Debt analysis

Local Government Debt RestructuringNotoria International Ing. Mauro Giorgini

Rome, February the 8th., 2015

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CYPRUS LOCAL GOVERNMENT DEBT RESTRUCTURING

ANALYSIS and PROPOSALS

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INDEX

INDEX................................................................................................................................. 2SUMMARY.......................................................................................................................... 3LOCAL GOVERNMENT DEBT STATUS.............................................................................3

Municipalities................................................................................................................3Communities................................................................................................................11Sewerage Boards........................................................................................................14Considerations............................................................................................................15

ACTIONS.......................................................................................................................... 18Process optimization..................................................................................................18Central purchasing and payment office..................................................................19Clustering....................................................................................................................20Debt rescheduling......................................................................................................20

DEBT ANALYSIS AND RECOGNITION.....................................................................21DEBT RENEGOTIATION............................................................................................22

Solidarity fund...................................................................................................................22DEBT REDUCTION FUND.........................................................................................23EQUALIZATION FUND..............................................................................................26ADMINISTRATIVE COUNCIL.....................................................................................35

IMPLEMENTATION SCHEDULING..................................................................................38

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SUMMARYThe aim of this document is to take a picture on the debt contracted by the Local Government of Cyprus: Municipalities, Communities and Sewerage Boards, to identify the affected banks, responsible for issuing those credits and to propose some actions, having the objective to easy the present debt burden that the Local Government entities have to carry on and to handle.LOCAL GOVERNMENT DEBT STATUSMunicipalitiesBased on the data collected through the session interviews with all the Municipalities during our assessment and on the statistical data, issued by the Treasury of the Republic of Cyprus, regarding the economic situation of the Municipalities, it is possible to consolidate the following global picture:

From the annual budgeting perspective (based on 2012 financial data)

a. The total annual income of the Municipalities is: 256.255.853 €

b. The total annual operating cost of the Municipalities is: 267.231.288 €

c. The total interest paid annually by the Municipalities is: 11.726.300 €

d. In terms of debt distribution among the Municipalities we have:

i. 11 Municipalities are above the negative threshold limit of – 250.000 €

ii. 11 Municipalities are in the average range of – 250 K€ --- + 250 K€

iii. 8 Municipalities are in the consolidated positive area

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Every fiscal year, due to the inefficiency associated to the delivery of the services and to the low productivity in some area, there is a total loss of 20.445.412 €.

The distribution of the balance sheet, among the Municipalities is presented in the following picture

€ 1.600.000€ 800.000€ 0-€ 800.000-€ 1.600.000-€ 2.400.000-€ 3.200.000

FAMAGUSTALARNAKA

LIMASSOLNICOSIA RURALNICOSIA URBAN

PAFOS

Balance

DIST

RICT

+ 250.000 €- 250.000 €

20.445.412 €Total inefficiency:

Municipalities Balance Sheet Distribution

variabilitytargetBalance sheet

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The detailed data on the balance sheet of each Municipality is presented in the table below.

TOT INCOME TOT EXPENSES % DEFICIT BALANCE SHEET

2012 2012 2012 2012MUNICIPALITY

NICOSIA € 30.349.701

€ 30.160.670 0,0% € 189.031

STROVOLOS € 19.422.130

€ 18.534.166 0,0% € 887.964

AYIOS DHOMETIOS € 4.308.667 € 4.836.896 -12,3% -€ 528.229AGLANTZIA € 6.668.014 € 8.470.237 -27,0% -€ 1.802.223

LAKATAMIA € 8.917.600 € 11.679.162 -31,0% -€ 2.761.562

LATSIA € 5.955.069 € 6.135.655 -3,0% -€ 180.586ENGOMI € 5.939.737 € 9.609.352 -61,8% -€ 3.669.615IDALION € 4.516.847 € 3.255.239 0,0% € 1.261.608

YERI € 2.302.916 € 1.376.192 0,0% € 926.724TSERI € 2.233.074 € 2.269.034 -1,6% -€ 35.959

LIMASSOL € 40.661.641

€ 39.002.454 0,0% € 1.659.187

MESA YITONIA € 4.496.423 € 7.992.508 -77,8% -€ 3.496.085AYIOS ATHANASIOS € 4.558.677 € 4.663.961 -2,3% -€ 105.284

KATO POLEMIDIA € 5.198.194 € 5.664.526 -9,0% -€ 466.332YERMASOYIA € 7.544.213 € 6.839.811 0,0% € 704.402

IPSONAS € 3.557.815 € 3.706.671 -4,2% -€ 148.855

LARNAKA € 19.946.999

€ 23.317.184 -16,9% -€ 3.370.185

ARADIPPOU € 5.861.578 € 7.122.490 -21,5% -€ 1.260.912ATHIENOU € 2.385.390 € 2.583.691 -8,3% -€ 198.301

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LEFKARA € 1.164.750 € 1.205.022 -3,5% -€ 40.272LIVADIA € 3.157.513 € 4.712.843 -49,3% -€ 1.555.330

DROMOLAXIA-MENEOU € 2.505.842 € 991.942 0,0% € 1.513.900

PAFOS € 19.329.374

€ 19.991.843 -3,4% -€ 662.469

POLIS CHRYSOCHOUS € 2.859.962 € 1.541.101 0,0% € 1.318.861GEROSKIPOU € 4.333.368 € 4.408.921 -1,7% -€ 75.553

PEYIA € 5.660.121 € 5.082.765 0,0% € 577.356SOTIRA € 939.598 € 1.812.068 -92,9% -€ 872.470

PARALIMNI € 15.387.671

€ 15.273.486 0,0% € 114.185

AGIA NAPA € 11.053.655

€ 11.039.516 0,0% € 14.139

DERYNEIA € 2.432.085 € 2.290.629 0,0% € 141.456

TOTAL€

253.648.625

€ 265.570.034

-€ 11.921.410

Notes The “Balance Sheet” is calculated as difference between the

“Total Income” and the “Total Expenses” the deficit is calculated as percentile ratio between the

