Section II(c)
Terms of reference
| Section Reference |
||
| "To determine the adequacy of the provision for losses in the following areas: | ||
| Royalties receivable | A | |
| Loans and guarantees issued under the Economic Development Act | B | |
| Loans and guarantees issued by Provincial Holdings Ltd. | B | |
| Loans issued under the Fisheries Development Act | C | |
| Property taxes receivable | D | |
| As also assigned by Steering Committee Loans issued under Agricultural Development Act" |
E |
The Province accounts for loans, advances, guarantees and receivables in the following manner.
With respect to the loans, advances, receivables and guarantees, as set out in the terms of reference, our review was limited to the amounts recorded in the draft financial statements of the Province for year ended March 31, 1999 as follows:
We confirmed with staff that no accounts had been written-off between March 31, 1999 and July 31, 1999.
We determined that of the $21.3 million recorded as receivable at March 31, 1999 nearly $21 million had been collected by July 31, 1999. The remaining balance was adequately provided for in the year end allowance for doubtful accounts.
The Minister of Economic Development, Tourism and Culture also administers the immigrant investment program of the New Brunswick Economic Development Funds. These funds do not fall within our terms of reference and have therefore not been reviewed.
Under the terms of the Economic Development Act, the Minister provides financial assistance to aid and encourage the establishment or development of industry in the Province. As we understand, amendments to the Act in recent years have expanded the scope of eligible investments, reducing the utilization of PHL, which has traditionally been to provide assistance in means not provided for by the Act.
Each loan, equity investment and guarantee issued by EDTC or PHL is monitored by a staff member. The monitoring plan is tailored to the risk of the associated investment and, as a minimum, includes review of current financial information of the borrower or investee.
Loss reserves are established by management on a specific item by item basis, upon consultation with the staff member monitoring each loan/guarantee. No general provisions are made for loans/guarantees, which are not specifically identified as requiring a specific allowance.
We concurred with the conclusions of management on most items within the sample. Significant findings and conclusions within the sample are:
Standards for Public Sector bodies, are set by the Public Sector Accounting Board (PSAB) of the Canadian Institute of Chartered Accountants. The PSAB Handbook(PSAB Handbook) in section 3050 states "that loans receivable should be carried at the lower of original cost or net realizable value", and that valuation allowances/loss provisions "should be used to reflect collectibility and risk of loss". The PSAB Handbook also states that "provisions can be made on an individual loan basis, or for a particular class of loans". The PSAB Handbook further states that the lender should consider several factors including past collection experience.
Further guidance is available from the federal Office of the Superintendent of Financial Institutions (OSFI). While this guidance is not specifically for government entities, it does provide guidance on implementation of a methodology only referenced in general terms by PSAB. OSFI recommends a combination of specific and general provisions for losses on loan portfolios. OSFI requires specific allowances for loans identified as impaired, and a general allowance for those not specifically identified as impaired. The general provision is a judgmental estimate made after considering the institution's historical loss ratios, credit risk factors related to the portfolio, and the current phase of the economic cycle. The OSFI contends that a strong economy makes identification of likely impairment difficult, and thus recommends an increase in the general provision during upturns in the economy and decreases as the economy declines.
To test the validity of the department's methodology we have assessed the impact of calculating a general provision, by reviewing loss histories for loans/investments issued in the fiscal years 1988 through 1999. We compared total loans/investments made each year to the amount of those loans later deemed to be non-recoverable (either written-off or fully allowed for as non-collectible as of March 31, 1999). We found that of all loans made in the fiscal years ended 1988 through 1990, 63.4% of the original loan principal was determined non-recoverable. Since repayment terms for a substantial portion of the portfolio at any given time is well beyond 5 years, this population reflects the final results of a relatively mature loan portfolio.
We also calculated the loss ratio for loans/investments issued during the extended period of fiscal 1988 through fiscal 1994, and calculated a total of 49.8% as non-recoverable. The years 1991 through 1994 represent a portfolio that is semi-mature and still open to possible deterioration prior to full collection. Years beyond 1994 have been excluded from the historical statistics since they are still subject to the possibility of substantial future deterioration due to the lack of maturity of this portion of the portfolio.
