt and the failure of the segmented debt policy.

At times the report is not very clear in that it tends to confuse the core debt with the segmented debt and it is unclear which debt is being discussed.

One has to accept that the report merely skims the surface and hints at problems rather than offering a rigorous audit assessment. No doubt the terms of reference were very limited and the reviewer was in the difficult position of being contracted to the Council for advice and financial workshop assistance and therefore scarcely in a position to offer a thorough independent audit.

However, the report still paints a pretty grim picture.  It points out that one of the problems with the financial models that were applied for the repayment of the EcoCare debt is that they did not “provide any sensitivity analysis as to the changes in the projected number of lots over a period of time”. In my book that is a very gentle way of saying that the models were optimistic and inaccurate.

Another problem was that any shortfall in revenue could not be identified because there was no mechanism to pick up that shortfall. Quite a fundamental problem one would think.

It was clear from the models that in the early stages additional borrowings would be needed to meet interest payments. However, there were two difficulties. Firstly, the amount of these borrowings was understated. Secondly, according to the model the funds for these borrowings were to come from Council Created Reserves. Unfortunately there was no money in those reserves to meet any payments.

The report also raises the issue of non-complying rates but does not delve at all, and adds that the failure to include the development contributions policy in the Long Term Plan “poses risk for Council”. But it does no elaborate.

What it omits to say is that in respect of the Certainty requirement Council has committed the cardinal sin of failing to ensure that EcoCare’s income sources - targeted rates and development contributions - are readily available to fund the project. This means that the rates and the development contributions must be compliant with the law. If it turns out that they are not – and the report only skims this issue – then the risk to Council is of having to refund a massive amount in rates and development contributions that have already been paid, and incurring even more debt to enable it to do this.

Another risk not mentioned is the requirement under the LGA that all development contributions collected must be used for capital expenditure and not for maintenance and interest repayments.

Have all the development contributions that have been collected actually been applied to capital expenditure or have they just disappeared into the melting pot to meet current expenditure? Questions need to be asked.

Current situation
It is clear that the whole EcoCare debt facility was doomed from the outset.  It did not meet the requirements of Circumstances and Certainty and should never have been allowed to pass GO.

In hindsight it is clear that the benchmarks of prudent financial management were always at risk of being breached, and as time went on with more monies being borrowed, and the likelihood of targets for new sections not being met, it would have been clear to any financial expert that Council was heading for a debt situation that was completely unsustainable.

The problem was that once it was kick-started it chugged along without anyone really knowing what was going on. It was a debt structure based on wrong assumptions, where the basic principles of financial prudence and sustainability had been ignored, where there was no provision to meet any further debt, and with no reporting and monitoring mechanisms.

Those who created the monster had been paid and were no longer interested. The time-bomb was left ticking and those left in charge - the Chief Executive and his staff, and Councillors - did not have the expertise, the ability, or the inclination to do anything about it. It was simply a question of time before the financial bomb went off.

Chief Executive and staff
The Chief Executive is responsible for the preparation of the accounts, the reporting and the monitoring of accounts. Therefore all the shortcomings that are set out in the PJ Associates report are the responsibility of the Chief Executive.

The PJ Associates report paints a picture of a completely dysfunctional financial system. The report is strewn with criticisms that underline the failure of the Chief Executive to meet the necessary “good practice” standards, to present accurate and meaningful accounts, to monitor the financial situation and re-examine the original assumptions of the EcoCare debt.

Note the pages of recommendations for reports and monitoring for the future. That is what the Chief Executive should have been doing since day one.

The Chief Executive’s lack of understanding of the true status of the Council’s core debt and segmented debt situation is illustrated by the fact that there is no mention of any problems relating to the debt, or breach of the benchmarks of financial prudence, in the Long Term Plan or the annual plans for the last few years.

However, the Chief Executive was well aware of the problems because there was a continuing need to raise more finance. It seems to me that Council’s finances were being operated on the Piggy Bank theory of financial management. If there is money in the Piggy Bank then spend it. If the money is running short then borrow some more.


