Agenda of Extraordinary Finance Audit & Risk Sub-committee

HAWKE’S BAY REGIONAL COUNCIL

Finance Audit & Risk Sub-committee

Tuesday 15 December 2020

Subject: 2019-20 Annual Report for Adoption

Reason for Report

1. This item presents the Annual Report for the 2019-20 financial year to 30 June 2020.

Executive Summary

2. Operating surplus is $40.8m, up from $3.08m in prior year but $47.3m below budget as a result of stranded Napier Port IPO funds retained within Hawke’s Bay Regional Investment Company (HBRIC).

3. Excluding the one-off Port IPO dividend, the year delivers a $3.2m deficit for the year against a budget surplus of $7m.

4. The impact of the pandemic on the financial markets and subsequent investment returns reduced actual investment income from managed funds and other financial deposits to $0.43m ($0.892 revenue less $0.465m losses), $7.3m short of an expected $7.7m.

5. The pandemic delayed some projects and increased some costs particularly those relating to Emergency Management to support Council’s pandemic response. However, despite the pandemic, the levels of services were largely delivered as per the Annual Plan.

6. The annual revaluation of the Napier and Wellington investment property portfolios provided a further $11.5m of unrealised revaluation gains towards the operating surplus.

7. Total Other Comprehensive Revenue is $130.5m, up from $66.5m in prior year and above budget by $125m, mostly due to the revaluation of HBRIC/Napier Port.

8. On the balance sheet, the main movements reflect the revaluations and the Port/HBRIC transactions with non-current borrowings increasing by $14m to reflect the loan from HBRIC to the Council ($16m loan increase offset by debt repayments through the year).

9. From the cost centre perspective, direct employee costs including restructuring costs were up on cost centre budgets overall by $750k (3%) this is due to additional headcount and implementation of the remuneration review to better align staff to market, address historic under-remuneration of some roles and the introduction of a formal performance pay mechanism. The cost of this was approximately 4% of salary compared to the 2% budgeted for increases.

9.1. Note that the actual personnel costs in the financial statements include Works Group salaries, wages and allowances etc. which are not included in the annual plan budgets. The annual plan budget includes the net profit from Works Group external contracts only. This is being addressed as part of the Long Term Plan budgeting process.

10. External costs were over budget by $1.8m (31%). Specifically, general overheads (including accommodation and IT infrastructure) was $1.25m (34%) overspent and the support services cost centres were $395k (45%) overspent. Some of this overspend is the result of increased headcount (rent for additional accommodation, energy costs for more staff, services (cleaning etc for more accommodation), recruitment fees, IT licenses, etc), some overspend is due to additional costs caused by the pandemic (increased cleaning, sanitiser, protective screens, IT infrastructure to support remote working, etc), additional audit fees for the 18/19 audit, and the general increase in IT costs have not been adequately budgeted.

11. The net funding requirement for 2019-20 for Operating and Capital is over budget by $0.8m (3.5%). Asset Management was $2.9m underspent mainly offset by the overspending in Consents and Compliance ($1.508m), Governance ($869k), and Emergency Management ($467k).

	Net Funding Requirement
Group of Activities	Actual	Budget	Variance $	Variance %
Strategic Planning	$2.246m	$2.680m	$0.434m	84%
Asset Management	$3.623m	$6.528m	$2.905m	55%
ICM	$11.668m	$12.058m	$0.390m	97%
Consents & Compliance	$3.426m	$1.918m	$(1.508m)	178%
Emergency Management	$0.605m	$0.138m	$(0.467m)	438%
Transport	$0.271m	$0.254m	$(0.017m)	107%
Governance & Community Engagement	$3.189m	$2.320m	$(0.869m)	137%
Total	$25.03m	$25.9m	$(0.868m)	97%

12. Capital expenditure across the Groups of Activities was $3m (18%) below budget and asset purchases (new vehicles, computers, furniture, etc) was $1.6m (39%) below budget.

13. The presentation of the Annual Report to the Council for adoption has been delayed due to staffing issues at Audit New Zealand and the additional audit work that has been required to assess the impact of the Covid-19 pandemic on organisations that has been mandated by the Auditor General.

14. Karen Young, Director, Audit NZ will attend the meeting to answer any questions and allow for auditor only time with the committee as per the Term of References.

Discussion

15. The main driver for the financial surplus for 2019-20 is the IPO of Napier Port with the sale of 45% of the group’s holdings in the port generating $107m in one-off revenue for the group. The net proceeds from the sale exceeded expectations by $24m.