It should be noted, the 1991 loss ratio at 21.3% would become 56.5% had we included the impact of our additional specific provision for $3 million, on a 1991 investment discussed previously, in our review of specific provisions.
We compared these ratios to the ratios created by management's provision for losses for the years1995 through 1999, which was less than 14% of loans issued. This substantial difference in projected loss ratio could be the result of several factors including decreased risk profiles within the loan portfolio, improved credit methods or loan security, a fundamental long term improvement in the New Brunswick economy, or the result of an inadequate provision for loan losses as of March 31, 1999.
Based upon our review procedures we have concluded that at least a portion of this difference relates to an inadequate general provision caused mainly by the policy of making specific provisions only. We estimate the shortfall to be between $6 million and $21 million.
Guarantees
We performed similar analytical procedures with respect to guarantees issued in all years from fiscal 1988. We compared total loan guarantees issued each year to actual net payouts and provisions to date.
We found that losses on guarantees issued during fiscal years 1988 through 1990 equal 17.5% of the guarantees originally issued. For the more extended period of 1988 through 1994 we found the overall loss ratio to be 7.3%. This population included a number of individually significant items which were large enough to skew the results of our review and our resulting conclusions. We reperformed the analysis eliminating individual items greater than $5 million, and found the loss ratio on the remaining items to be 11.7% for each of the 1988-1990 and 1988-1994 periods.
The loss ratio created by management's provision made on specific accounts (under $5 million) for the years 1995 through 1999 totaled 20.2%. While this ratio exceeds historical results it was deemed appropriate based upon the individual items reserved.
Based on our review the allowance for loss provisions on guarantees appears adequate.
We recommend that management, in consultation with the Office of the Comptroller, establish and review a general provision annually, using a methodology which segregates investments by risk profile, and determines provision ratios specific to each profile.
We recommend that the previous policy of the annual approval of write-offs by the Board of Management be re-instituted and the present portfolio of fully provided/inactive accounts be reviewed and addressed as part of the write-off process for the fiscal year ended March 31, 1999.
Loan assistance may be provided for new vessel construction, major refits or overhaul of existing vessels, the purchase of used fishing vessels, new on-board equipment or for purposes deemed to be in the aid of and to encourage the development of fisheries in the Province of New Brunswick. In addition the Department provides loans or loan guarantees for marine shell-fish and / or fin-fish cultivation operations in the Province of New Brunswick.
Our findings, observations, recommendations and comments on the adequacy of the provision for losses in regard to the loans and advances of the Department of Fisheries and Aquaculture follow.
Financial Statement Amounts:
Included in the amounts outstanding to the Department of Fisheries and Aquaculture is interest receivable which amounted to $20,320,907 as at March 31,1999. This outstanding interest represents 22% of the total loans and advances outstanding to the Department. Total assets related to the Department of Fisheries and Aquaculture lending program as at March 31,1999 are summarized below.
An accepted method of valuing a loan or a portfolio of loans that have become impaired, where the amounts and timing of future cash flows cannot be estimated with reasonable reliability, is to measure the value of the loan by way of the fair value of the security underlying the loan, net of expenses.
We reviewed 11 transactions where vessels were sold or transferred. We compared the value of the vessel used for loss provision purposes at the immediately preceding year end and the second preceding year end to the net proceeds obtained for the vessel. When the proceeds were compared to the immediately preceding year end values, a shortfall in value of 20.7% resulted. When the proceeds were compared to the second preceding year end value estimates, a shortfall in values of 44.0% resulted. The decrease in the shortfall from year two to year one can be explained by the fact that boat values are reduced at year end when staff are aware of a loss that will occur subsequent to year end.
Interest is calculated on loans, even after all avenues of collection have been exhausted, until the loan is written off, except for certain loans noted previously as "designated to be written off". While the interest is fully provided for, the amount that is finally written off is higher than needed.
The following is a summary of the loan portfolio by category as determined by the Department.
Policy No. 1000-06 requires that a loss provision be set by a specific percentage of the total balance of delinquent loans in seven separate categories.
In fact the department has deviated from the above policy by providing for 100% of all loans with arrears more than 4 years.
A subsequent review of the provision for losses by Department staff in July 1999 indicated that the provision was adequate.
Policy No. 1000-06 requires aquaculture loans to be assessed individually, and a percentage is set for each account as a loss provision.