“Balance Sheet” and the “Total Income”

From the contracted debt perspective to cover development projectsConcerning the contracted debt by the Municipalities and guaranteed by the Central Government and used to finance the Municipalities development projects, the related picture can be summarized in the following points:

Total amount of the debt, payable at December 2013 is 240.519.821 €

70% of the debt will expire in the 2030 – 2032 time frame 28% of the debt will expire in the 2020 – 2025 time frame 2% of the debt will expire in 2015- 2020 time frame The most affected bank, responsible for the delivering of the

credit to the Municipalities to finance their development projects are:

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o Co-Operative Central Bank: owning 115.349.236€ of the total debt, 48%

o KA Finanz AG: owning 93.997.655€ of the total debt, 39,1%

o Bank of Cyprus: owning 26.812.989€ of the total debt, 11,1%

A detail on the debt contracted by the Municipalities to finance their development projects, is represented in the table below.

MUNICIPALITY TOTAL

NICOSIA€

10.060.956

STROVOLOS€

33.503.750AYIOS DHOMETIOS € 4.736.558

AGLANTZIA€

14.227.207

LAKATAMIA€

17.498.312

LATSIA€

13.843.148ENGOMI € 99.671IDALION € 5.192.887YERI € 130.238TSERI € 143.395

LIMASSOL€

13.600.146MESA YITONIA € 5.831.563AYIOS ATHANASIOS € 9.733.078KATO POLEMIDIA € 3.984.276YERMASOYIA € 4.754.547IPSONAS € 11.641

LARNAKA€

48.213.727

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ARADIPPOU € 5.265.565ATHIENOU € 0LEFKARA € 321.368LIVADIA € 1.845.349DROMOLAXIA-MENEOU € 0

PAFOS€

16.307.790POLIS CHRYSOCHOUS € 4.514.470GEROSKIPOU € 7.646.558PEYIA € 167.299SOTIRA € 0PARALIMNI € 4.899.732AGIA NAPA € 8.149.402DERYNEIA € 5.837.188

TOTAL

€ 240.519.82

1

In the picture below the debt sharing among the banks that have issued the credit to the Municipalities is presented.

€ 0

€ 40,000,000

€ 80,000,000

€ 120,000,000

Guaranteed Project's Loans

The distribution of the contracted debt by the Municipalities among the banks is presented in detail in the table belowBank of Cyprus € 26.812.989 11,1%

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Co-operative Central Bank € 115.349.236 48,0%

KA Finanz AG € 93.997.655 39,1%

Co-operative Credit Society Lakatamias-

Defteras€ 566.624 0,2%

National Bank of Greece € 2.114.676 0,9%

Regional Co-Operative

Society Nicosia€ 143.395 0,1%

Co-Operative Savings Society € 94.808 0,0%

Delphi Investment Bank € 504.524 0,2%

C Credit Society Ypsonas € 11.641 0,0%

Alpha Bank € 697.597 0,3%

Hellenic Bank € 226.676 0,1%

TOTAL € 240.519.821

From the loans perspective, contracted by the MunicipalitiesConcerning the contracted loans by the Municipalities and guaranteed by the Central Government, the related picture can be summarized in the following points:

The total amount of loan contracted by the Municipalities and payable at December 2013 is: 213.029.711 € 70% of this loan has an expiry date between 2030 and 2035 25% of this loan has an expiry date between 2020 and 2025 5% of this loan has an expiry date between 2015 and 2019 The most affected banks, relating to the above are:

o Co-Operative Central Bank, owning 92.278.847€, 43,3%o Bank of Cyprus, owning 50.856.554€, 23,9%o KA Finanz AG, owning 33.827.810€, 15,9%o Council of Europe Development Bank, owning 20.000.000€, 9,4%o European Investment Bank, owning 12.107.036€, 5,7%

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Detail on the loans contracted by the Municipalities to finance their operational duties, are presented in the table below.MUNICIPALITY TOTAL

NICOSIA€

48.146.728

STROVOLOS€

5.287.541AYIOS DHOMETIOS

€ 1.869.109

AGLANTZIA€

12.346.812

LAKATAMIA€

5.334.417

LATSIA€

2.402.177

ENGOMI€

1.424.778IDALION € 687.520YERI € 24.811TSERI € 0

LIMASSOL€

46.592.579

MESA YITONIA€

4.039.201AYIOS ATHANASIOS

€ 3.565.189

KATO POLEMIDIA € 792.816

YERMASOYIA€

6.208.614IPSONAS € 5.301

LARNAKA€

29.824.200

ARADIPPOU€

1.322.171

ATHIENOU€

4.616.045

LEFKARA€

1.044.698LIVADIA € 180.791DROMOLAXIA-MENEOU € 0

PAFOS€

12.510.247POLIS CHRYSOCHOUS

€ 6.511.928

GEROSKIPOU€

5.069.14610


PEYIA € 253.336SOTIRA € 0

PARALIMNI€

8.013.308

AGIA NAPA€

3.547.489

DERYNEIA€

1.408.759

TOTAL

€ 213.029.7

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In the picture below the loan sharing among the banks that have issued the credit to the Municipalities is shown.

