LOCAL GOVERNMENT FINANCE AUTHORITY OF SOUTH AUSTRALIA

 

 

FUNCTIONAL RESPONSIBILITY AND STRUCTURE

 

Establishment

 

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.

 

Functions

 

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.

 

Structure

 

The Authority operates with a staff of six including a Chief Executive Officer, a Manager Lending, and a Manager Funding and Investment with other staff providing accounting and administrative support.

 

Guarantee by 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.

 

 

AUDIT MANDATE AND COVERAGE

 

Audit Authority

 

Audit of the Financial Report

 

Subsection 31 (1) (b) of the Public Finance and Audit Act 1987, provides for the Auditor-General to audit the accounts of a public authority.  In addition, 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.

 

Assessment of Controls

 

Subsection 36(1)(a)(iii) of the Public Finance and Audit Act 1987 provides for the Auditor-General to assess the controls exercised by the Local Government Finance Authority of South Australia in relation to the receipt, expenditure and investment of money, the acquisition and disposal of property and the incurring of liabilities.

 

This assessment also considers whether those controls are consistent with the prescribed elements of the Financial Management Framework as required by Treasurer’s Instruction 2 Financial Management Policies.

 

Scope of Audit

 

The audit program covered major financial systems and was directed primarily to obtaining sufficient evidence to enable an audit opinion to be formed on the financial statements and internal controls.

 

During 2005-06, specific areas of audit attention included:

 

·                     Board of Trustee minutes

·                     budgetary control and management reporting

·                     investments and investment income

·                     debenture loans, cash advance debentures and interest income

·                     short-term borrowings, deposits, borrowings and interest expense

·                     derivatives transactions

·                     operating expenses and salaries and wages.

 

 

AUDIT FINDINGS AND COMMENTS

 

Audit Opinions

 

Audit of the Financial Report

 

In my opinion the financial report presents fairly in accordance with the Treasurer’s Instructions promulgated under the provisions of the Public Finance and Audit Act 1987, applicable Accounting Standards and other mandatory professional reporting requirements in Australia, the financial position of the Local Government Finance Authority of South Australia as at 30 June 2006, the results of its operations and its cash flows for the year then ended.

 

Assessment of Controls

 

In my opinion, the controls exercised by the Local Government Finance Authority of South Australia in relation to the receipt, expenditure and investment of money, the acquisition and disposal of property and the incurring of liabilities are sufficient to provide reasonable assurance that the financial transactions of the Local Government Finance Authority of South Australia have been conducted properly and in accordance with law.

 

Audit Communications to Management

 

Matters arising during the course of the audit were detailed in a management letter to the Chief Executive Officer.  The response to the management letter was considered to be satisfactory.  Matters raised with the Authority and the related responses are considered herein.

 

LGCS — Shared Services

 

A follow-up review was conducted of audit matters raised in 2004-05 in relation to the loan provided by the Authority to the LGCS Unit Trust, which commenced operations during 2000-01.  The Authority has provided the LGCS Unit Trust No. 1 (LGCS), the organisation trading as Local Government Corporate Services, a convertible cash advance debenture facility of $700 000 of which $683 000 was drawn down.  The loan was due for repayment in January 2006.  As LGCS has no major tangible assets, this cash advance debenture is effectively unsecured (unlike council loans which are secured over general revenue of the council) and the recovery of the loan is dependent upon the success of the venture.  

 

Audit reviewed the financial performance of LGCS to assess likely recoverability of the loan and compliance with the new Australian Accounting Standard AASB 128 Investments in Associates.  The follow-up review included an examination of LGCS’s latest available audited financial statements for the year ended 30 June 2005, a review of the recoverability of the loan and compliance with AASB 128.  That review revealed that LGCS accumulated losses (as at 30 June 2005) were $815 000 and its net assets deficiency $715 000 (liabilities exceeded assets).

 

The loan was not recovered by January 2006 and therefore under AASB 128, the interest in an associate (LGCS is classified as an Associated Company) should not only include shares but also long-term receivables or loans, therefore the loan to LGCS of $683 000 should be shown separately and written down by LGFA’s half share of the losses of LGCS.  The matter was raised in a management letter to the Chief Executive Officer and the recommendation made for the Authority to consider a write-down.

 

In response to the matter raised, the Chief Executive Officer advised the following:

 

·                     The loan facility (due in January 2006) was extended (to January 2011) and provides that the loan funds can be repaid on an overnight basis.  This therefore does not qualify as a long-term loan (under AASB 128) and the requirement of the standard to bring a half share of losses of LGCS to account under the equity method of accounting does not apply.

 

·                     The improved cash flow forecast of LGCS shows that cash surpluses can be used to commence repayments of the loan.  To this end a loan repayment of $50 000 was made by LGCS in June 2006, reducing the balance outstanding to $633 000.

 

 

INTERPRETATION AND ANALYSIS OF FINANCIAL REPORT

 

Highlights of Financial Report

 

	2006	2005	Percentage
	$’million	$’million	Change
OPERATING INCOME
Interest income	48.7	46.9	4
Total Income	48.7	46.9	4
EXPENSES
Interest expense	42.6	41.4	3
Guarantee fee, administration and other expenses	2.3	2.1	10
Total Expenses	44.9	43.5	3
Profit before tax	3.8	3.4	12
Income tax expense	1.1	1.0	10
Net Profit	2.7	2.4	13
Net Cash Flows from Operations	2.7	2.8	(4)
ASSETS
Investments, loans and advances	432.9	404.7	7
Other assets	10.2	16.3	(37)
Total Assets	443.1	421.0	5
LIABILITIES
Deposits and borrowings	386.0	361.5	7
Other liabilities	7.3	10.8	(32)
Total Liabilities	393.3	372.3	6
EQUITY	49.8	48.7	2

 

Income Statement

 

Income

 

As the Authority is a financial institution servicing Local Government, its main operating revenue is interest income with other income being insignificant.  For the four years to 2006 a structural analysis of interest income for the Authority is presented in the following chart.

