Internal Borrowing
Wednesday, May 29, 2013 at 11:23AM
Bill Barclay

One subject that constantly causes puzzlement amongst colleagues of mine is that surrounding the logic, process and effects of 'Internal Borrowing'. You will have noticed from previous posts that the self-appointed 'guru' of council debt throughout the country - Mr Larry Mitchell, wont even go there when commenting and rating councils on their debt/rates performance, thus compromising the integrity of his conclusions. 

This is a shame, because the general public are entitled to know just what it is that councils get up to in order to disguise and obfuscate their actual financial position. 

Once upon a time, reserves were just that - funds put away through legislated depreciation deductions that enabled infrastructure to be replaced in a timely manner. 

Then someone had the bright idea that it would be better to borrow against those reserves rather than going to the market for funds when new capital works expenditure was required, and short of borrowing or jacking up rates, the funds were simply not available. The concept was that internal borrowing would be repaid by the time that the infrastructure for which the particular depreciation had been set aside was required to be replaced. This is I imagine the average Joe Blow's understanding of the position.

Even better, it could be well hidden within the accounts and everyone would be happy - particularly fiancially unsophisticated councillors who would have no idea that the wool was being pulled their eyes as long as their re-election prospects were enhanced by the practice. 

What is even more remarkable is that the regulating authorities - namely the Auditor General, permitted the deception to take place in plain view, and so we have reached the situation where reserves are fully drawn, and when infrastructure needs to be replaced, the cupboard is bare. Never mind how this is dealt with in the case of companies - there are are many and varied methods adopted that comply with the requirements of the Companies Office and the IRD.

The situation with councils is quite different because it is our money that they are playing with, and the methods adopted vary greatly between the various public bodies. TCDC is at a disadvantage because it has virtually no source of income other than rates, and over the years it has adopted every possible available technique to keep right on the edge of income/expenditure. One of those techniques (and it is by no means the only public body to have done so), has been to take full advantage of whatever internal borrowing that it was able to undertake within the limit of the available reserves - currently at 100%, and varying up and down around the $50m mark, and 'rolled-over" annually as desribed below. 

A similar situation exists on a far larger scale in Auckland as the result of the consolidation of the accounts of the eight previous councils, and has suddenly come to the attention of Cameron (Whaleoil) Slater - he has written an "Emperor has no clothes!" post on the subject today in regards to the Auckland Council: 

"On depreciation each former council of Auckland should have had a book value (asset) attributed to that capital derived income (depreciation). It would appear that councils have for years loaned money from one part of the ledger to another as internal loans.

Internal loans do not have to be declared. If they were, they would affect the credit rating of a Council (presuming they have not repaid the loans). I think that to avoid the embarrassment of showing on the books a declining asset base and the declining capital income accrued, councils play an accounting trick by revolving the internal loans annually to keep from declaring them. So rather than repay them, they simply never repay them and the amount on the books that is borrowed gets bigger and bigger. But because it is a loan it will likely be that treasury will continue to consider it an ‘asset’."

This is interesting for a number of reasons, not the least of which is the fact that most rate-payers appear utterly oblivious to this little accounting ploy, though anyone in business generally shakes their head with the comment - "How do they get away with it?"

On the face of it, it appears to defeat the whole purpose of depreciation, and transfer not only the cost of new infrastucture to future generations through additional external borrowing ($22m in our case up to 30 June 2014), but indeed the total cost of replacing existing infrastructure. 

This is what makes a total nonsense of the argument surrounding generational transfer that lies at the heart of Leach's 'rate-reduction' policy. Through this little boondoggle we are literally able to have our cake and eat it - for cake, read assets. 

This whole nonsense is a trick that has been foisted on large numbers of rate-payers throughout the country - not the least here in TCDC, and chickens will surely come home to roost when future generations of councillors realise that they have screwed over in no uncertain terms.

There is no free lunch - Leach's boast of having achieved the greatest rate decrease in the entire country is nothing more that a illusion, and re-election ruse. It is a great pity that so few of his supporters and rate-payers in general are able to see through it, and it is deplorable that staff have for so long been aiding and abetting the process.

 

 

 

Article originally appeared on BillBarcBlog (http://billbarclay.co.nz/).
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