The Authority, a body corporate, was established under the Local Government Finance Authority Act 1983 (the Act). It is managed and administered by a Board of Trustees. In accordance with the Act the Board consists of seven members and up to two co-opted additional members.
The functions of the Authority, as specified in subsection 21(1) of the Act, are to develop and implement borrowing and investment programs for the benefit of Councils and prescribed local government bodies; and to engage in such other financial activities as are determined by the Minister, after consultation with the Local Government Association, to be in the interest of local government.
In addition, subsection 21(2a) of the Act provides that the Authority must not make a loan, other than one to a Council or prescribed local government body; make an investment; or enter into a partnership or joint venture or form a company, except with the approval of the Treasurer.
Liabilities incurred or assumed by the Authority in pursuance of the Act are guaranteed by the Treasurer pursuant to subsection 24(1) of the Act. As a result of this guarantee the Authority pays an annual guarantee fee to the Treasurer.
The net profit (in total or in part) of the Authority may be distributed amongst the Councils and local government bodies with which the Authority has entered into financial arrangements. Distributions are described as bonus payments in the Accounts.
Activities for the year resulted in a profit from ordinary activities before income tax expense of $2.6 million($4 million).
Reserves increased by $0.7 million to $45.7 million.
Total assets increased by $32.8 million and total liabilities increased by $32.1 million.
Subsection 33(2) of the Local Government Finance Authority Act 1983 specifically provides for the Auditor-General to audit the accounts of the Authority in respect of each financial year.
The audit program covered all major financial systems and was directed primarily towards obtaining sufficient evidence to enable an audit opinion to be formed with respect to the financial statements and internal control.
During 2001-02 specific areas of audit attention included:
interest income, other income and expenses
council loans, advances, and deposits
investments, derivatives and investment income
administrative expenses including payroll
borrowings, derivatives and interest expense
budgetary control and management reporting
computer information systems environment.
During the year a letter communicating issues arising from the audit was forwarded to the Chief Executive Officer of the Authority and a written response was received. Further details relating to these issues are contained in ‘Audit Findings and Comments’ hereunder.
The review of the internal control structure of the Authority concluded that an adequate system of internal control, including segregation of duties, delegations of authority and an independent checking activity, was in place and operating effectively.
The Authority operates the computerised Quantum Treasury Management System which accounts for the majority of the Authority’s financial transactions. A review of Quantum was undertaken as part of the audit coverage in 2001-02. The review covered controls over information resource strategy and planning, information systems operations, information security, business continuity planning, applications systems implementation and maintenance, database implementation and maintenance, network, systems software and hardware support.
Controls were assessed and tested and it was concluded that they were adequate, in place and operating effectively.
In addition to the scope of audit previously mentioned, a review was conducted of the investment and loan provided by the Authority to the Ecouncils e-commerce venture, which commenced operations during 2000-01. It was noted that Board approval was given for the Authority to participate in this venture. Approval was also obtained from the Minister for Local Government and the Treasurer, as involvement in the e-commerce proposal constituted an investment of a nature which required approval under the Local Government Finance Authority Act 1983.
In monetary terms, the Authority has $50 000 invested in the LGCS Unit Trust (LGCS), the organisation trading as Ecouncils, and a convertible cash advance debenture facility for $700 000 has been approved for LGCS of which $683 000 has been drawn. This results in a total exposure to the LGFA of $733 000. As LGCS has no assets as such, this cash advance debenture is effectively unsecured (unlike council loans which are secured over general revenue of the council). As there is no effective security for the loan, this would indicate a risk as to the recovery of the loan which is dependent upon the success of the venture.
Given the degree of risk inherent in this venture, it was recommended that the Board of the Authority closely monitors the financial position of LGCS in order to assess its ability to make interest payments and to repay its debt when it becomes due. As reporting to the Board of the Authority was only a narrative presentation, it was also recommended that the Board obtain at least quarterly financial statements of the LGCS. This would enable the Board to assess and monitor the valuation and recovery of the investment and loan made to LGCS. It was further recommended that should recovery be doubtful, then consideration be given to either writing down the loan, or establishing a provision for doubtful debts.
In response to the matter raised, the Chief Executive Officer advised that the Board of the Authority had requested to be provided with quarterly financial statements of LGCS so that the Board could monitor progress.
Audit will continue to monitor developments as to the security of the investment and recovery of the loan made.
As required by subsection 36(1)(a)(iii) of the Public Finance and Audit Act 1987, the audit of the Local Government Finance Authority included an assessment of the controls exercised in relation to the receipt, expenditure and investment of money, the acquisition and disposal of property and the incurring of liabilities. The assessment also considered whether those controls were consistent with the prescribed elements of the Financial Management Framework as required by Treasurer’s Instruction 2 ‘Financial Management Policies’.
Audit formed the opinion that the controls exercised by the Local Government Finance Authority in relation to the receipt, expenditure and investment of money; the acquisition and disposal of property; and the incurring of liabilities, were sufficient to provide reasonable assurance that the financial transactions of the organisation were conducted properly and in accordance with law.
The Authority achieved a profit from ordinary activities before tax of $2.6 million ($4 million) and a net profit of $1.8 million ($2.6 million) which was available for appropriation.