A subsequent review of the provision for losses by Department staff in July 1999 indicated that the provision should be increased to $321,439 at March 31, 1999 from $292,059, an increase of $29,380.
Policy No. 1000-06 requires weir loans to be provided for at 75% of the total balance of all accounts.
Policy No. 1000-06 requires the provision for set aside loans to be 100% of the set aside amount as a loss provision.
Three loans totaling $2,371,905 were set aside during the year.
Repossessed boats are placed in this category and are to be fully provided for.
These loans were presented for write off in 1996. The write off has not been approved to date.
Policy No. 1000-06 requires that the provision for losses equals the total account balance less the estimated book value of the vessel.
This section of the loan portfolio decreased by $111,546 from March 31,1998 to March 31,1999. This decrease resulted from applying proceeds from a sale of a vessel of $90,000, payments on two loans of $35,000 and $13,454 added to a loan for interest and insurance premiums. No interest or principal payments have been required on these loans since 1994 due to the moratorium on the groundfishery. Interest was charged in the one isolated case as mentioned above.
A subsequent review of the provision for losses by Department staff in July, 1999 indicated that the provision should be increased to $15,717,206 at March 31,1999 from $15,314,149 an increase of $403,057
This section of the loan portfolio increased by $957,855 from March 31,1998 to March 31,1999. This increase was mainly the result of loan payments being insufficient to cover interest costs. The only loan advance in this increase was for $258,486. Two loans showed a reduction in the amount outstanding.
A subsequent review of the provision for losses by Department staff in July, 1999 indicated that the provision should be increased to $14,462,945 at March 31,1999 from $13,391,541 an increase of $1,071,404.
This section of the loan portfolio decreased by $18,462 from March 31,1998 to March 31,1999. Of the loans outstanding six decreased by $ 63,631 while five increased by $45,169 due to inadequate payments to cover interest charges.
A subsequent review of the provision for losses by Department staff in July, 1999 indicated that the provision should be increased to $637,539 at March 31,1999 from $603,961 an increase of $33,578.
This section of the loan portfolio increased by $85,305 from March 31,1998 to March 31,1999. Of the loans outstanding 15 decreased by $ 380,941 while 14 increased by $466,246 due to inadequate payments.
A subsequent review of the provision for losses by Department staff in July, 1999 indicated that the provision should be increased to $11,864,407 at March 31,1999 from $10,090,973 an increase of $1,773,434.
This section of the loan portfolio decreased by $350,606 from March 31,1998 to March 31,1999. Of the loans outstanding 5 decreased by $251,926, one decreased by $1,030,674 as a result of a payment of $58,768 and the remainder of $971,906 was being set aside and transferred to another loan category. New loan advances of $587,370 were added to the portfolio. Six loans increased by $344,624 due to inadequate payments.
A subsequent review of the provision for losses by Department staff in July, 1999 indicated that the provision should be increased to $10,388,015 at March 31,1999 from $9,388,015 an increase of $1,000,000.
The formula for determining the provision for losses on inshore loans appears reasonable based on the above information, and also due to the fact that the Department is taking 100% of all loans in arrears more than four years. This formula results in a provision for losses for inshore loans of 25.4%.
Weir loans
No additional provision required.
In determining boat values for purposes of setting the loss provisions on offshore loans, independent professional appraisals are normally obtained only when a vessel is to be foreclosed upon or transferred to another fisher. Sister vessels and / or similar vessel values are also adjusted when an independent appraisal is obtained. For vessels where no independent appraisal is available, field representatives who are familiar with the vessels estimate the value of the vessels.
It appears that once values are set they are arbitrarily revised downward as a method of increasing the provision for losses. While this effectively increases the loss provision, it impairs the credibility of these vessel values. In fact there are four loans where the estimated boat value is currently nil, but the boats are still in existence. As mentioned previously, a review of the actual realized value of vessels has historically, on average, been 56% of the amount used to set the loss provision. It is therefore appropriate to reduce the vessel values by up to 44% when determining the loss provision for offshore loans.
A more detailed review of vessel values by each separate group of loans in the offshore portfolio may result in a different percentage reduction of value in each group and a different overall loss provision. This is outside our current terms of reference.