 

 

The increase in interest income in 2006 reflects increases in the average balance of loans and advances and the hedge receipts notional balance.  Details of interest income, interest rates and balances are provided in Note 24 to the accounts.

Expenses

 

As the Authority is a financial institution servicing Local Government, its main operating expense is interest expense with guarantee fee, administration and other expenses being less significant.

 

For the four years to 2006 a structural analysis of the main operating expense items for the Authority is shown in the following chart.

 

 

The increase in interest expense in 2006 reflects increases in the average balance of deposits and the hedge payments average notional balance.  Details of interest expense, interest rates and balances are provided in Note 24 to the accounts.

 

Profit Before Tax

 

The following chart shows the income, expenses and profit before income tax expense for the four years to 2006.

Profit and Distributions

 

In 2005-06 the Authority achieved a profit before tax of $3.8 million ($3.4 million) and a net profit after tax of $2.7 million ($2.4 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.

 

 

Profit before tax increased by $400 000 (12 percent) in 2006 due to interest income increase of $1.8 million while interest expense only increased by $1.2 million.  That reflects minimal changes in interest rates but some increases in the average balances of loans and deposits (Note 24 refers).

 

Net Average Interest Margin

 

The following chart highlights that the Authority has established a net average interest margin of the same order for the past four years.

 

 

Details of interest margins are provided in Note 24 to the accounts.

 

Tax Equivalent Payments

 

The Authority is required to make payments equivalent to Company Income Tax under the Taxation Equivalent Payments System.  The amounts are paid into an account established with the State Treasurer titled the ‘Local Government Taxation Equivalents Fund’.  The funds are 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 $1.1 million.

Provision for Bonus Payments

 

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 2005-06, a provision for a bonus payment of $1.5 million was made which was consistent with amounts provided in the previous year.

 

The following chart shows net profit after tax, the provision for bonus payments and the ratio of the provision for bonus payments to net profit after tax for the past four years.

 

 

This chart highlights the consistency of the amount of the provision for bonus payments, (average of $1.3 million per year) for the 2003 to 2006 years.

 

Balance Sheet

 

Assets and Liabilities

 

For the four years to 2006, a structural analysis of assets and liabilities is shown in the following chart.

 

 

The Balance Sheet shows assets of $443 million and liabilities of $393 million at 30 June 2006 compared with corresponding amounts of $421 million and $372 million at 30 June 2005.

 

The increase in assets and liabilities was due mainly to:

·                     an increase in the Asset — Net Loans and Advances made to Councils and Local Government Bodies of $28.1 million (7 percent);

·                     an increase in the Liability — Deposits from Councils and Local Government bodies of $52.7 million (19.6 percent) offset by a decrease in borrowings of $28.1 million (30.1 percent).

Asset Quality

 

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 9 to the Financial Report 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.

 

Liabilities of the Authority

 

The following chart displays the variations in the composition of major liabilities over the period 2003-04 to 2005-06.  Accrued interest payable, provisions and other liabilities have been excluded from the analysis.

 

 

The chart highlights the trend in the composition of the Authority’s liabilities.

 

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 21(a) to the Financial Report refers to interest rate risk management.

 

General Reserve and Equity

 

The Authority appropriated $1 million from total profit available for appropriation to the General Reserve, resulting in a balance as at 30 June 2006 of $49.1 million.

 

Total equity of the Authority amounted to $49.8 million as compared to total assets of $443 million.  The equity comprises the General Reserve of $49.1 million, and Retained Profit of $0.7 million.  The earlier produced table titled ‘Profit and Distributions’ demonstrates the policy of regularly appropriating a significant portion of the profit to the General Reserve ($4.1 million over the five years to 30 June 2006).

 

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 six years.

 

 

The chart highlights that, notwithstanding the increase in equity through retained profits and transfers to reserves, the ratio has fallen in 2002 through to 2006 with the increase in loans and advances (7 percent in 2006).  As indicated previously, the majority of these loans are secured by debentures.

 

Cash Flow Statement

 

The following table summarises the net cash flows for the four years to 2006.

 

	2006	2005	2004	2003
	$’million	$’million	$’million	$’million
Net Cash Flows
Operations	2.7	2.8	2.6	2.5
Investing	(25.3)	(11.2)	(19.6)	(24.5)
Financing	22.0	8.9	17.0	22.1
Change in Cash	0.6	0.5	0.0	0.1
Cash at 30 June	-	0.6	0.1	0.1

 

The Cash Flow Statement shows that the main inflow in 2006 was financing activities of $22 million. The main source of this inflow was deposits from Councils and Local Government Bodies of $52.7 million offset by repayment of short-term money market facilities of $24.4 million and repayment of inscribed stock of $3.4 million.  These inflows were used to fund investing activities, which mainly represented loans to Councils and Local Government Bodies of $25.1 million.