Bank of C

yprus

Co-operative Centra

l Bank

KA Finanz AG

European Inve

stment B

ank

Council of E

urope Development B

ank

Co-operative Credit S

ociety

Laka

tamias

Co-Operative

Savings S

ociety

Lemesso

s

Delpha Inve

stment B

ank

Pireus B

ank

Co-Operative

Credit Socie

ty Ypsonas

Co-Operative

Credit Socie

ty Le

fkara

Hellenic

Bank€ 0

€ 20,000,000€ 40,000,000€ 60,000,000€ 80,000,000

€ 100,000,000

Affected Banks

The distribution of the contracted loans by the Municipalities among the banks, is presented, in detail in the table below11


Bank of Cyprus € 50.856.554 23,9%

Co-operative Central Bank € 92.278.847 43,3%

KA Finanz AG € 33.827.810 15,9%

European Investment Bank € 12.107.036 5,7%

Council of Europe Development Bank € 20.000.000 9,4%

Co-operative Credit Society Lakatamias € 295.326 0,1%

Co-Operative Savings Society

Lemessos€ 88.782 0,0%

Delphi Investment Bank € 126.360 0,1%

Piraeus Bank € 2.855.869 1,3%

Co-Operative Credit Society Ypsonas € 5.301 0,0%

Co-Operative Credit Society Lefkara € 489.079 0,2%


TOTAL € 213.029.711

CommunitiesBased on the data collected by using the official web sites of the Cyprus Treasury Department and of the Ministry of Finance, regarding the economic situation of the Communities, it is possible to consolidate the following global picture:

From the contracted debt perspective to cover development projectsConcerning the contracted debt by the Communities and guaranteed by the Central Government, the related picture can be summarized in the following points:

Total amount of the debt payable at December 2013 is 13.235.516€

95% of the debt will be expire in the 2015 – 2020 time frame

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5% of the debt will be expired in the 2020 – 2025 time frame

The most affected bank, related to the above loans to the Communities to finance their development projects are:

o Bank of Cyprus: owning 3.894.199€, 29,4%o Co-Operative Central Bank: owning 2.758.327€ of the

total debt, 20,8%o Hellenic Bank: owning 1.315.877€ of the total debt,

9,9%o Co-Operative Savings Limassol: owning 1.208.566€ of

the total debt, 9,1%o Co-Operative Credit Society Troodous: owning

743.554€, 5,6%

A detail on the debt contracted by the Communities to finance their development projects, is presented in the table below.

COMMUNITY TOTAL

Sia € 114.094Alampra € 35.472Lympia € 20.117Farmakas € 58.586Alona € 1.386Kapedes € 47.322Ergates € 91.953Palaiometocho € 66.248Palaichori Oreinis € 133.041Palaichori € 396.304Xyliatos € 61.711Agia Marina Xyliato € 116.601Galata € 62.946Kalopèanagiotis € 388.701Pyla € 476.750Xylofagou € 564.977

Kiti€

1.064.973

Pervolia€

1.295.265

Mazotos€

1.472.80513


Anafotica € 69.806Kivisili € 244.507Aglisides € 321.634Maroni € 148.147Kofinou € 841.815Kato Lefkara € 21.274

Pano Polemidia€

1.208.566Fasoula € 262.008Korfi € 68.728Ayios Tychonas € 544.028Parekklisia € 630.534Prastio Kellakiou € 92.330Pissouri € 368.716Pano Kivides € 145.646Trimiklini € 36.268Pera Pedi € 72.388Pano Platres € 498.284Pelendri € 289.731Kyperounta € 518.224Empa € 44.281Salamiou € 60.476Agios Fotios € 140.842Panagia € 44.824Peristerona € 10.829Chorio € 15.052Steni € 67.326

TOTAL

€ 13.235.51

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The debt sharing among the banks that have issued the credit to the Communities is presented in the graph below.

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Bank of C

yprus

Co-Op. S

ociety

Pervolia

Co-Operative

Central

Co-operative Credit S

ociety

Tamassou

Co-Operative

Credit Rural D

ev.

Regional Co-O

perative Socie

ty Nico

sia

Co-Operative

Credit Socie

ty Allil

egiis

Co-Operative

Savings L

imasso

l

C Credit Socie

ty Xylo

fagou

Alpha Bank

Hellenic

Bank

Co-Operative

Credit Mesa

Geito

nia

Co-Operative

Credit Anatolik

is

Co-Op. C

redit Socie

ty Troodous

Co-Op. C

redit Socie

ty Paphos

€ 0

€ 1,000,000

€ 2,000,000

€ 3,000,000

€ 4,000,000

Communities Credit Bank Sharing

The distribution of the contracted loans by the Communities among the banks, is presented in detail in the table below.Bank of Cyprus € 3.894.199 29,4%

Co-Op. Society Pervolia € 45.548 0,3%Co-Operative Central € 2.758.372 20,8%

Co-operative Credit Society Tamassou € 445.012 3,4%

Co-Operative Credit Rural Dev. € 314.313 2,4%Regional Co-Operative Society

Nicosia € 479.455 3,6%Co-Operative Credit Society Allilegiis € 476.750 3,6%

Co-Operative Savings Limassol € 1.208.566 9,1%C Credit Society Xylofagou € 510.434 3,9%

Alpha Bank € 54.543 0,4%Hellenic Bank € 1.315.877 9,9%

Co-Operative Credit Mesa Geitonia € 262.890 2,0%Co-Operative Credit Anatolikis € 594.822 4,5%

