Corporate services committee meeting (5 May)

The corporate services committee meeting was held on 5 May 2016. Apologies were received from Cr Mirfin and Cr Dowler for absence, and Cr Ensor for lateness. All other councillors were present.

The agenda (requiring no decisions of council, other than to receive reports) included: (1) Treasury presentation from PWC, (2) Treasury report, and (3) Corporate services activity report. A confidential (in-committee) report in relation to the proposed sale of 11 Fittal Street in Richmond was discussed.

Treasury presentations

Brett Johanson and Jason Bligh from PricewaterhouseCoopers (PWC) gave a presentation on treasury matters. This included responding to questions presented by councillors.

Cr Bouillir and myself submitted several questions on behalf of some concerned residents of Golden Bay – much to the frustration of the chair (apparently this was not normal practice). In my opinion, one of the roles of a councillor is to ensure residents concerns are adequately addressed and answered – even if they may disagree with the outcome.

Unfortunately, Cr Norris took the opportunity throughout the rest of the day (as a bit of a running joke) to ask councillors if they were asking questions on behalf of someone else. While I could see the amusing side, some people might suggest this is a form of bullying or intimidation (ie, don’t ask questions on behalf of others, otherwise I will make fun of you all day).

My three questions on behalf of a Golden Bay resident were:

1. Why is our local authority paying an interest rate higher than I could obtain by walking into my local building society? At the time of the question was submitted, TDC was paying around 5.331% in interest.

2. Could the TDC provide factual examples of local authorities that have derived significant financial benefit from dealing in interest rate swaps?

3. If interest rates were to fall to say 1% for the remaining duration of existing swap contracts, what would the financial impact on TDC’s finances be at that time?

Background

Before jumping into PWC’s responses, its useful to understand how council borrows money and what “swaps” are.

At present, council continues to carry a large amount of debt. However, this total debt is actually made up of much smaller parcels of debt that have been entered into at different times, have different durations and end dates, and have different interest rate obligations. It’s also why council often talks in terms of “average” interest rates.

So what is a “swap”? A swap is a derivative contract whereby two parties exchange financial instruments (containing specified obligations). The swap agreement defines the dates when cash flows are to be paid and the way they are accrued and calculated. Swaps do not trade on exchanges.

Swaps can be used to: (1) hedge certain risks such as interest rate risk (which is what TDC is doing), or (2) speculate on changes in the expected direction of underlying prices or interest rates, in order to make money.

This later (revenue earning) type of swap is common in America, where local government might have their income (or total rates take) capped. In order to raise additional revenue above their cap (perhaps for an unexpected infrastructural expense), they use their capacity to service debt to raise income (by underwriting the interest rate risk of the other parties).

In the UK, the Hammersmith council entered into such an arrangement, and while making money at first (when interest rates were low), subsequently made substantial losses, when it had to underwrite the rising interest rate obligations of the other party. The TDC is “not” engaged in these type of swap arrangements. Rather, the TDC has entered into swaps to reduce exposure to interest rate risk, not make money.

The most common type of swap is an interest rate swap that has the effect of transforming a fixed rate loan into a floating rate loan (or vice versa). TDC has a number of floating rate loans. In order to obtain interest rate certainty and mitigate risk, TDC has entered into a number of swap contracts. Council also has the the opportunity to blend (and\or extend) SWAP agreements where they provide TDC financial advantage (ie as interest rates lower).

Is TDC paying to higher an interest rate?

PWC advised that TDC borrows at commercial rates, not domestic mortgage rates. TDC also borrows funds on longer terms than the average domestic mortgage. Most domestic mortgages will be on a short term 1-year floating rate, or fixed for short durations (perhaps 1-3 years, before they are reviewed). The approach of PWC is to borrow funds on the 5 year interest rate market. This is because most TDC assets will have a life expectancy of at least 5 years (or more). At present, TDC’s borrowing costs are tracking well below the 5-year mortgage rate.

2016-swaps-5yr-rates

Does TDC (or PWC) have evidence of swaps benefiting local authorities?

PWC advised that they did not have an immediate answer to this question (as they were not given these questions in advance of this meeting, but were open to providing this information from their global network of resources). At this point, the chair intervened, and suggested the question was not an invitation for PWC to charge TDC for making further investigations. The chair, then asked if I had any other questions.

In answer to the question, over the past 10 years, TDC has consistently achieved a lower interest rate than either budget or the 5-year mortgage rate (see above graph). Further, between 1999 and 2008, as interest rates were climbing, significant financial benefits accrued to TDC.