3.  Some serious questions

What is the true size of the KDC debt?
The financial reports are full of errors and inconsistencies so that is impossible to get a true picture of Council’s total debt and its true financial position. Although the total debt is said to be $83 million or thereabouts I question whether this is accurate given the errors in the various accounts. For instance the draft annual plan for 2011-12 has, according to the PJ Associates report, understated borrowings by $16 million. Is this amount to be added to the $83 million?

We need to know the exact amount of Council’s debt as it stands now, and only a full independent forensic assessment could give us that figure.

In 2005 the Council debt was $8 million. In 2007 it was over $30million. In 2011 it is over $83 million.

I suspect that a deeper analysis would reveal a larger debt because of inaccuracies in the accounts that may only become obvious with a more radical audit.

Whatever the debt is now is not the end of the matter. The debt will have to increase because there is insufficient cash flow to meet the interest repayments and raising more debt is the only solution.

The proposed District Plan - if it goes ahead - will create a further massive debt liability which was glossed over by the PJ Associates report. Critics suggest that the true total cost of the plan will be far more than currently revealed by the Chief Executive and Mayor.

There is a potential blow out because of the legal situation in respect of development contributions and EcoCare rates with the probability that Council will have to borrow monies to enable it to make repayments to ratepayers.

Why is financial prudence suspended for a segmented debt?
 have to question the whole basis for the segmented debt process. It was invented to allow local authorities to borrow beyond what are considered to be the prudent benchmarks of local government financial management. By segmenting a specific debt that can be totally self-funding then that debt can be ignored when considering the benchmarks of prudent management for the core debt. It has been clothed in a lot of fancy theories to make it sound like a creditable mechanism for resolving debt problems.

The fundamental flaw, to my way of thinking, is that for some reason the benchmarks of prudent management are not applied to, and treated as completely irrelevant to, the segmented debt. I fail to understand why. If the core debt needs prudent management and benchmarks then why should the segmented debt not have the same? Calling it by a different name does not make it any different in essence. It is still a debt and there is no reason that it should not be treated with the same prudence as a core debt.

Is the notion of segmented debt mere financial puffery disguised in fancy theories?  In reality is it simply a convenient device for circumventing the rigidity of the benchmarks, the debt parameters or the Treasury Policies (or whatever) while still pretending that they have some universal credibility?

And if those benchmarks are so indictive of standards of financial prudence why are they breached by so many councils, and why are the breaches of the benchmarks ignored by auditors?

How can segmented debt be amalgamated with core debt?
The PJ Associates report is insistent that the segmented debt for EcoCare be spread across the whole district. In other words the segmented debt becomes part of the core debt.

It appears to me that the benchmark figures quoted in the report, which are said to be above the recommended upper limit, relate solely to the existing core debt of Council. If that is the case then surely the addition of the segmented debt of some $50 odd million to the core debt (of about $30 odd million) is going to blow those benchmarks to smithereens.

Am I missing something or is that the reality?

Or is that why Larry Mitchell is adamant in his report that the EcoCare debt must at all costs remain ring-fenced to those few hardy souls in the Mangawhai Ecocare Drainage District?

More on that to come.

4.  Where were the auditors?

The question is where were the auditors in all this? Why did we not hear them screaming about the benchmarks being exceeded or the segmented loans policy being in complete disarray?

What is the point of all this benchmark theory, the principles of sustainability, of Certainty and Circumstances, if, when the going gets tough, the auditors and everyone else simply ignore these high-flown principles and theories of financial prudence?

Surely the auditors knew about the segmented debt for EcoCare. Why did they not keep an eye on it and constantly prod Council and remind it of its obligations to constantly assess and re-examine the basic assumptions. Why did it endorse accounts that clearly did not present a true picture of Council's financial state?

Likewise, why did the auditors not pick up all the errors and inconsistencies that were picked up by PJ Associates and breached the requirements of the Local Government Act?