Co-Op. Credit Society Troodous € 743.554 5,6%Co-Op. Credit Society Paphos € 131.181 1,0%

TOTAL € 13.235.516

Sewerage BoardsBased on the data collected from the official web sites of the Cyprus Treasury Department and of the Ministry of Finance, regarding the economic situation of the Sewerage Boards, it is possible to consolidate the following global picture:

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From the contracted debt perspective to cover development projectsConcerning the contracted debt by the Sewerage Boards and guaranteed by the Central Government, used to finance the development projects, approved in the past by the Board of Directors, the related picture can be summarized in the following points:

Total amount of the debt payable at December 2013 is 33.461.982€



The most affected bank, responsible for the delivering of the credit to the Municipalities to finance their development projects are:

o Co-Operative Central Bank: owning 28.755.389€ of the total debt, 85,9%

o Co-Operative Credit Society Troodous: owning 2.928.982€ of the total debt, 8,8%

A detail on the debt contracted by the Sewerage Boards to finance their development projects, is presented in the table below.

Bank of Cyprus € 59.475 0,2%

Co-Operative Central € 28.755.389 85,9%

Co-operative Credit Society

Tamassou€ 1.258.852 3,8%


Co-Op. Credit Society

Troodous€ 2.928.553 8,8%

TOTAL € 33.461.982

The picture below the debt sharing among the banks that have issued the credit to the Sewerage Boards is presented.

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Bank of Cyprus

Co-Operative Central

Co-operative Credit Society Tamassou

Hellenic Bank

Co-Op. Credit Society Troodous

€ 0

€ 10,000,000

€ 20,000,000

€ 30,000,000

€ 40,000,000

Sewerage boards debt sharing

ConsiderationsBased on the data results presented in the previous paragraphs, it is possible to underline the following considerations:

a. The credit issue is concentrated on the Municipalities; their total debit is 177% of their present annual total income. For the Communities, having a total annual income of 110 M€, their total debt is only 11% of their total income.

b. The majority of the grant credit to the Municipalities and to the Sewerage Boards will expire in the 2030 – 2035 time frame; this means the Municipalities and the Sewerage Boards are limited financing possibilities in the future.

c. If we apply to the Municipalities the European Stability rules, 3% of the GDP max in the deficit and 60% of the GDP max in the debt, we would have the following pictures

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DERY

NEIA

AGIA

NAPA

PARA

LIMNI

SOTIR

APEYIA

GERO

SKIPO

U

POLIS

CHRY

SOCH

OUSPA

FOS

DROMOL

AXIA-

MENEO

U

LIVAD

IA

LEFKA

RA

ATHIE

NOU

ARAD

IPPOU

LARN

AKA

IPSON

AS

YERM

ASOY

IA

KATO

POLEM

IDIA

AYIO

S ATH

ANAS

IOS

MESA YI

TONI

A

LIMAS

SOL

TSERI

YERI

IDALIO

N

ENGO

MI

LATS

IA

LAKA

TAMIA

AGLA

NTZIA

AYIO

S DHO

METIO

S

STRO

VOLO

S

NICOSIA

0,0%-10,0%-20,0%-30,0%-40,0%-50,0%-60,0%-70,0%-80,0%-90,0%

MUNICIPALITY

% D

EFIC

IT

-3,0%

Chart of % DEFICIT

Based on the above picture many Municipalities has a balance sheet conforming to the European Stability Mechanism, regarding the deficit; these are: Nicosia, Strovolos, Latsia, Yeri, Dali, Tseri, Limassol, Ayios Athanasios, Yermasoia, Dromolaxia-Meneou, Polis Chrysochous, Geroskipou, Peyia, Paralimni, Ayia Napa and Deryneia.

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DERY

NEIA

AGIA

NAPA

PARA

LIMNI

SOTIR

APE

YIA

GERO

SKIPO

U

POLIS

CHRY

SOCH

OUSPA

FOS

DROM

OLAX

IA-MEN

EOU

LIVAD

IA

LEFKA

RA

ATHIE

NOU

ARAD

IPPOU

LARN

AKA

IPSON

AS

YERM

ASOY

IA

KATO

POLEM

IDIA

AYIO

S ATH

ANAS

IOS

MESA YI

TONIA

LIMAS

SOL

TSERI

YERI

IDALIO

N

ENGO

MI

LATS

IA

LAKA

TAMIA

AGLA

NTZIA

AYIO

S DHO

METIO

S

STRO

VOLO

S

NICO

SIA

400,0%

300,0%

200,0%

100,0%

0,0%

MUNICIPALITY

% D

EBT

60,0%

Chart of % DEBT

Based on the above picture only few Municipalities are conforming to the finance parameter of 60% of the income as a debt limit. These are: Engomi, Yeri, Tzeri, Ipsonas, Dromolaxia-Meneou, Peyia and Sotira.The bottom line is that it is very important to take immediate actions, with the objectives to address the following present issues:

1) Inefficiency : the action is to Increase the efficiency and the productivity inside every Municipality by implementing the process improvement, by setting up the Key Performance Indicators in each delivered service and by instituting a central purchasing and payment department, responsible for buying and paying for all the Municipalities. By performing this corrective initiative, the Deficit indicator will get better, allowing the Municipalities to have more cash.