It is also widely acknowledged that some councils have benefited from swaps. Significantly, the following observation comes from a website (www.debtresistance.uk/the-ghosts-of-hammersmith-fulham-the-return-of-toxic-council-derivatives-debt/) that criticises some forms of swaps. It states:

… some councils had “guessed right” with their interest rate bets, and were profiting handsomely from the trades, whilst others, such as Hammersmith taxpayers faced a potential bill …

Importantly (and to avoid any confusion) the Hammersmith scenario was a different type of swap arrangement to the type TDC has entered into. Hammersmith was benefiting from rates going down (effectively covering others from rates going up), rather than hedging against rates going up.

TDC is not entering swaps to make money, nor is it covering other parties from interest rate increases. Rather it is using swaps to consolidate a mixture of different interest rates and debt parcels, as well as mitigate the risk of 5-year interest rates going up. Effectively, swaps are being used as a risk management tool.

In my opinion, the above information supports the proposition that some councils have benefited from swaps.

What happens if interest rates drop?

PWC advised that they are continually reviewing the swap market to take advantage of any downward movements. Unlike a domestic mortgage, TDC has a large number of loan arrangements that have different start and end dates. TDC does not have one single loan arrangement. Similarly there are a number of separate swap arrangements that cover those loans. As arrangements come up for renewal, there is an opportunity to take advantage of a lowering market. This is why TDC’s average interest rate has been falling over the last year or two.

In reality the Council acts within the overall strategy of keeping rates down, as interest rates move. When interest rates drop the Council uses tools such as “forward starts”, or “blends and extends”, to take advantage of the movement at the time and to capture the low rates, as swaps come due.

Council’s ability to manage the forward risk in interest rate movements is greater than the person who goes into their local building society and borrows say $100,000 for 2 years at a fixed interest rate of 4.99%. If interest rates fall to say 1% for the remaining duration of their loan agreement they are faced with a break fee or toughing it out until their mortgage matures. TDC has more options than that.

More information

These questions were again answered in more detail in the Golden Bay Community Board meeting (which I also attended), see the Agenda (from page 11) at: www.tasman.govt.nz/council/council-meetings/community-boards-meetings/golden-bay-community-board-meetings/?path=/EDMS/Public/Meetings/GoldenBayCommunityBoard/2016/2016-05-10. See also the Golden Bay Weekly (27 May 2016, page 6) at www.gbweekly.co.nz/uncategorized/27-may-2016/#27-may-16/page1. For NZ swap rates, see: www.interest.co.nz/charts/interest-rates/swap-rates.

Treasury report

Council’s debt at 31 March 2016 stood at $134.5 million, with an average interest rate of 5.417% (contrasted to June 2015 when it was 5.166%).

Council’s actual weighted average cost of funds at 31 March 2016, including interest rate swaps, bank margins, and line fees at 5.464% against a budgeted rate of 5.7%. The gradual decrease is from more favourable terms resulting from the refinancing of the bank facilities and favourable 2 to 4-year term swap rates. The ‘spike’ in the weighted average cost of funds for September and December 2015 and March 2016 are due to a lower debt position. This has meant that the Council’s debt is currently over covered by interest rate swaps which are at a higher rate than current floating debt rates.

At 31 March 2016, the Council had $147.78 million of interest rate swaps in place, including some “forward start” swaps. After adjusting for the forward start swaps, $144.78 million is “live” which is equal to 108% cover over existing debt and 87% over forecast 31 March 2017 net debt (ie 12-month debt). I asked staff when the debt levels and swap coverage would realign. Staff advised that they anticipated alignment by the end of June 2016.

Existing committed bank facility expiry dates and term debt maturity dates are spread based on defined maturity band limits of 0-3 years, 3-5 years and 5 years plus. Minimum and maximum percentage limits within each time band ensure a spread of maturities and reduce the risk of maturity concentrations.

The Council currently has $30 million in private placements. The private placements allow the Council to place longer term debt in the years between the Local Government Funding Agency (LGFA) issues. The Council also has $90 million of debt placed with the LGFA.

