Sunday, 20 January 2013

Tassie's balance sheet Part 2

We are often assured that the State Government itself is net debt free.

Is this of any comfort when Governments enterprises are loaded with debt?

Any discussion about net debt or the broader measure of net financial liabilities is pointless without looking at both the Government itself and all its subsidiaries.
In legal and accounting terms the General Government (GG) comprising Government departments and agencies is the Parent company.

GG also owns all the Government Business Enterprises (GBEs) and State Owned Corporations (SOCs) which altogether comprise the Total State Sector (TSS).

The Statement of Financial Position (or Balance Sheet) as at 30th June 2012 for both GG and TSS is as follows.

As is immediately evident the net assets of both the GG and the TSS are identical at $11.066 billion. This confirms the iron law of consolidation.... the net assets of the parent will always equal the net assets of the consolidated group. With the latter there are more assets and more liabilities but the net figure is the same.

The GG balance sheet contains a single figure for the total net assets of all the GBE/SOCs at $6.298 billion. This represents 57% of the total value of our Total State Sector (TSS).

The breakup of the net value of GBE/SOCs is as follows.

Over 83% of net value is in the 3 electricity entities and the water and sewerage corporations (soon to become one as from 1st July 2013).

Interestingly Forestry Tasmania’s share of GBE/SOC net assets is only 1.9%. This implies only 1% of net assets of the Total State Sector, an immaterial amount, inversely proportional to the time devoted to discussing its future.

Furthermore FT’s latest Annual Report foreshadowed a reduction in inventory value given the proposed changes in the TFA Bill currently before Parliament which would have the effect of wiping out all its net assets leaving it at the bottom of the table behind even Private Forests Tasmania and in serious danger of relegation.

Strictly speaking the GBE/SOC share of TSS net assets is higher than 57% or $6.298 million if one includes other amounts hidden in GG’s balance sheet under ‘other financial assets’.

Of the total ‘other financial assets’ of $1,061 million is $1,045 million which is best described as income tax equivalent payments due from GBE/SOCs, most being deferred amounts. Small amounts however are due in the next 12 months based on 2012 income.

The explanation for the deferred income tax equivalent amounts due is a little complicated but because it’s such a significant amount it’s worth making an attempt to understand.

In simple terms:

·       GBE/SOCs calculate profits just like any company. The accounting profits thus derived may differ from taxable profits, again just like any other company.

·       GBE/SOCs lodge tax returns just like any other company but tax is not paid to the ATO but rather income tax equivalent payments are paid to GG. This is pursuant to the tax neutrality changes introduced as part of national competition policies.

·       A GBE/SOC reduces its profits and hence its net assets by calculating tax on accounting profits.

·       However it will only pay tax based on taxable income, leaving an amount termed ‘deferred tax liability’. Depending on the applicable tax laws at the time deferred amounts may eventually become due and payable to GG. Accountants describe these as ‘timing differences’.

·       The sum of the deferred tax liabilities for all GBE/SOCs at 30th June 2012 was $1,045 million.

·       The sum of the income tax equivalent amounts due to GG is therefore $1,045 million. This is an asset of GG.

When the deferred tax amounts due are added to the sum of the net assets of the GBE/SOCs of $6,298 million, the amount is $7,343 million or 66% of net assets of TSS.

The significance of GBE/SOCs is often lost in the hurly burly of partisan politics.

Returning to the balance sheet for GG and TSS, let’s have a closer look at the cash and investments (assets) and borrowings (liabilities). Investments include mainly deposits and bonds but to a lesser extent (by MAIB) listed shares, listed and unlisted trusts etc.

It will be immediately evident that the cash on hand for GG is considerably more than that for the consolidated group, the TSS, as a whole.

How come? Where did it go?

It’s because much of GG cash was on deposit with Tascorp. The cash was an asset of GG but a liability for Tascorp. GG lent money to Tascorp in other words and Tascorp consequently owed money to GG. These amounts are eliminated when the consolidated accounts for TSS are prepared.

Similarly when amounts are borrowed by Tascorp (it undertakes most borrowings on behalf of TSS) and subsequently lends to a GBE, the loan to the GBE is an asset in Tascorp’s books and a liability in the books of the GBE.

Such inter sector amounts, as they are termed, are eliminated when TSS’s consolidated accounts are prepared so that the balances in TSS books for borrowings represent total loans due to external parties by TSS.

The same occurs with cash and investments so that the balances in TSS’s books represent amounts invested with external parties.

It might be the law of the bleeding obvious to some, but let’s call it the second law of consolidation.....amounts owed/owing to and from members of a group are eliminated on consolidation.