2) Debt: the counter action is to create a common solidarity fund, to be used by the Municipalities to pay their loan interest. To this common fund, every Municipality will provide with 5% of its total income. In addition, a rescheduling of the present debt must be performed. By setting a fund for all the Municipalities to be used

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to pay off all the associated debt and to restructure the debt, the Municipalities will be able to have more financing facilities to cover the future development needs that at the moment, due to the credit crunch are out of scope.

In the following paragraphs the above points will be illustrated in more details, in addition to the identified potential recovery actions.

ACTIONSThe actions we have identified to solve the problems associated to the inefficiencies of the administrative processes delivered by the local government entities and to their debt exposure, can be summarized in:

1. Optimization of the administrative processes, delivered by each municipality or community.

2. Central purchasing and payment office for the local government 3. Clustering between municipalities and/or communities on specific

services.4. Debt rescheduling5. Solidarity fund

In the following subchapters the details of each proposal will be outlined.

Process optimizationAs already described in our assessment study, the phase 1 of our proposed solution focuses on the optimization of the processes delivered by each Municipality. This approach has the aim to improve the existing infrastructure, identify for each process the Key Performance Indicators, set the quality target to achieve and define the related monitoring and control platform of the achieved results.

This corrective action is mandatory because it will:

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eliminate all the inefficiencies today imbedded in the organization,

reduce the waste linked to the idle time of each process

create a positive virtuous quality cycle in each organization

As we have already stated in our assessment document, our estimation in terms of savings by implementing this process optimization proposals, in one year project is 67,8 M€. With this result, the total Municipalities balance sheet will go from the present -11,9 M€ to the positive +55,9 M€, allowing the Municipalities to use these extra cash either to finance new services, than to reduce their debt.

Central purchasing and payment officeTo reduce additional operational costs we suggest to concentrate all the purchasing and payment activities of the Municipalities in only one office; this department will have the responsibilities to: analyzing the needs and defining the costs and the standardizing procedures mapping and analyzing the existing service contracts defining adequate contract SLAs for the suppliers Renegotiating the existing contracts and the debt settlements Defining the cash pooling procedures and the centralization of payments Defining the certification procedures of accounting documents and the related control system. Centralizing the purchasing policies by strengthening the mode of governance and control

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Standardizing the behavior of structures that are responsible for trading activities, this through the redefinition of competencies for the operational and procedural rationalization. Implementing the economy of scales and incrementing the level of completion among market operators, with the aim to obtaining cost savings Achieving the savings related to administrative expenses of supply processes and the optimizing the purchasing processes Developing and disseminating telematics tools to support the purchasing proceduresA steering committee will be set up, with the duty to manage the unified purchasing and payments for the overall Municipalities.

The experience achieved in other sectors, by implementing this common purchasing office, is to reduce the operational costs, provided by suppliers, of 10%.

Applying this measure to the Municipality scenario, in six months deployment project, the total amount of savings can be assessed to 6 M€.

ClusteringWith the objective to reduce the operational costs of the services delivered by the municipality, one action is to let a group of municipalities and/or communities to join together, combining all their resources; by doing this, through the establishment of the cluster, is possible, by a different dimension of scale, to reduce the operational costs of each services.Considering the existing Cyprus reality of the municipalities and of the communities, by implementing the clustering approach among the local government entities is possible to reduce the present operational costs of the combined municipalities and communities by 70 M€ yearly.

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Debt reschedulingConsidering the present debt composition, contracted by the Municipalities, a debt restructuring is strongly suggested. By doing this financing action it is possible to:

Analyze the outstanding amount of liability

Recognize the total contested volume

Debt renegotiation and definition of the ways to extinction

By implementing the restructure of the existing debt, it is possible to reduce the total debt amount by 15%; considering the present total Municipalities debt, this means to save 68 M€.

Below are explained, in more details, the ways to achieve the planned saving:

DEBT ANALYSIS AND RECOGNITION The most utilized indicator of the indebtedness is “Per capita debt”, the total debt of a municipality divided by its population; this way to characterize the debt is not a meaningful measure, because it doesn’t provide any information on the risk involved with a specific debt level. Moreover, there are two types of municipality debt:

Investment Loans : long-term investments, useful to build up infrastructure that can generate wealth and eventually future incomes.

Short-term loans : loans that help the municipality through periods of low revenue.

Out of the two kind of loans, investment loan is less problematic because they create value; on the other hand the short-term loan is quickly consumed and it only leaves a higher debt level behind. Based on the KPMG and Notoria International experiences, acquired on the

23


same matter in other geographies, the percentage of short-term loans versus investment loans, should not exceed the 25% threshold. In the analysis phase, we have already conducted on the Cyprus municipalities indebtedness data, the present ratio is 43%, 213 M€ of short term loans against 274 M€ of project investment loans.Other data, very important to identify during the debt analysis, is to determine the reasons of the indebtedness and to identify, for each involved municipality, the threshold beyond which indebtedness becomes dangerous. For instance a possible classification of the reasons of the indebtedness could be as follow:

Recurring annual deficits: in which the municipality, for many years, spent more money than it actually had.

Accumulating short-time loans: with the aim to bridge the budget gap until times get better, the municipality activated short-term loans.

In both possibilities it will be important to identify the Exogenous and the Endogenous causes that have produced the municipality debt; an example of these causes is represented in the table below.

EXOGENOUS CAUSES ENDOGENOUS CAUSESFinancial crisis Local mismanagementViolation of the principle of grant by the central government

New local financial management

Unreliable revenues due to changes in the law

Missing of an independent supervisory authority

Solidarity fund Missing of an early warning system

Rising social welfare costs Limited accountability

DEBT RENEGOTIATION In this phase, the objective is to collect all the financial data, associated to each active loans, and to verify with the issuing banks the possibility to reduce the related interest rate and/or to increase

24


the loan period. In any case, the Pros and the Cons, linked to this action in both cases will be represented to the involved municipality.