15.1. The 2019-20 budget for HBRC was based on all proceeds from the Port IPO being available to HBRC but tax implications have resulted in a split with $63m remaining with HBRIC.

15.2. $44m of the IPO receipts reverted to HBRC with all receipts being invested in managed funds. Prior to year-end, an asset/loan swap between the Council and HBRIC placed a further $16m of managed funds under direct Council control.

16. Expected dividends received from HBRIC were down from $10m to $2.5m due to the deferral of the anticipated interim Napier Port dividend. The Port dividend is based on free cash flow which has been affected by the uncertain trading conditions and the Port commencing work on the new wharf.

17. Expected capital growth, dividends and interest from the managed funds was significantly impacted by the financial market and share price fluctuations but recovered at the end of the year resulting in small growth for the year of 1%.

18. The increase in Total Other Comprehensive Revenue is due to the:

18.1. Revaluation of HBRIC based on the value of its Port shareholdings resulting in an increase of $117m

18.2. Revaluation increases in carbon credits of $1.2m

18.3. Unrealised growth in the managed funds of $1.4m

19. Operating expenditure was up $9.4m from prior year and $5.7m (10%) over budget. This relates to $2.25m of cost centre overspend, depreciation $600k above budget and fair value losses on some of the forestry offset by reduced finance costs.

20. The general overhead cost centres were overspent by $1.25m (34%) compared to budget:

21. Audit fees were particularly high due to the inclusion of cost over-runs for the 2018-19 audit and fully accruing for the 2019-20 audit.

22. The support cost centres were overspent by $643k (10%) compared to budget on staff costs and $395k (45%) overspent on external costs. The external costs below have been adjusted to exclude overhead allocations. Additional resource was required, and cost incurred in the finance team due to significant turnover, and a need to add both capacity and capability to the team as a result of the organisations growth and increased complexity. Contractors were required during the recruitment of new staff. This team is now right-sized and providing a professional service to the organisation.

23. Computer overheads are significantly over budget due to the increased headcount and the associated licence costs, additional software to support staff working remotely during the pandemic, and previous under-budgeting of IT costs through not adequately budgeting for the increase in costs of IT services and not accounting for the increase in use of IT services (e.g. storage costs are increasing exponentially). The increased IT costs in the new LTP have recognised this deficiency.

24. Across all activity cost centres, the results were close to budget with an overspend in external costs $192k (11%) offset by an underspend on staff costs of $131k (1%) when allocated overheads are excluded.

25. The User Charges and cost recovery revenue across the groups of activities showed significant variance but was $1.6m (15%) more than budget. The increased revenue for Emergency Management is due to the expected cost recoveries from government for the welfare costs incurred, ICM obtained un-budgeted external funding for two projects (SkyTEM, LiDAR) that had been included in the operating budget, and the under budget revenue of Consents and Compliance was comparable to prior year. The Consents and Compliance result is an expected outcome based on the LTP cost recovery expectations for S36 charges.

26. Operating expenditure across all activities for each group of activities was within 10% of budget except for Emergency Management which was 100% over budget due to the pandemic response costs.

27. Strategic Planning underspent operating expenditure over the year by $287k (6%) due to delays in projects 191 Regional Coastal Plan and 192 Strategy and Planning offset by an overspend in 196 Statutory Advocacy.

27.1. Regional Coastal Plan work was delayed due to the team being under-staffed and staff being prioritised to other resource management planning projects.

27.2. Strategy and Planning work was delayed due to TANK notification and an extended submission period resulted in the budget being off-track and associated costs (communications, IT, staff input etc) will be pushed into 2020/21. Hearings have also been delayed in TANK (RPC decision making and Covid-19) and OWB (6-month consultation) resulting in significant costs rollover to 2020/21 (est. $800,000). A new submissions database was purchased to support accurate management of public submissions on plans. The Senior planner vacancy was not filled until April. The Covid-19 pandemic response delayed this workstream as all members of the Planning Team were deployed to assist for some time in the CDEM Group Covid-19/drought response event.

27.3. Statutory Advocacy work was overspent due to additional external expenses that are primarily due to the commissioning of evidence from HBRC's experts on Environment Court proceedings for the Ngaruroro/Clive Rivers Water Conservation Order (WCO), plus associated legal services in same proceedings. Environment Court WCO proceedings have encountered delays due to Covid-19. Legal expenses were also incurred for the unbudgeted work to prepare evidence for first tranche of High Court proceedings on Marine & Coastal Area (Takutai Moana) Act applications.