Are they in breach of their duty of care?

We had the same problem with the auditors (appointed by the Auditor General) missing the glaring omissions in the Long Term Plan in respect of the policy on development contributions, and the failure to include a definition of a SUIP in the funding impact statements. Both of these omissions, that the auditor should have picked up, have put Council at great risk financially.

It seems to me that auditors today have a lot to answer for. Just think of every finance company that ripped investors off. Think of South Canterbury Finance etc and ask why the auditors did not pick up what was going on.

(If any auditor thinks this criticism is unfair then please email me and tell me why.)




Financial Health and Sustainability Audit of Kaipara District Council

by PJ Associates dated 7 July 2011


*   Read the report itself

*   Read the Summary by legal Eagle

*   Read Legal Eagle's comments on the report


Summary by Legal Eagle
The audit highlights two major issues:

+  The high level of debt and lack of cash reserves caused by the Mangawhai Wastewater Scheme and the costs of the District Plan review.

Council financial reports do not provide sufficient information to monitor the financial health of the organisation. 

Findings from the review of Council documentation
The reviewer considers some of the Council's documentation including the 2009-19 long term plan, the annual report for 2009-10 and the draft annual plan for 2011-12. 

In spite of Audit NZ giving the long term plan an unqualified tick, the audit notes that the plan does not comply with section 100 Local Government Act because it does not disclose operating deficits in two years of the plan. 

The biggest issue however, is the financial model for the EcoCare rates and the overall debt assumptions based on that model. 

Debt assumptions
The Long Term Plan shows overall interest payable by Council as peaking at 25% of rates income.  This is higher than the recommended upper limit of 20%.  However the situation is in fact much worse because of material errors made by Council in its assumptions and its accounts.  Those errors are as follows: 

+  The additional debt required to pay for operating expenditure for the Mangawhai Scheme (to make up for the shortfall of rates) was not included in the overall debt of Council.  This debt figure is therefore understated.

+  In the cash flow statement in the long term plan the "opening cash position" was significantly overstated - by nearly $3 million - which created a need for additional borrowings.

+  Significant errors in the Council's annual report for 2009-10 and the draft annual plan for 2011-12 have increased the need for additional borrowings.

As a result of these errors the true picture of the debt situation shows that rather than interest peaking at 25% of rates income it will now in fact peak at 30 %.  Well beyond the recommended upper limit of 20%. 

In addition  there are problems with the Mangawhai Wastewater Scheme that have to be factored in. 

Mangawhai Wastewater Problems
I have quoted these directly from the report; 

1.  "The (financial) models as provided to me did not provide any sensitivity analysis as to changes in the projected number of new lots over a period of time. This poses the risk to Council that, should development slow beyond that predicted, there will be a shortfall in revenue. Currently there is no mechanism to identify the shortfall of revenue and how it is to be ultimately recovered." 

2.  "The PWC (PriceWaterhouseCooper) model (for Mangawhai) forecasts additional borrowing requirements. Council's (long term plan) model funded these borrowing requirements from Council Created Reserves. Unfortunately there are no reserves that could fund these borrowing requirements and therefore a fundamental error was made in the development of the (long term plan) and Council’s projected borrowings were understated." 

3.  "The current PwC model has different operations and maintenance expenditure when compared with Council's Annual Plan and (long term plan) models." 

4.  "There have been a number of comments and minor legal issues over the rates currently being set to recover the capital expenditure. As part of the next LTP these need to be re-consulted with the community." 

5.  "Accepted practice requires that the policy and methodology for assessing development contributions is included within the LTCCP (LTP). However, this Policy is not in the current (2009/19) LTCCP and therefore poses risk to Council."  

1.  "Because of the high value of both Development Contributions and the one off Targeted Rate (UTR), Council needs to ensure that all future income is based on a legally sound methodology and that all projected revenue is reasonable."