Solidarity fundIn the time of economic constrains, the solidarity among people and institutions is the right response; also for the Cyprus Municipalities we suggest to change the present compensation mechanism, adopted by the central government in support of the local government institutions, through the setting of two financing vehicles:

the debt reduction fund : a vertical support, managed by the central government and with the aim to help the local government institutions to write off their debt; this financial technicality should substitute the present grant mechanism, utilized by the Central Government to help the local government.

The equalization fund : an horizontal support, managed by the local government and with the aim to establish an horizontal solidarity fund between the local government administrations, today completely absent, realizing a financial homogenization, through the collection of money from the richest municipalities and redistributing the collected sum among the poorest local administrations.

In the next figure is depicted the present Cyprus situation in which only a vertical solidarity fund exists and the future proposed scheme, characterized by a vertical and an horizontal fund.

25


At this point, the document analyzes the two proposals having the aim at first to limit the present indebtedness of the municipalities and secondly to establish a compensation mechanisms among the municipalities.

DEBT REDUCTION FUNDIf the municipalities and/or the communities were private businesses, considering their present indebtedness level, some of them should have to declare bankruptcy, but this is impossible. Public institutions for the duties they have to provide to the citizens, can not go bankrupt. This aspect put more responsibility to the central Government, who is the final actor to whom all the indebtedness local government entities will ask to support their burdens. As a consequence of this sanctum, the debtor and the creditor are strongly tight together in a moral hazard that will lead to over borrowing. For this specific reason the central government should propose a bill on the Insolvency Law for the local government entities and to modify the present financing support to the local administrations, based on grants, by introducing a new mechanism called “Debt Reduction Fund”.

26


The idea of the debt reduction fund is for the central government to substitute the existing grant support scheme with a fund into which the participating municipalities and/or communities transfer for ten years all their debts, accumulated in the past.The function schemes, managing this fund, should be following these rules:

1. The central government relieves the local administration entities of the interest payment, forcing the participating bodies to use this recovered sum to consolidate their budget, writing off their debt.

2. The central government provides aid to pay off the debts of the local administration entities by assuming liability for ten percent of the total borrowing per annum. Through the adoption of this method, when the Debt Reduction Fund will phase out after ten years, 73 % of those loans will be amortized (without the additional write off support of the central government).

3. The central government, with the aim to accelerate the repayment process of the loans, will support the local administration entities with an additional aid: for every Euro the local bodies pay off, the central government adds another one. This is to incentivize the individual municipality/community effort to reduce its indebtedness.

4. All the measures described are conditional on significant budget consolidation measures, undertaken by the local administration entities by adopting the process optimization and the clustering.

5. For the municipalities and for the communities that will attempt to avoid these adaptation method, the grant provided by the central government will be reduced or cancelled immediately.

6. In case of repeated misconduct by a municipality or by a community, or in the case the local administration is not able to balance its budget, an external entity, provided by the central government, will investigate the case and, possibly allow for an adjustment period that can’t be more than five years.

27


The Debt Reduction Fund is a comprehensive instrument improving the financial situation of the local administration bodies and incentivizing individual consolidation efforts. In addition, all the involved actors which contribute to the development of the municipalities/communities debt problem, are tight together in its solution. Due to this strong pact, the central government may be more cautious in the future concerning the present habit to assign a task to the local government without simultaneously allocating the necessary financial means to fulfill the task.Concerning the Cyprus reality, below is depicted how the Debt Reduction Fund will function for the Cypriot municipalities.

ASSUMPTIONS

10%

€ 11.720.3002,35%

5%

ANNUAL STREAMLINE

1 € 499.515.214 € 11.720.300 € 111.623.343 € 74.927.282 € 36.696.0612 € 387.891.871 € 9.101.243 € 86.679.617 € 58.183.781 € 28.495.8363 € 301.212.254 7.067.448 € 67.309.899 € 45.181.838 € 22.128.0614 € 233.902.355 5.488.133 € 52.268.604 € 35.085.353 € 17.183.2505 € 181.633.751 4.261.736 € 40.588.486 € 27.245.063 € 13.343.4246 € 141.045.265 3.309.394 € 31.518.447 € 21.156.790 € 10.361.6587 € 109.526.818 2.569.866 € 24.475.230 € 16.429.023 € 8.046.2078 € 85.051.588 1.995.595 € 19.005.913 € 12.757.738 € 6.248.1759 € 66.045.675 1.549.653 € 14.758.788 € 9.906.851 € 4.851.93710 € 51.286.888 1.203.362 € 11.460.740 € 7.693.033 € 3.767.707

€ 39.826.148

ANNUAL LOCAL GOV. SUPPORT

Total annual interest paid

Additional capital write off from Munic.

Annual standard capital write off %

ANNUAL CEN. GOV. SUPP.

Annual interest rate paid by Central Gov.

Annual interest rate ammount used by Municipalities to

write off loan capital

10% Total debt yearly written off by Central Gov.

For any additional € written off by municipalities another

€ will be added by Central Gov.

Total Municipalities debt € 499.515.214DEBT REDUCTION

FUND

YEAR CAPITAL INTEREST PAIDWRITE OFF

CAPITAL

The general scheme that summarizes how the Debt Reduction Fund should function, is presented in the figure below.