Most of the balance sheet inter sector eliminations occur with cash, investments and borrowings.

So how come there is $244 million in cash, $4,199 million in investments and $5,644 million in borrowings? Why not sell some investments to reduce debt?

Most of borrowings owed by TSS are owed by Tascorp ($5,041 million). As we saw in part 1 the GG owes a little directly to the Australian Government re housing (circa $230 million) and the rest (circa $400 million) is owed by various GBEs directly to external parties.

Tascorp’s balance sheet is quite revealing.

As with any bank, funds are obtained from borrowings and deposits. The borrowings of $5,040 million are from wholesale sources. Client deposits of $1,178 million are funds deposited with Tascorp as per the following:

Most client deposits (except for the small amounts deposited from local governments) are from within the TSS and hence will be eliminated upon consolidation.

Looking at Tascorp’s assets, $3,064 million has been lent to entities within TSS plus a small amount ($78 million) to local government as shown below.

Almost all, 94%, represent loans to the 3 electricity entities and the water corporations.

A prominent omission from the list of Tascorp advances is the overnight loan of $650 to GG (and the simultaneous overnight client deposit from GG). The Auditor General considered both amounts should be netted off against one another rather than each adding to advances and client deposits, and he requested an adjustment to Tascorp’s financials. The reason cited was to satisfy a lesser known accounting standard AASB 119 relating to Financial Instruments. It is not clear why the same standard didn’t apply to GG which didn’t net the amounts off in its books but rather showed an increase in both cash and loans of $650 million (see Part 1 HERE) at 30th June 2012. In any event it is not important as the amounts are eliminated when TSS’s balance sheet is compiled.

Going back to Tascorp’s balance sheet, investments of $3,081 million are deposits with external parties. This forms ¾ of the investments of $4,199 million on TSS’s balance sheet. The other ¼ are investments by MAIB.

The MAIB balance sheet looks like this:

MAIB together with Tascorp are the State’s 2 public financial corporations. Most of the State’s borrowings as we have seen are on Tascorp’s books and most of the State’s investments are via either MAIB or Tascorp.

MAIB is needless to say the State’s personal injury motor vehicle accident insurance company. It has $1,101 million invested to meet future claims, which are estimated at 30th June 2012 to be $894 million (see MAIB balance sheet). This latter liability is included in ‘other liabilities’ in TSS’s balance sheet.

GG is a self insurer in regard to its own workers comp, general insurance and public liability. For all intents and purposes it is an unfunded scheme. Although amount are appropriated into an account known as the Risk Management Account, the pattern of internal borrowings described in part 1 HERE means the account has little cash backing. The estimated insurance liability of $166 million is included with ‘other liabilities on both GG’s and TSS’s balance sheets.

To revert back to Tascorp’s balance sheet, the main assets (client advances and investments) and the main liabilities (client deposits and borrowings) are again shown below.

The client deposits and advances are eliminated on consolidation but the investments of $3 billion and the borrowings of $5 billion are assets and liabilities respectively of TSS.

When added to MAIB assets and a few borrowings directly with other external parties (not via Tascorp) TSS ends up with $244 million in cash, $4,199 million in investments and $5,644 million in borrowings? The balance sheet is reproduced again:

Doesn’t look too bad?

Why not redeem  the investments and reduce the borrowings? Are they expecting  David Bartlett’s Second Coming and the possible need to fund another election campaign?

Hopefully not.

It’s all part of the long term capital management of the State’ borrowings. The GBE/SOCs with advances are loaded up with debt and are likely to roll over any debt at maturity which gives Tascorp a much longer time horizon and as a consequence it is moving to longer term borrowings. Simply aligning borrowing and lending maturities isn’t necessarily prudent banking practice as there is always a refinancing risk.

To a lay person in these matters Tascorp appears to be doing ok.

A table in Tascorp’s Annual Report gives a good breakup of the maturity spread for both investments/advances and borrowings/deposits from ‘at call’ to ‘over 5 years’.

The weighted average cost of Tascorp’s funds is 4.40% whilst the weighted average rate earned from investment and advances to GBE/SOCs is 4.89% which allows Tascorp to make a small profit.

The above closer look at GG’s and TSS’s balance sheets and the attendant consolidation issues, in particular cash, investments and borrowings, hopefully provides the necessary background to understand the measures of net debt and net financial liabilities, which will be tackled in the next post.

Future posts will cover a detailed review of the unfunded superannuation liability, which increased by one third in 2012, a comparison of Tasmania’s net debt and net financial liabilities with other States, and a critical look at the fiscal strategies currently adopted by the Government.

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