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Port Macquarie-Hastings Council

Key Findings from an Independent Review of Financial Reserves

What are financial reserves and why do we need them?

• In order to adequately provide infrastructure to support development activity in the

community, Council identifies infrastructure priorities and puts money aside in

“reserve”.

• This is kept aside (held in reserve) until the money is required for the major

infrastructure projects that have been prioritised in the Capital Works programme

– which is a list of projects, such as new infrastructure works, which are

programmed for upcoming construction. Such new works could include

construction of Council buildings, roads and bridges, or other Council-managed

installations. In particular, the most common use of this money at -

Hastings Council is for building new roads, community facilities, and water and

sewer systems.

• By saving this money in “reserve”, Council can use these funds as either an

alternative, or in addition, to borrowing money to provide these assets.

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• It is generally preferable to use savings rather than borrow because a reliance on

borrowings could result in the burden of excessive interest costs, which can have

an adverse impact on Council’s financial sustainability. In addition, when

infrastructure is funded through savings rather than borrowing, the money that is

held in reserve can earn some interest income for Council.

o As a result, when infrastructure is provided using reserve funds, there is

both an interest saving (compared to if Council borrowed money instead of

saving) and an interest earning (from the income earned by Council when

this money is held in its savings fund). This means that there is less

pressure on future rate increases for residents and on other user fees to

recover infrastructure delivery costs.

What are current reserves being used for?

• Most of the funds which are saved in reserve have external restrictions. This

means that Council can only use them for specific purposes and cannot be used

by Council to fund general operations. This restriction on the usage of these funds

is imposed externally by State government legislation which councils in New

South Wales must comply with. Funds which carry external restrictions make up

around 72 per cent of all reserve funds of Council.

o An example of externally restricted funds are the contributions received by

property developers in the form of levies (developer contributions). This

makes up around 44 per cent of externally restricted reserves. This money

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is saved in reserve and can only be spent on infrastructure delivery

associated with development activity (that is, on infrastructure related to

growth and cannot be used for existing assets such as repairing existing

roads). Developer contributions that are held in reserve are broadly split

into the following categories:

▪ a water and sewer fund (called Section 64 reserve funds), or

▪ a set of funds for roads, traffic, open space, and community facilities

(called Section 94 reserve funds).

▪ These developer levies are charged differently and the funds are

separately managed. This is so that there is no conflict of priorities

between Section 64 and Section 94 infrastructure projects.

o In addition to developer contributions, money is also set aside amongst

other external reserves for other purposes in order to ensure sufficient

maintenance of assets is undertaken. This is mostly saved so that water,

sewerage, and waste management facilities, for example, are maintained

and quality services can be delivered to the community.

• There are also some funds set aside for other priority infrastructure as deemed

by Council and Councillors. These are known as internally restricted reserves

because they have been set aside for a particular purpose that has been

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determined internally by Council and so the money can only be used for this

specified purpose. This makes up around 28 per cent of all reserve funds.

o The internal reserves have largely been set aside for commitments such

as employee leave entitlements, plant replacement, playing fields, airport

and transport infrastructure renewal.

• The composition of reserve funds into usage categories (expenditures) as at end

of the 2016-17 financial year has been summarised in Figure 1 below.

o The pie chart on the left of the Figure splits the internal and external

reserves of Council for 2016-17.

o The pie chart on the right of the Figure splits the components of the external

reserves of Council for 2016-17.

• The composition of reserve funds into major asset categories (holdings) as at end

of the 2016-17 financial year has been summarised in Figure 2 below.

o The pie chart on the left of the Figure splits the internal and external

reserves of Council for 2016-17.

o The pie chart on the right of the Figure splits the components of the external

reserves of Council for 2016-17.

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Figure 1. Composition of reserves by category.

26% 24%

28% 72% 18% 17%

10% 6%

Internal External s94 Developer s64 Developer Water Sewerage Waste Mgt Other

Figure 2. Composition of reserves by major asset class.

31% 17% 28% 72%

24%

Internal External Water Sewer General/Waste

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What is an appropriate level of financial reserves to set aside?

• It is difficult to determine precisely the right mix of money to set aside in reserve

for future infrastructure and money to use today for current infrastructure.

• Councils who are good financial managers strive to have sufficient money put

aside to ensure that priority projects can be delivered to the community in a timely

and cost-effective manner. Just like household savings, this can mean that some

current income is saved rather than spent, in order to provide for the future. In

particular, sometimes current minor renewal projects may need to be deferred in

order to ensure that sufficient savings are being put aside in reserve for major

future projects.

• If councils have not allowed enough funds in reserve for infrastructure projects,

they need to either borrow, sacrifice some spending, or increase rates bills.

Conversely, if councils have set aside too many funds rather than put into use for

infrastructure projects, this can contribute to a backlog in infrastructure delivery.

• The challenge for Council is to balance these interests to ensure that an

appropriate level of reserves is held, in consideration of developments within the

council area, as well as the state of, and demand for infrastructure.

