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The road to $59 million

Former councillor says debt is hidden; Town says financial statements are accurate. Both could be right.

BY SAMUEL PICCOLO
The VOICE

Since former Councillor Marvin Junkin’s resignation, the Town of Pelham has repeatedly asserted that its 2016 audited financial statements are not misstated, an assertion that implies a denial of Junkin’s claim that the Town has $17 million in undisclosed debt. But Bill Karner, a Pelham CPA and Chartered Accountant with some 25 years experience, argues that it’s possible that the 2016 audited financial statements are not misstated, while at the same time the Town is indeed—or shortly will be— $59 million dollars or more in debt.

As you’d expect, there are a number of numbers in this story, but we’ve done our best to present Karner’s assessment in terms we can all understand. Here we go.

Using the Town’s publicly available 2016 and prior year audited financial statements, 2017 and prior capital and operating budgets (and related schedules), Karner demonstrated last week how he independently arrived at his conclusion, which matches the figure that Junkin alleges was presented to Council by the accounting firm KPMG during a closed-door meeting on September 5.

Karner divides his debt calculation in to five sections. (For simplicity, the following dollar amounts are rounded to the nearest whole number).

Long-term debt and bank indebtedness

The single biggest portion of the $59 million figure is in black and white, in the Town’s 2016 audited financial statements, which present $21.3 million in long-term debt and $1.8 million of bank indebtedness, for a total of $23.1 million at year end.

Cash shortfall

The next largest portion stems from what appears to be a substantial cash shortfall.

According to its financial statements, the Town should have had $9.3 million in cash on hand at end of 2016. But Karner says that this cash is likely almost entirely from a loan—the first portion of a debenture received near the end of the year. The loan advance of slightly over $9 million was cash that happened to be present in the Town’s accounts when it was audited. This money was earmarked, however, for building the new community centre arena in East Fonthill.

By subtracting this $9 million from the reported cash on hand of $9.3 million, Karner calculates that the Town could have had only $259,000 of cash on hand unrelated to the loan.

This would make sense historically. At the end of 2015, cash on hand was reported at $554,400.

The Town also claimed to have had $5.8 million in reserve funds at the end of year, money that Karner says is set aside and accumulates for future capital projects, or is used to smooth out operating costs that are subject to fluctuation, like a winter roads budget dependent on how much snow falls.

Further, the Town claimed to have $3.4 million in deferred revenue.

However, Karner says, theoretically numbers on a financial statement don’t equal actual number on a bank statement.

“If the deferred revenue and reserves are not backed by cash in the bank, then the cash is really not readily available,” he says.

In other words, if deferred revenues and reserve cash have been used for other purposes, then the cash isn’t really there. In effect the Town has “borrowed internally” from these accounts, instead of borrowing through debentures or other third party sources, such as banks.

At the end of 2016, the reserves and deferred revenue balances should have totalled $9.2 million, according to the Town’s financials. However, after deducting the actual cash on hand—$259,000— Karner calculates there was a shortfall of $8.9 million.

Junkin alleges that an emergency bank loan of $8 million was sought by the Town in September to cover a cash shortfall.

In effect, such “internal borrowing” is hidden, since it is not technically part of the Town’s long-term debt or bank indebtedness, and would therefore not appear as such in the Town’s audited financial statements.

The audited statements of several other Niagara municipalities reveal substantially greater consistency. These municipalities appear to have cash on hand and temporary investments roughly equal to, or greater than, their stated reserve funds and deferred revenue.

Only Pelham shows a large discrepancy between its purported reserves/deferred revenue balances, and the cash purportedly on hand to back them up.

Since 2012, the Town has reported no temporary investments in its financial statements—i.e., no stocks, bonds, or certificates of deposit.

In the five years prior to 2016, the Town never reported possessing more than about $554,000 in cash.

Wainfleet, Niagara’s least populous municipality with just one third of Pelham’s population, has consistently reported cash on hand of roughly six times that of Pelham. West Lincoln, a town of 14,000, reported combined cash and temporary investments of over $15 million in 2015, roughly 28 times greater than Pelham’s cash balance in the same year.

2017 Community Centre Arena debenture (loan)

A 2017 debenture advance of $12 million for the Town’s new community centre arena was received this year, a loan which the Town asserts will be paid back with future development charges totalling approximately $19 million (principal and interest combined) over the next 30 years.

