Risky business

Audit Committee looks at what went wrong with pre-payment agreements

It was a novel way of paying for infrastructure. The problem Shire Hall was trying to fix was that municipalities pay for waterworks, roads and such to enable developers to build homes. But builders only pay (permits and development charges) as they go.

The County’s ambitions were massive. $100 million in Wellington alone. That meant, in the best scenario, this money would take many decades to be paid back. Meanwhile, waterworks customers would carry the debt burden.

So Shire Hall came up with a way to get developers to pay for this infrastructure partially upfront. This way, developers would finance the infrastructure expansion required to provide water and sewer services to new homes. That was the idea.

However, nearly four years after the first of these agreements were signed, the County has spent $45 million for pipes, pumps, tanks, and a water tower. The developer has paid $12 million in upfront development charges (DCs). No new homes have been built. And none are on the horizon. Waterworks customers are on the hook for the remaining $33 million. And much more waterworks spending is in the queue.

Questions have arisen about the effectiveness of the agreements. Last fall, the County’s audit committed to finding out what went wrong and how it might be fixed.

Jason Reyner from Lerner’s LLP presented his findings to the committee last week. Reyner suggested the agreements were sufficient on a high level to get infrastructure expansion started, but lacked the tools and mechanisms necessary to manage a big, expensive project. Specifically, he noted that the amount of money secured by the agreements was insufficient for the scale of the project proposed.

“[It] assumes the County cannot stop the project once it has begun,” explained Reyner. “Presumably, the servicing infrastructure project has key milestones that, ideally, would align and track with the development projects so that as payments are required to be made on the servicing infrastructure project, there are payments being made by the developers.”

Reyner recommended a list of changes that would make the agreements stronger. They include:

• An increase in the security percentage or non-refundable amounts through the life of the servicing project as ‘sunk costs’ increase and the necessity to complete the works becomes more critical.
• A strict timetable for payment of the development charges, disconnecting it from the developer’s ability to slow development phases based on market pressures.
• Introducing more detailed development milestones that must be met by the developers, failing which the security increases to compensate for escalating risk to the municipality.
• Requiring a pre-payment rather than security at the time of servicing allocation provisions.
• Obtaining the necessary permissions to enter encroachments and/or easement agreements in order to be able to complete any infrastructure works on the land regardless of a change of ownership or insolvency of the developers named in the DCPA, and
• Increasing the period of time that the County has to notify the developer in the event of a force majeure event from twenty-four (24) hours to seven (7) days.

While Councillor John Hirsch accepted Lerner’s recommendations, he contends the issue remains one of poor communication rather than of risk management.

“We should try and put as many of these improvements in place as the development community will permit,” said Hirsch. He added, however, that Shire Hall struggles to explain how it funds infrastructure with debt and then gets repaid over 30 years.

“For a number of years, you don’t have to have all the money,” explained Hirsch.

Reyner countered that understanding the cost of debt—especially in the early years—and mitigating interest costs with upfront payments and accelerated payment of development charges was crucial to the structure of financing agreements.

That’s the typical approach, being able to manage the debt servicing payments in the initial phases of that infrastructure,” said Reyner. “And if possible, to accelerate the payment, ultimately to reduce the interest cost if you can.”

Public audit committee member Jane Lesslie wanted to know how the County’s agreement and processes stacked up against other municipalities.

“We aren’t the GTA, but are there peers that you are aware of we could look to who are farther down this path?” she asked.

Reyner said he hadn’t prepared a comparison analysis, but in general terms, he noted that in larger urban areas it is the developers who take on the bulk of the risk of financing infrastructure.

“Across the province, DC pre-payments are common. [In the GTA], you have high demand from developers for the infrastructure, and then typically, you see stronger, more direct front-end financing from the development community, where it is their money and their risk. Outside of the GTA, it tends to be more of a balance where the risk is shared between the developers and the municipality,” acknowledged Reyner.

He emphasized, however, that there are tools and mechanisms that detail precisely money in and money out.