The profit and principal distributions from the total profit available for appropriation for the past five years are presented in the following chart:
The decrease in profit in 2001-02 shows in the trend of profit before tax to average assets as demonstrated in the following chart.
The amount of $1.8 million in 2000-01 was higher (about double) the income generated from this deal in prior years and the effect of that boost in revenue in 2000-01 is clearly evident in the preceding chart.
Future profitability levels, all other things being equal, would be more likely to be in the order of that achieved in 2001-02.
The following chart highlights that in terms of financial performance while profitability has reduced overall, the Authority has re-established a net average interest margin in the order of (but slightly higher) than what was achieved prior to 2000-01.
The net interest revenue in 2001-02 was $331 000 higher than the previous year also in part due to the increase in loans to councils and local government bodies. Margins of this order will be necessary to maintain profitability achieved in 2001-02 in the future. Details of interest margins are provided in Note 21 to the accounts.
The following chart indicates that while operating expenses (other than interest expenses) reduced to $1 863 000 from $1 947 000 in 2000-01, as a proportion of net operating revenue (net of interest expenses) there was a substantial rise. This reflects the substantial reduction in net operating revenue from previous years.
Again, with the maturing of the structured finance deal and reduction in related revenue, this ratio is, all other things being equal, likely to remain around the 2001-02 level.
As from 1 June 1996, the Authority came under a Taxation Equivalent Payments System and is required to make payments equivalent to Company Income Tax. The amounts are paid into an account established with the State Treasurer titled the ‘Local Government Taxation Equivalents Fund’ and the funds are then available for local government development purposes as recommended by the Local Government Association of South Australia and agreed by the Minister for Local Government in accordance with section 31A of the Local Government Finance Authority Act 1983. For this financial year, the amount payable for income tax equivalent was $0.8 million.
Under subsection 22(2) of the Local Government Finance Authority Act 1983, the Authority has discretion to make distributions from the surplus for the year to Councils and local government bodies. These distributions are recorded as bonus payments in the financial statements. In 2001-02, a provision for a bonus payment of $1.1 million was made which was consistent with amounts provided in the previous year.
The following chart shows net profit, the provision for bonus payments and the ratio of the provision for bonus payments to net profit for the past five years.
This chart highlights the consistency of the amount of the provision for bonus payments, (average of $1.1 million per year) and the net profit up to 2001. As indicated the provision for 2002 represents a substantially higher proportion of net profit than the previous four years.
The Statement of Financial Position shows assets of $362.2 million and liabilities of $316 million at 30 June 2002 compared with corresponding amounts of $329.4 million and $283.9 million at 30 June 2001.
The increase in assets and liabilities was due mainly to the following:
the increase in assets was due to an increase in Loans and Advances made to Councils and Local Government Bodies of $32.6 million (10.4 percent); and
the increase in liabilities resulted from an increase in Deposits from Councils and Local Government bodies of $41.2 million (25.5 percent).
The Authority predominantly lends to councils and local government bodies on a secured basis. The security is by debentures providing a charge over the Council’s general revenue. Note 1(g) and Note 8 to the accounts explain the details.
The Authority has not experienced defaults or losses associated with those loans and as a consequence has no provision for doubtful debts against the assets.
The following table displays the variations in the composition of major liabilities over the period 1999-2000 to 2001-02. Accrued interest payable, provisions and other liabilities have been excluded from the analysis.
Analysis of Liabilities
The table highlights the trend in the composition of the Authority’s liabilities. In recent years reliance is being placed on deposits from Councils and Local Government Bodies and short term money market borrowings to fund the Authority’s lending activities.
During recent years, the Authority has moved towards placing more reliance on the funding of loans to Councils via deposits lodged by Councils. Put simply, the Authority borrows short term to take advantage of low interest rates and lends long term. Interest rate exposures are hedged through the use of interest rate swap agreements and futures contracts. The fixed side of the ‘swap’ is organised so that the Authority achieves a small interest profit margin on each loan. On the variable side of the ‘swap’, the Authority receives from its derivative financial institution, the 90 day bank bill swap rate which covers the interest paid to Councils for deposits at the at call rate. Therefore, any movements in interest rates are hedged allowing the Authority to achieve a small interest rate margin. Note 20(a) to the Financial Statements refers to interest rate risk management.
The Authority appropriated $0.7 million from total profit available for appropriation to the General Reserve, resulting in a balance as at 30 June 2002 of $45.7 million.
Total equity of the Authority amounted to $46.2 million as compared to total assets of $362.2 million. The equity comprises a General Reserve of $45.7 million, and Retained Profit of $0.5 million. In relation to the General Reserve, the earlier produced table titled Profit and Distributions demonstrates the policy of regularly appropriating a significant portion of the profit to that reserve ($7.7 million over the five years to 30 June 2002).
The total equity is invested in financial securities and in loans and advances. Equity has no corresponding cost of capital and generates investment returns. These returns provide a buffer for the Authority against unforeseen unfavourable impacts on revenues and expenses.
The following chart shows the trend of equity to loans and advances over the past five years.
The chart highlights that notwithstanding the increase in equity through retained profits and transfers to reserves, the ratio has fallen in 2002 with the substantial increase in loans and advances (10.4 percent). As indicated previously, the majority of these loans are secured by debentures.