28. Governance and Community Engagement was 3% overspent in operating expenditure where a $300k underspend in Community Partnerships was offset by a $400k overspend in 840 Community Representation. The overspend was mainly attributed to additional Executive, Governance and Project Management resources required to support meetings and Long Term/Annual plan development processes.

29. Asset Management had a $600k (5%) underspend in operating expenditure and $2.7m (67%) underspend on capital works. The capital expenditure shortfall included:

29.1. $800k underspend on the planned Clive River dredging due to delays in land purchase.

29.2. $700k on HPFCS Flood and River Control as work has been focused on hydrological modelling, planning and communication (internal staff or consultant). No physical work or land acquisition has been progressed any further.

30. Works Group returned a surplus of $65k from external contracts.

31. ICM was close to budget overall (1% overspend) in operating expenditure but had a $3.9m overspend on capital expenditure.

32. There were variances across the ICM operating projects but this reflected work carried out under complementary projects with costs attributed to one project but budgeted under the alternative project (e.g. 312 Regional Surface Water Ecology underspent and 315 Surface Water Quality being overspent by a similar margin).

33. The ICM capital expenditure did not include the SkyTEM and LiDAR work which had been classified as operating expenditure in the LTP and annual plan. The SkyTEM and LiDAR capital costs have effectively been offset by external funding.

34. The Sustainable homes programme has been very successful leading to a $2.4m overspend compared to budget. The cost of installation (and the debt repayments by the rate payers) is classified as capital expenditure due to the loan asset created as a result. The additional expenditure will be recouped over the next 10 years through the voluntary targeted rate applied in each case.

35. Overall Consents and Compliance was overspent by $400k (8%) on expenditure and income was $1.1m below budget due to an under recovery in fees and charges of $300k for 402 Resource Consent Processing and $800k in 450 Compliance programmes.

36. Emergency Management was overspent by $2.4m (100%) due to the pandemic and drought responses. This was partially offset by an extra $1.5m in revenue being mainly cost recovered from the government.

37. Transport overall was overspent by $240k (4%) predominantly on 790 Subsidised Transport where the cost of the bus contract has increased substantially due to increased indexation rates and payment of drivers for a ten-minute break every 2 hours worsened by lower revenues through declining patronage.

38. The systems integration projects were underspent by $1.9m. This was due to a lack of organisational readiness (vacancies in Finance and People & Capability delaying the start of the Finance and HR implementations), a focus on using existing capabilities to deliver solutions to ICM and other teams, and re-prioritising the work programme based on risk resulting in the work on FUSE, Telephony and customer experience solutions being prioritised.

Decision Making Process

39. Council and its committees are required to make every decision in accordance with the requirements of the Local Government Act 2002 (the Act). Staff have assessed the requirements in relation to this item and have concluded:

39.1. The decision does not significantly alter the service provision or affect a strategic asset, nor is it inconsistent with an existing policy or plan.

39.2. The use of the special consultative procedure is not prescribed by legislation.

39.3. The decision is not significant under the criteria contained in Council’s adopted Significance and Engagement Policy.

39.4. The decision is in accordance with the Finance, Audit and Risk Sub-committee Terms of Reference, specifically:

39.4.1. The Finance, Audit and Risk Sub-committee is to satisfy itself that the financial statements and statements of service performance are supported by adequate management signoff and adequate internal controls and recommend adoption of the Annual Report by Council.

39.5. Given the nature and significance of the issue to be considered and decided, and also the persons likely to be affected by, or have an interest in the decisions made, Council can exercise its discretion and make a decision without consulting directly with the community or others having an interest in the decision.

Recommendations

1. That the Finance, Audit and Risk Sub-committee receives and notes the “2019-20 Annual Report”.

2. The Finance, Audit and Risk Sub-committee, after receiving the Draft Annual Report and hearing from Audit NZ, recommends that Hawke’s Bay Regional Council adopts the 2019-20 Annual Report.

Authored by:

Tim Chaplin

Senior Group Accountant

Ross Franklin

Contractor, Finance

Geoff Howes

Treasury & Funding Accountant

Bronda Smith

Chief Financial Officer

Approved by:

Jessica Ellerm

Group Manager Corporate Services