• Among the main factors that may weigh on Council’s determination of the

appropriate level of reserves is the level and nature of development activity within

the council area.

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o This is because councils experiencing a high level of development activity

(such as Port Macquarie-Hastings Council, see Figure 3) require relatively

high levels of reserves in order to adequately cope with the required levels

of infrastructure spending.

o In addition to requiring relatively higher levels of reserves in areas of high

development activity, these councils are also required to accumulate these

funds relatively quickly – because it is likely that major infrastructure

commitments also may fall due sooner than in other areas.

Figure 3. Number of Lots Created (Land Subdivisions).

1250

1000 large increase in new lots created in PMHC from 2014-15 750 compared to peers

500

250

0 08-09 09-10 10-11 11-12 12-13 13-14 14-15 15-16 16-17 Port Macquarie - Hastings Tweed Ballina Coffs Harbour Kempsey Midcoast

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• In light of the pressures placed upon Port Macquarie-Hastings Councils’ asset

and financial management as a result of development growth (see Figure 3), the

water and sewer capital works programme, in particular, has recently undergone

a major revision.

o This includes ensuring all projects are named in a consistent and clear

manner. The projects have also been split into preconstruction and

construction phases, with the aim of clearly defining the phase of the

project and improving planning and budget estimates for the construction

phase.

• Because different councils have different experiences of development activity,

infrastructure needs, varying size and capacity to raise funds, and so on, this

means that making comparisons between councils’ reserve balances for the

purposes of benchmarking is difficult. In particular, straight comparisons between

two neighbouring councils may result in misleading conclusions about respective

performance of councils.

What is the assessment of the current reserves level?

• The University of Technology , Centre for Local Government (UTS:CLG)

was engaged by Council to conduct an independent analysis of the

appropriateness of Council’s reserve levels.

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• UTS:CLG identified that Council has projected relatively fast development growth

into the medium term. This means that Council may be required to fund

infrastructure going forward relatively quickly and to a relatively larger scale

compared to some of its peer councils – which may be reflected in relatively high

levels of reserves compared to some neighbouring councils.

• Overall, UTS:CLG found Council’s reserve levels to be broadly appropriate and

reasonable in light of Council’s circumstances. In particular, it is UTS:CLG’s

assessment that Council has successfully maintained a prudent buffer to prepare

against potential financial risks associated with the predicted high development

activity.

• In particular, UTS:CLG determined that:

o Compared to councils experiencing similar development activity and

demand, Port Macquarie-Hastings Council’s Section 94 reserve funds sit

at an appropriate level.

o Compared to councils experiencing similar development activity and

demand, Port Macquarie-Hastings Council’s Section 64 reserve funds are

currently higher than some of its peer levels. As at 30 June 2017 Section

64 reserve funds were at just over $71m.

▪ This is relatively high, in part, because the provision of Water and

Sewerage infrastructure can be relatively expensive in Port

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Macquarie-Hastings Council to construct, as a result of Council’s

particular features. For example, the size of the local government

area, the topography of the land, as well as the pace and nature

(such as location of growth corridors) of development growth all

place additional pressure on infrastructure costs – and, as a result,

on the required balances of funds held in reserve for infrastructure

provision.

• Funds have been built up in this reserve fund in order to support upcoming

significant expenditures expected in the coming years. For instance, Council is

currently planning upgrades to water and sewer infrastructure. This includes an

investment of around $120,000,000 to deliver a planned Water Treatment facility.

In addition, other upcoming projects under Council’s consideration to take place

in the coming years include the following:

Area 13 (Thrumster) Sewerage Treatment Plant $38,000,000 Southern Arm trunk main Pacific Highway to $13,700,000 Southern Arm Trunk Main Cowarra balance tank to Pacific Hwy $ 5,000,000 Thrumster Reclaimed Reservoir $ 3,985,000 New Inlet trunk Main to Cowarra Dam from King Creek $12,000,000 Trunk Main Bonny Hills to Kew Reservoir $ 6,200,000 Area 15 Reservoir $ 5,350,000 $84,235,000

▪ Together, this expected investment of around $200 million in water

and sewer infrastructure upgrades means the current level of funds

held in reserve is expected to not only be exhausted but possibly

require additional accumulation of reserves, in order to avoid

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requiring substantial borrowing to fund this infrastructure. This

means that it is necessary for Section 64 reserves to remain

relatively high for the time being, in preparation for this.

o In particular, new water service reservoirs and water transfer capacities

have been prioritized as a result of development growth. This is necessary

in order to prevent potential future water service shortages or outages.

o Similarly, priority sewerage services projects currently being saved for

include new sewerage pumping stations and a sewerage treatment plant.

This will ensure sewerage services can continue to be delivered at a high

standard for all residents, as well as assisting in the prevention of potential

sewerage discharge.

• In sum, and with Council’s expected medium-term level of development activity in

mind, it would be broadly necessary for Port Macquarie-Hastings Council to

maintain its reserve levels consistent with its current practice.

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