Debt worsened by rate swap
A report into the massive indebtedness of a North Island council found that its woes were exacerbated by an interest rate swap sold to it by Dutch investment bank ABN Amro.
Until last year, when the Commerce Commission started investigating the sale of interest-rate swaps to farmers, claims of mis-sold swaps seemed to be a European and US phenomenon.
Across Europe and the US, the Global Financial Crisis revealed many local authorities had entered interest-rate swap deals under advice from investment banks, visiting large losses on local ratepayers and leading to high-profile court cases and compensation.
But though many larger councils and corporates here use interest-rate swaps, they are not suited for smaller councils which lack sophisticated in-house treasury departments.
The Auditor-General's report into the Kaipara District Council's (KDC) massive debt blowout in building a wastewater scheme at Mangawhai, north of Auckland, claims explanations to the council on how the swap worked were inadequate. The swap had not matched the council's borrowing circumstances and it had needed to borrow an extra $840,000 to break the contract, adding to its spiralling debts - now at $63.3 million. In February 2006, the cost was expected to be $35.6m.
The council's borrowings were complex, and the use of a swap breached the council's treasury management policies, the Auditor-General found.
Its financing arrangements involved it borrowing money short-term from ABN Amro (the Land Acquisition Facility Agreement, signed in December 2007), a loan that would be paid off by drawing down in two tranches (on dates referred to as Commercial Acceptance 1 and 2) on a second ABN Amro-provided loan facility called the Term Loan Facility.
Both facilities were floating rate, and both covered by the interest-rate swap which the council agreed to buy on advice from ABN Amro's New Zealand subsidiary. This swap converted the floating rate to a fixed rate.
The report said: "ABN Amro advised that interest rates were unlikely to ease in 2008, and it recommended that the council fix the interest rate on the debt KDC expected to incur between May 2008 and August 2009 by using an interest-rate swap to fix the rate at 8.36 per cent for that period."
"ABN Amro advised that, if the floating rate increased, KDC would save money in interest payments."
Actually, the reverse happened, and interest rates fell.
But the Auditor-General's report noted the council was not told what would happen, if that occurred. "The reverse also applied - that is, if the floating rate reduced, KDC would be unable to take advantage of the lower rate - but this was not explained to the council."
And, ABN Amro told KDC, if a key target date was missed, then, "the value in the existing swap can be retained and embedded in a new swap with a new modified debt tranche".
However, the Auditor-General found, the council was not told that doing this would incur costs, or what those costs would be.
She also found the dates of the swap did not match KDC's wastewater project timetable.
"We do not know why neither ABN Amro nor EPS (consultants to KDC) identified this mistake," said the Auditor-General, whose investigation was hampered by the council's lack of record-keeping.
In February 2009, the swap was cancelled on advice from ABN, which charged a fee of $7500, and also increased the margin on the Land Acquisition Facility from 0.55 per cent to 1.5 per cent.
The Auditor-General said EPS prepared a report stating: "ABN Amro and Beca/EPS International have been in negotiations since late 2008 to restructure or cancel the swap arrangement to enable council to take advantage of the lower interest rates now available."
"However, the report did not explain that the swap needed to be broken and that the increased margin needed to be paid on the Land Acquisition Facility because modifications meant the date for Commercial Acceptance 1 could not be met," the Auditor-General said.
A former ABN Amro banker, who had been involved with the financing arrangements, conducted an "independent review of the financing arrangements with ABN Amro" to confirm cost savings supposed to flow from breaking the swaps.
But, the Auditor-General said: "We were unable to establish what the figures were based on or whether there were significant savings from breaking the swap. However, we would be surprised if there were any net savings . . . "
The cost blowout on a EcoCare wastewater project, designed to clean up the harbour in the rapidly growing Mangawhai Heads ocean-side community, has left Kaipara District Council mired in debt. A litany of failures by the council means ratepayers will have to repay the money, with Government help unlikely. Auditor-General Lyn Provost's report serves as a wake-up call to ratepayers everywhere. The report found: Although Mangawhai needed a wastewater system, the cost – possibly $63.3 million – was enormous. The council had poor governance, lax management and record-keeping. It agreed to costly and complicated financing arrangements it did not understand. Councillors failed to keep oversight of council officers, including the chief executive. Audit New Zealand, which is controlled by the Office of the Auditor-General, failed to properly audit the council. Local MP Mike Sabin hopes for millions towards the debt from Audit New Zealand's insurers Complaints to the Auditor-General did not prompt detailed investigations. Councillors could not be held legally liable for the debts.
- © Fairfax NZ News
Do you read your work emails after hours?Related story: France frowns on after work email