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FOR IMMEDIATE RELEASE                               February 28, 2006





Officials of the City Department of Budget and Fiscal Services said the Office of the City Auditor’s Audit Report on Debt Service released publicly today is, sadly, an example of an audit gone bad.

“We have serious concerns about the conduct of the audit and the veracity of its findings. The audit staff’s unfamiliarity with the subject matter produced a report rife with errors, omissions, misrepresentations, unsubstantiated comments and flawed conclusions,” said Mary Pat Waterhouse, director the Department of Budget and Fiscal Services.

“We appreciate the work the Office of the Auditor has done in its audits of Sunset on the Beach and personal services contracts,” she said. “However, those audits were confined largely to compliance with defined practices and mandates that are widely recognized and understood. This audit, self-initiated by the auditor, should have been conducted by impartial experts with the requisite knowledge and experience. Failure to do so led to findings and recommendations that undermine the validity of the entire report.

“Since we took office, we have tried to take the auditor’s reports seriously, rather than simply ignore them as our predecessors did. However, that will be very difficult to do with this kind of work. When this audit began, in light of the esoteric nature of the subject matter and the limitations of the auditor’s staff, we suggested that experienced, qualified persons review the City’s debt service and management,” Waterhouse said. “Unfortunately, our advice went unheeded.”

In fact, the Office of the Auditor, admits as much in page 48 of his final report: “We recognized the complexity of municipal debt and therefore examined practices of a non-technical nature.”

City Chief of Treasury Edlyn Taniguchi said:

·                 Auditors confused investments with bond and debt activities, a fundamental error.

·                 Auditors ignored several administration requests to provide a definitive scope-of-audit statement.

·                 Lack of understanding of the significance of bond rating categories led to inappropriate comparisons between AA-rated Honolulu with AAA-rated municipalities, resulting in a meaningless analysis.

·                 Omission of the City Council’s role in Honolulu’s debt management. This is not insignificant in light of the Council’s amendment and approval authority over the capital budget that causes the increase in the City’s debt service.

·                 The auditors incorrectly included debt service on revenue bonds in a discussion of debt service limits as a percentage of the operating budget. Those limits by policy apply only to general obligation bonds.

·                 The auditors mistakenly concluded that competitive bond sales are preferable to negotiated bond sales. One hundred percent of private sector firms and some 80 percent of U.S. municipalities and states, including the state of Hawaii and Kauai and Maui counties, use negotiated bond sales, where a bond underwriter is chosen through a competitive “request for qualifications” proposal. Even the Finance Director of Hawaii County, which for the first time in years is selling its bonds competitively rather than through negotiated sales, testified before the Legislature last month that, “There is no clear evidence to support the notion that competitive sales are cheaper than negotiated sales.”

       During the period under review, nationwide underwriter spreads, the fee per $1,000 of bonds charged by underwriters, for negotiated sales declined from $6.20 to $5.53 while for competitive sales it increased from $5.89 to $6.45.  In addition to lower underwriter spreads, negotiated sales provides the cities and counties with financial services from underwriters that actually allow them to save money.  For example, prior bond issues are continually monitored for refinancing opportunities that lower debt service costs. 

Taniguchi said, “The report speaks in generalities and contains seemingly willful misrepresentations of the City’s debt service practices without corroboration.  The report is fatally flawed because it makes baseless claims of conflicts of interest and higher than necessary rates but fails to cite a single example where the City was harmed or where the City would have been better off.”

Taniguchi and Waterhouse said the findings in the final report are similarly flawed:

  • Finding 1: Contrary to the auditor’s claims of fragmentation and uncertain accountability, the City Charter clearly states that the director of Budget and Fiscal Services has “the responsibility for issuing, selling, paying interest on and redeeming bonds of the city.” Despite that, the auditors did not communicate with Waterhouse except for the initial pre-audit conference.  The City does have a comprehensive plan, its six-year capital improvements program. “And we’ve been paying out debt on time,” Waterhouse added.
  • Finding 2 results from the auditor’s inexperience with debt financing.  The potential conflict between the same party serving as an underwriter and financial advisor is recognized by the City and throughout the industry, and the City maintains the separation of roles to avoid such conflicts. As previously discussed, the auditor mistakenly seems to assume that competitive sales are inherently better than and less expensive than negotiated sales. The reality is far different, because negotiated sales provide far greater flexibility, for example, to seek a better price.

Waterhouse noted that the auditor decided to perform this audit on its own, rather than at the direction of the City Council. His staff spent four and a half months on the audit, yet they gave the administration only 15 days to respond. Nonetheless, Budget and Fiscal Services answered with an 88-page rebuttal. Finally, the auditor unilaterally cancelled the customary exit conference for the audit, after BFS officials were forced to reschedule by, among other things, a special City Council meeting in late December.



Bill Brennan 527-6928

Mark Matsunaga 527-5767


Tuesday, February 28, 2006

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