 2.  There is no certainty that Council will continue to pay reasonable interest rates and runs the risk (liquidity risk), at some time in the future of being unable to raise funds  at normal commercial rates.  There is a recommendation that an external Treasury adviser be appointed to help Council raise funds at a lower corporate level based on more accurate debt forecasting. 

3.  There is a consideration of the District Plan review and the associated borrowings.   

4.  Rate increases to fund the deficit caused by the high level of loans is also considered.  However the audit points to the average lower income of ratepayers in Kaipara, and concludes that at the end of the day such a move is a political decision.   

Templates for strategy and reporting
The audit then goes on to set out various templates for setting strategy and for financial reporting.  The report is critical of the current monthly financial report which does not include a cash flow statement or a balance sheet - "the last two items are critical for establishing overall financial sustainability".

Clearly the report considers that there has to be a new financial strategy developed with expert assistance, and there has to be regular financial reporting and monitoring to ensure that the strategy is adhered to. 

 "While the overall financial position of the Council is not positive, Council is in a unique position as being able to influence the future outcome because of the development of the next 2012/22 Long-Term Plan including Financial Strategy. 

"The key to the success will be ongoing regular financial monitoring to ensure that Council's financial direction is consistent with the financial strategy."




Leagle Eagles comments on the report

1.  Poor financial reporting
The financial reporting by Council has been woeful.  Financial reports have been contradictory at times and have not included the necessary information that is required to monitor the financial situation. 

2.  Errors in the financial model for EcoCare and elsewhere
The overall debt situation has not been correctly stated and therefore Council's projections for interest repayments have been based on incorrect figures.  The true projected interest payments are therefore well in excess of the recommended upper limit.

However, there are matters that the audit is silent on, or where insufficient emphasis is given to them.  

3.  Councillors denied access to financial information
For instance, the report omits to say that the Chief Executive has denied Councillors access to many of the financial reports and financial models.  It is hard to believe that Councillors could be denied access to such vital information when they are the ones who are supposed to make the financial decisions.  Perhaps what is even harder to comprehend is Councillors' meek acceptance of this state of affairs. 

4.  EcoCare non-compliance issues
There is a mention of "minor legal issues over the rates currently being set to recover the capital expenditure". There is also the recommendation that:  "As part of the next long term plan these need to be re-consulted with the community." 

This last sentence is rather ironic as the EcoCare rates and the appication to secondary units have never been "consulted with" the community.  With respect to the reviewer what he terms minor legal issues may well turn out to be major legal problems.  Not only that, they could turn out to be major financial problems.  If my submissions in respect of the validity of EcoCare rates are upheld, and I have no doubt that they will be, Council may well find itself having to refund a large part of the EcoCare rates charged over the last three years.  That may well just tip the Council over the financial edge. 

5.  Development contributions
In respect of development contributions the audit states; 

  "Accepted practice requires that the policy and methodology for assessing development contributions is included within the LTCCP (LTP). However, this Policy is not in the current (2009/19) LTCCP and therefore poses risk to Council." 

It is not simply 'accepted practice'.  The Local Government Act makes it a legal requirement that the policy on development contributions is included in the long term plan.  Legal Eagle has advised Council on many occasions that for this reason its policy on development contributions does not comply with the Local Government Act.  (The audit of the plan by Audit NZ failed to pick up this omission even though it is a matter that is clearly listed on its audit check-list.)   

The current audit suggests that "this poses risk to Council".  That is quite an understatement.  To quote from the Society of Local Government Managers (SOLGM) The Green Book: Developing Local Authority Revenue Systems - An Update:

 Although imposition of development contributions cannot be challenged in the Environment Court (as financial contributions may be), they may be challenged by judicial review in the High Court. One risk is that, if such a challenge is successful, it could invalidate all collection of contributions under the policy (and therefore have a much wider impact than an Environment Court challenge to a particular financial contribution).

It is a house of cards situation.  If one single development contribution is challenged and found to be illegal because of non-compliance with the Local Government Act, then all development contributions paid will have to be refunded.