This figure must be added to the Town’s long-term debt and will appear on the Town’s 2017 audited financial statements.

2018 Community Centre Arena debenture (loan) advance

The Town has been approved for an additional debenture advance in 2018 of approximately $12 million dollars, also intended to pay for construction of the new community centre arena. The Town says it plans to pay back this loan by selling its surplus East Fonthill lands, now on the market.

Karner says that this loan can be considered a sort of “soft debt,“ since while the lands will probably sell, the sale may not complete before cash is required to complete construction of the community centre arena.

Interestingly, when explaining the financing plan for the community centre arena in March 2016, Pelham CAO Darren Ottaway recommended that Council proceed with any such sale cautiously.

“You may—and probably—want to piece it down so you’re selling areas of an acre or less to maximize the value of the land,” said Ottaway. “That’s where most of the dollars will be generated, the smaller the size of the lot that’s sold.” He noted that such an approach could take a number of years to accomplish.

Instead, the Town is currently attempting to sell all 18 acres at once, using a single listing with an auction type process and a requirement that the purchaser buy all the land.

Karner speculates that this change in strategy was driven by a need to remedy the cash flow shortage the Town may now be facing, even if it means giving up greater income had the sales occurred piecemeal as Ottaway suggested last year.

Worse, an unknown but significant cut from the sale price—whatever it ends up being—will be paid off the top in legal and brokerage fees.

Finally, over the years the Town has spent an unknown amount on servicing of these lands. While these expenses likely contributed to the value of the lands, based on the Town’s financial plan they not being covered by the net sales proceeds.

The obvious question, Karner says, is: “How were these servicing costs paid for, and should a portion of the sale proceeds not cover them?”

Fundraising debenture (loan)

The Town has an additional debenture of $3 million that it says will be paid back via fundraising for the new community centre arena.

Karner says that this can also be considered a “soft debt,” assuming that the Town is indeed capable of raising the $3 million. This fundraising may take many years to complete, as there can be a significant gap between the time that funds are pledged and when cash is actually received. In the event that the Town can’t raise the full $3 million, then any remaining amount will be added to long-term debt that must be financed by other means, such as rises in property taxes.

Conclusion

In sum, the figures above total $59.2 million in debt.

Karner emphasizes that all of the numbers he used were taken from the Town’s audited financial statements and capital/operating budget materials and schedules, publicly available on the Town’s website.

“I arrived at this figure just by looking at the Town’s financial statements and budget materials,” says Karner. “I’ve never spoken to Junkin about any ‘in camera’ Council meetings or the contents of any KPMG reports, and I got the same number that he says was given to Council.”

While parts of the $59 million debt are to be repaid through land sales and fundraising, Karner remains concerned about the Town’s five-year projections for development charge revenue, and projected additional debentures to be taken out between now and 2021.

Karner says that budget materials suggest that the Town intends to use some $7.6 million in Development Charges over the five year period to fund various capital projects—these are in addition to the loans that the Town says it plans to repay, also with Development Charges.

The combined total would appear to be in excess of the Development Charges the Town forecasts actually to collect in the same period—meaning there may not be sufficient cash available to carry out their capital plan.

Karner’s concern over funding for the community centre arena dates back to spring 2016, before Council approved the project. After reviewing the Town’s five year Development Charge Fund projections, he says he noted a number of issues, which prompted him to dig deeper.

Karner says he sent several emails to the Mayor and Council, pointing out possible flaws in the plan to pay for new arena, urging Council to defer approval, if only for a few months so that more analysis of the plan and its impact on the Town’s finances could be conducted.

In the end, only Councillors Peter Papp and Marvin Junkin voiced concerns about the project before the final vote was taken.

Detailed questions sent last week to Mayor Augustyn and Treasurer Teresa Quinlin on the points raised above went unanswered until shortly before press time.

In a two-line email, the Mayor responded: “The CAO told Council and the community that staff can account for every nickel. We understand that will form part of Ms. Quinlin’s presentation this week.”

Karner, who has played hockey at the Pelham Arena for many years, says that he was never opposed to the construction of a new arena. “Everyone knows that we need a new one,” he says. “I just think that it needs to be done in a way that’s financially sound.”