There are several factors that lead us to believe that 100% of the groundfish portion of the portfolio should be included in the loss provision.
The moratorium placed on this fishery has resulted in the Department suspending the requirement for principal payments and implementing the interest relief program whereby no interest has been charged on these loans since 1994. The interest relief program is in place until December 31, 2000.
There are 17 boats in the groundfish fleet with an average age of 19 years, with the newest boat at least 11 years old. It is also safe to assume that the fleet is deteriorating due to lack of maintenance.
The provision for losses has been increasing steadily each year and it is evident it is only a matter of time before this category of the loan portfolio is fully provided for.
The provision for losses on the offshore portion of the loan portfolio should be increased to $64,660,117. This is an increase of $15,871,670 over the provision in the draft 1999 financial statements. The increase consists of the following components:
Additional Recommendations
The loss provision should be increased by $15,900,000 and adjusted to $74,530,000 as indicated above.
Loans should be written off when all avenues of collection have been exhausted.
Loans should be written off in cases where a vessel has been scrapped or sold.
Interest should cease to be charged to loans when they are determined to be uncollectible.
Interest should be charged on the total balance outstanding, including arrears interest.
Payments should be applied to all outstanding interest before being applied to principal outstanding.
The boat values, used to set provisions, should be set at a portion of the appraised values and this discount should be monitored and adjusted periodically.
Any inshore loan that is known to be uncollectible should be fully provided for over and above the formula used to set the provision.
All loans should be reviewed periodically and the assessment of the loan status should be documented in the files. Consideration should also be given to obtaining future cash flow information to assist in valuing loans.
The municipal portion of property taxes are payable to the municipalities regardless of whether the property tax payment is collected by the Province. Thus, the Province bears the risk of non-collection. As we understand, the risk is mitigated by the status of the municipal portion of the assessment, which forms a lien on the property in the event of bankruptcy (to the extent of two years of unpaid taxes), and would be collected prior to any title transfer to a purchaser.
These bills were due for payment by May 30, and subject to monthly interest thereafter. Bills paid prior to April 15, received a discount equal to the lesser of 3% or $20.
The Province also has the right of tax sale to collect overdue balances receivable. The effectiveness of this policy appears somewhat limited due to practical limitations with respect to the number of tax sales that can be effectively managed by staff on an annual basis.
Provisions for losses are calculated by staff based on specific provisions for individually significant balances or groups (Federal government; Not-for-Profits etc.), and formula based provisions are used for remaining items based on account agings.
No taxes were initially assessed on the property when it was built in 1986. In 1994 the Geographic Information Centre of New Brunswick reviewed the Act that created the Centre and determined that it was taxable. The Province has since assessed tax, penalties and interest from 1986 to present. The balance recorded as receivable as of March 31, 1999 is approximately $8.8 million, including approximately $5 million of interest and penalties.
This issue has been subject to negotiation for a number of years without resolution. Based on correspondence within the Province's files, it does not appear that the Centre itself has the resources to pay this item, and would need to recover this amount from its principals. The principals in this instance are the Federal government, the Provincial government, the University of New Brunswick which receives the majority of its funding from the Provincial government, and the Forest Ranger School, which is funded by the Province along with other Maritime Provinces. Schedules within the file indicate the Federal Government represents the vast majority of these required funds. However, the Federal Government is by law exempt from property tax and in this specific instance the Province does not qualify for the grant in lieu that applies to other Federal properties.
We reviewed the methodology and calculations relating to the treatment of assessments to the Federal Government, for which the Province receives a voluntary grant in lieu of property taxes. We concluded that the provision for Federal Government receivables is also materially adequate.
We reviewed the methodology employed to create a general provision for losses on the remaining receivables. In summary we found the following:
We further recommend a more detailed assessment of past collection experience be carried out in order to improve this methodology for future reporting periods.
New Entrant Financing ProgramThe loans are secured by 1st mortgages on property and assignments of any applicable quotas. Also personal guarantees are obtained from the principals involved.New Land Purchase Program
Perennial Crop Establishment Loan Program
None of the Perennial Crop Establishment loans have any payments presently due. Interest is capitalized for the first five years; then the entire principal and interest is to be paid off. These loans related to blueberry and cranberry development.