6.  Future rates and development contributions
No wonder the reviewer made the recommendation: 

"Because of the high value of both Development Contributions and the one off Targeted Rate (UTR), Council needs to ensure that all future income is based on a legally sound methodology and that all projected revenue is reasonable."

This means that Council needs to ensure that all future rates are set in accordance with the Rating Act and the LGA, and that a new policy on development contributions is put in place as a matter of urgency.

The problem is that the EcoCare rates that have just been set for the 2011-12 rating year are totally defective and non-compliant and it is too late to do anything about it. 

The policy on development contributions is also non-compliant and this needs to be fixed immediately to ensure that future payments are legal. 

7.  Council's fundamental problems
The fundamental issue facing Council is that the Chief Executive and his staff simply do not have the expertise to be able to attend to these matters.  The audit report has highlighted the fact that the Chief Executive and his staff 's lack of financial nous has put Council in a very difficult financial position.  According to the audit the only way out is to appoint expert advisers who know what they are doing, and put in place appropriate strategies, reporting and monitoring. 

The situation is exactly the same with rates and legal compliance.  The Chief Executive and his staff do not have the competence to ensure that rates are set legally and that the development contributions are bullet-proof.  It is no good getting piecemeal legal advice after the event.  Council needs a full legal audit of the EcoCare rates and development contributions.  Once the problems have been identified then it needs to appoint an expert to see what can be salvaged from the rates debacle, and to oversee the drafting of all future rating and development contribution documentation to ensure that it complies with the law. 

8.  District Plan review
I find this part of the audit difficult to follow.  The figures presented appear to be based on surmise and assumptions for which there appears to be very little evidence.  No real conclusions are drawn and the whole matter seems to hang in the air.

Like the situation with the EcoCare rates and development contributions I suspect the vagueness of the audit disguises the potential for a huge blow-out in respect of this blighted venture. 

 9.  What is the conclusion of the audit?
The audit highlights the problems facing Council, sidesteps a few important issues, and suggests employing experts, setting a strategy and system of financial reporting and monitoring.  The conclusions to the report are as follows:

"While the overall financial position of the Council is not positive, Council is in a unique position as being able to influence the future outcome because of the development of the next 2012/22 Long-Term Plan including Financial Strategy.

"The key to the success will be ongoing regular financial monitoring to ensure that Council's financial direction is consistent with the financial strategy."

That says absolutely nothing.  As for Council being "in a unique position...etc", that is just meaningless verbiage.

What the audit does not say is how the interest bills are going to be paid.  It passes over briefly the possibility of ratepayers meeting the deficit, and that is all.  Perhaps, at the end of the day, it sees that as the only solution.

The other problem is that the audit is only concerned with Council's ability to meet the interest payments on the debt based on its own very narrow and rather optimistic projections.  Things may get much worse. 

With the lack of further lots being developed in the EcoCare area, and therefore minimal development contributions and one-off EcoCare rates, there will have to be more and more borrowings to meet interest payments alone. 

There may well be dramatic and unexpected capital costs required because of shortcomings in the design of the system. 

When the issue of the invalidity of the rates and development contributions comes to a head their will be a massive outflow of funds from Council to repay these illegal charges, and more debt will have to be incurred. 

There will come a stage when the interest burden will be too great.  Ratepayers will simply not be able to pay their rates.  Lenders will not lend to the Council, even with the help of a Treasury advisor, because the interest to rates ratio has gone through the roof.   Or if they do lend the greater risk will be reflected in the higher interest rates.  At present the recommended upper limit for the ratio of interest payments to rates is 20%.  Council figures show 25% at present.  The audit suggests the true figure is 30%.  Factor in some of the other projections made above and the ratio will be heading for 40%.

The other question that I have is:  What about the huge debt itself?  Is there any chance of that ever being paid off?  There is no mention of it in the audit and it appears that it is to be mill-stone around the necks of every person living in Kaipara for decades to come. 

I wonder how the Mayor and the Councillors feel about this huge debt, the huge interest bill and the legacy that they are leaving Kaipara ratepayers.