Bank Cash/Cash Investments $Million Notional Swaps $Million Credit Exposure $Million Compliance
Westpac $1.21 $63.05 $13.67 Within Policy
ASB $2.37 $41.73 $13.28 Within Policy
ANZ Nil $43.00 $11.11 Within Policy

The objective is to have a mix of 80% debt capital markets (such as the LGFA, private placements and commercial paper) and 20% committed bank facilities. The current mix is as follows:

Funding Source

Amount $Million

Percentage

Bank Debt

$14.50

10.80%

Private Placement

$30.00

22.3%

LGFA Debt

$90.00

66.9%

Total

$134.50

100.00%

Corporate services activity report

Highlights from the manager’s report included:

  • Finances. The department will end the year with a surplus, mostly driven by the treasury function. Tight and active management of treasury combined with benign external factors have reduced loan costs and high cash balances have increased interest income above budgeted levels. It is intended that part of the surplus will be used to repay outstanding treasury loans in relation to the LGFA share purchase.
  • Commerce commission. Work on port charges (and valuation) by PricewaterhouseCoopers and Simpson Grierson is drawing to a conclusion and a response to the Commerce Commission from council should be made within the next 6 weeks (ie June 2016).
  • Property. The Property section continues to operate at reduced capacity. A replacement for the Property Officer has been appointed and started on 2 May.
  • Aerodromes. Aerodrome landing charges are set to increase by $1 from 1 July 2016. The Motueka road sealing (hangar access) is currently on hold and likely to be cancelled.
  • Campgrounds. Overall campground income is up and expenditure down slightly on budgeted levels. The overall profit is $156,000 which confirms a good season and tight financial management. Infrastructure failures at Collingwood campground have stabilised.
  • Mapua. The tail end of the works related to the Shed 4 build and improvements to the public areas is underway. A report on the budget over-run is being prepared and is subject of a separate report to this Committee. Council officers are arranging for an additional temporary resource to assist in developing a Strategic Plan for the wider Mapua area (including the wharf, waterfront park, Grossi Point and remediated land). This strategic plan will assist in managing the competing interests in the area and ensure that agreed outcomes are met. The prospective purchaser of the Mapua causeway has advised that they no longer wish to pursue the purchase option. They have a right of renewal for five years under the current license to occupy.
  • Forestry. The forestry management tender process has been completed with PF Olsen Ltd being the successful tenderer. Income in forestry is forecast to be up on budget for the year due to higher market prices and increased cutting volumes. The current underspend on maintenance will correct by year end due to roading work in the Sherry and Borlase forests as we prepare for upcoming harvesting at those sites.
  • Port Tarakohe. Volumes over the wharf are good. The marina occupancy is stable. The YTD profit (for February) is $20,000, against a budgeted loss of $78,000.
  • Port Nelson. Port Nelson Ltd has declared an interim 2016 dividend of $1.5 million, of which $750,000 comes to TDC. Cr King is currently a director on the Port Board and is due to retire at the AGM on Friday 23 September 2016. His appointment was extended until March 2017 to allow a newly formed council to make the next appointment. It should be noted that council policy prohibits the reappointment of a director for a fourth successive term, unless there are special circumstances. Given the experience of other directors already on the board (see http://www.portnelson.co.nz/about-the-port/directors/), I cannot see why a any re-appointment of Cr King would be required.
  • Legal. The Council sought legal advice around the ability to ban (wicked camper vans) from the Council’s campsites, the summary being: (1) Any ban needs to be around the offensive slogans or images, not around specific provider, (2) Leased sites are not able to be controlled by the Council, unless our leases specifically permit it (which they currently do not) or each lessee agrees to it. It would not be commercially prudent to exert this control over our lessees’ businesses. However, discussions with the lessees has indicated a willingness to work with the Council. Collingwood campground is the only current operated site that can be controlled via an immediate Council policy. All four Council-owned commercial campgrounds, regardless of being leased or operated, are insisting on those slogans being covered before entry into our campgrounds. Staff recommended that no formal action is required, as the matter is being dealt with effectively at each campground.
  • Information technology. Digital Strategy interviews and staff workshops have been completed and the findings and proposed strategic priorities will go to a Councillor workshop on 28 April 2016. The new Council file structure is being tested across all departments between April and July 2016. Once testing has been completed and signed off, the new structure will be installed into our document management system and the process of moving departmental documents and records across will begin. This will involve document process reviews and training of staff to ensure the transition is successful. It is planned for all departments to be working within the system by the end of 2016. The final upgrade of the Confirm Enterprise asset management system took place during the weekend of 16 April 2016. Additional security cameras are being added to the Customer Services area of the Main Office. Information Services are now managing the security camera infrastructure.
  • Nelson Airport. The airport half yearly report and draft 2016-17 Statement of intent were considered by the Joint Shareholders Committee (comprising the mayor, deputy mayor, committee chairs, and audit subcommittee chair) on 15 April 2016.
  • Action items. Mapua land (vacant corner site) – Mike Drummond to report back within 12 weeks on potential alternate uses of this land.

Agenda and minutes

The agenda and minutes are located at: www.tasman.govt.nz/council/council-meetings/standing-committees-meetings/corporate-services-committee-meetings/?path=/EDMS/Public/Meetings/CorporateServicesCommittee/2016/2016-05-05.

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