28


EQUALIZATION FUNDToday in a critical economic situation, it is very important to establish processes having the objective to redistribute among the different government bodies, the collected financial resources. This fiscal equalization can take place both vertically, directly from the central government to the local governments, and horizontally as a redistribution of the local financial resources among the local government entities.

The Debt Reduction Fund, or the existing Cyprus support method, based on the government grant, cover the vertical fiscal equalization; for the horizontal fiscal redistribution, today in Cyprus there isn’t any mechanism. This chapter has the aim to propose a method to establish, among the local government entities, an additional fiscal redistribution process.

The Equalization Fund process, depicted in this proposal, is based on the following rules:

29


1. For every local government entities, municipality or community, their financial requirements must be determined by using an Equalization Indicator (E.I.). The Equalization Indicator is calculated by multiplying the number of inhabitants of the local body by the average nationwide per capita figure of the Total Municipal Revenue.

2. In addition to the Equalization Indicator (E.I.), for each local administration entity a Compensation Parameter (C.P.) must be defined. This specific parameter takes in account the peculiar characteristics of each considered local government body, like:

a. Geographical location: seaside, rural, urban or mountain

b. Population

c. Road network

d. Land surface

e. Economic resources: commercial, industrial, schools, universities, infrastructures density

f. Geopolitical constrains: buffer zone, English Army bases

3. Based on the calculated value of the Equalization Indicator for each local administration body, the proposal considers a Variability Indicator (V.I.), set by the local authorities; this multiplied by the Equalization Indicator, produces the Variability Range (V.R.), that will be centered on the value of the Equalization Indicator. See the figure below.

30


4. The variability range, calculated for each local involved bodies in the previous point, will be multiplied by the specific Compensation Parameter identified in the point 2). The result will be the specific Standard Financial Resource Indicator for that particular municipality or community.

5. If the Standard Financial Resource Indicator of that specific municipality or community is lower than its present annual total revenue, this local administration will devolve to the Equalization Fund a fixed percentage of its Financial Resource Indicator. The percentage is defined by the Local Government every year and is called Support Factor.

6. If the Financial Resource Indicator of that specific municipality or community is higher than its present annual total revenue, this local administration will receive from the Equalization

31


Fund a percentage of the total amount of the Equalization Fund according to its Compensation Indicator.

To summarize the mechanism used in the handling of the Equalization Fund, and to better explain its way of working, the following schemes are presented:

Concerning the Contribution Metric used in this proposal, the process detail utilized and depicted in the previous picture is so organized:

Step 1

The fixed data are:

Total Municipality Revenue (TMR) of each municipality

32


The total inhabitants of each municipality

The Variability Indicator (V.I.), defined by the Local Authorities

Based on the annual municipal total revenue and on the population of each municipality, the Equalization Indicator is calculated as a pondered average of the total revenue per capita.

Subsequently the calculated Equalization Indicator (E.I.), expressed in Revenue €/Inhabitant, is multiplied by the Variability Indicator (V.I.), obtaining the Variability Range (V.R.), measured in €/Inhabitant.

Step 2

For each municipality will be identified, based on its peculiar characteristics of the territory, a Compensation Parameter; this indicator can be positive if the specific municipality has some burdens to carry on, or negative in the case the municipality’s territory has some advantages, respect others. More precisely, the parameters that we have considered in the Compensation Parameter definition, is presented in the table 1.

For each municipality, a Standard Financial Resource Indicator will be calculated according to this metric: Equalization Indicator + Variable Range x Compensation Parameter.

Step 3

The fixed data are:

Support Factor, defined by the local authorities

33


If the Total Municipality Revenue is higher than the Standard Financial Resource Indicator for that municipality, the difference between these two variables will be calculated and subsequently the quote of money that the municipality has to donate to the Equalization Fund, will be as the result of this metric:

(Total Munic. Revenue – Std. Financial Res. Ind.) x Support Factor

34


Table 1: Municipalities characteristics table

35

0,10,0

5-0,

05-0,

1-0,

10

0,1-0,

10

0,10,1

0-0,

1-0,

02-0,

05-0,

01-0,

02-0,

10,0

70,0

3

NICO

SIA-0,

1-0,

1-0,

02-0,

05-0,

01-0,

02-0,

10,0

70

-0,33

STRO

VOLO

S-0,

1-0,

1-0,

1-0,

02-0,

050

-0,02

00

0-0,

39AY

IOS D

HOME

TIOS

-0,1

-0,1

0,1-0,

10

00

00,0

70

-0,13

AGLA

NTZIA

-0,1

00,1

00

-0,02

00,0

70

0,05

LAKA

TAMI

A-0,

1-0,

10

0-0,

050

00

00

-0,25

LATS

IA-0,

10,1

00

00

00

0EN

GOMI

-0,1

0,1-0,

10

00

-0,1

0,07

0-0,

13ID

ALIO

N0,0

50,1

00

00

00

0,15

YERI

0,05

0,10,1

00

00

00

0,25

TSER

I0,0

50,1

00

00

00

0,15

LIMAS

SOL

-0,05

-0,1

-0,1

0,1-0,

02-0,

050

-0,02

-0,1

00

-0,34

MESA

YITO

NIA

0,10,1

-0,1

00

00

00

0,1AY

IOS A

THAN

ASIO

S-0,

10,1

00

00

00

0KA

TO PO

LEMI

DIA

-0,1

00

00

00

-0,1

YERM

ASOY

IA-0,

050,1

0,10

00

-0,1

00

0,05

IPSON

AS-0,

10

00

00

0-0,

1LA

RNAK

A-0,

05-0,

1-0,

1-0,

02-0,

05-0,

01-0,

020

00

-0,35

ARAD

IPPOU

-0,1

-0,1

0,10,1

0-0,

010

00

0-0,

01AT

HIEN

OU0,0

50,1

00

00

0,07

00,2

2LE

FKAR

A0,0

50,1

0,10,1

-0,02

00

00

00

0,33

LIVAD

IA0,0

50,1

0,1-0,

10

00

00

00,1

5DR

OM.M

ENEO

U0,0

50,1

0,1-0,

1-0,

020

00

00

00,1

3PA

FOS

-0,05

0,1-0,

1-0,

05-0,

01-0,

02-0,

10

0-0,

23PO

LIS CH

RYSO

CHOU

S-0,

050,1

0,10,1

00

0-0,

10

00,1

5GE

ROSK

IPOU

-0,05

0,10,1

00

0-0,

10

00,0

5PE

YIA-0,

050,1

0,10

-0,01

0-0,

10

00,0

4SO

TIRA

-0,05

0,10

-0,01

00

00

0,04

PARA

LIMNI

-0,05

0,1-0,

1-0,

050

-0,02

-0,1

00

-0,22

AGIA

NAP

A-0,

050,1

-0,1

0-0,

010

-0,1

00

-0,16

DERY

NEIA

0,05

0,10

00

00,0

70

0,22

Low

<20.0

00Hi

gh >3

1M

edium

13 -

31Lo

w <1

3Inf

rastru

cture

CHAR

ACTE

RISTIC

S

Ind/C

omm

>1.20

0

GEOP

OLITI

CAL

Histo

rical

>12

Educ

ation

al>31

tour

istics

>20

Buffe

r Zon

eM

ilitar

Base

MUN

ICIPA

LITY

GEOG

RAPH

YRO

AD NE

TWOR

KPO

PULA

TION

SURF

ACE

Med

ium De

n. 36

-155

Low

Dens

ity<3

6Hi

gh>6

0.000

Med

ium

20.00

0-60

.000

RANK

ING

Mou

ntain

Rural

Seasi

deUr

ban

High

De

nsity

>155


Concerning the Distribution Metric used in this proposal, the process detail utilized and depicted in the previous picture is so organized:

Step 1

The fixed data are:

Total quantity of money deposited in the Equalization Fund by the municipalities that doesn’t carry on any territorial burdens, according to their Compensation Indicator.

The specific Compensation Indicator of each municipality

Based on the total amount of money, donated by the municipalities without any territorial burdens and assigned to the Equalization Fund, the quantity of horizontal support to assign to each receiving municipality will be calculated according to this metric:

36


(Positive Compensation Indicator/Total sum of positive Compensation Indicator) x Total amount Equalization Fund.

Now, applying the contribution and the distribution metrics to the specific case of the Cypriot Municipalities and assuming for the Support Factor a 5%, for the Variability Indicator a 15% and as revenues the 2012 data, the outcomes can be presented in the following table.

MUNICIPALITY TODAY INCOME (2012 data)

STANDARDIZED INCOME BASED ON THE RELATED

COMPENSATION INDICATOR

DELTA (INCOME -

STD.INCOME)CONTRIBUTION DISTRIBUTION

NICOSIA € 30.349.701 € 20.714.343 € 9.635.358 € 481.768 € 0

STROVOLOS € 19.422.130 € 25.057.008 € 0 € 0 € 0

AYIOS DHOMETIOS € 4.308.667 € 5.001.961 € 0 € 0 € 0

AGLANTZIA € 6.668.014 € 8.814.662 € 0 € 0 € 57.195

LAKATAMIA € 8.917.600 € 14.807.498 € 0 € 0 € 0

LATSIA € 5.955.069 € 7.009.867 € 0 € 0 € 0

ENGOMI € 5.939.737 € 7.951.732 € 0 € 0 € 0

IDALION € 4.516.847 € 4.570.568 € 0 € 0 € 171.584

YERI € 2.302.916 € 3.699.519 € 0 € 0 € 285.974

TSERI € 2.233.074 € 3.072.229 € 0 € 0 € 171.584

LIMASSOL € 40.661.641 € 37.902.763 € 2.758.878 € 137.944 € 0

MESA YITONIA € 4.496.423 € 7.747.880 € 0 € 0 € 114.390

AYIOS ATHANASIOS € 4.558.677 € 5.995.622 € 0 € 0 € 0

KATO POLEMIDIA € 5.198.194 € 9.039.611 € 0 € 0 € 0

YERMASOYIA € 7.544.213 € 5.692.776 € 1.851.437 € 92.572 € 57.195

IPSONAS € 3.557.815 € 4.661.683 € 0 € 0 € 0

LARNAKA € 19.946.999 € 19.915.506 € 31.493 € 1.575 € 0

ARADIPPOU € 5.861.578 € 8.011.290 € 0 € 0 € 0

ATHIENOU € 2.385.390 € 2.234.984 € 150.406 € 7.520 € 251.657

LEFKARA € 1.164.750 € 349.966 € 814.784 € 40.739 € 377.486

LIVADIA € 3.157.513 € 3.056.944 € 100.569 € 5.028 € 171.584

DROMOLAXIA-MENEOU € 2.505.842 € 2.952.552 € 0 € 0 € 148.707

PAFOS € 19.329.374 € 12.797.146 € 6.532.228 € 326.611 € 0

POLIS CHRYSOCHOUS € 2.859.962 € 1.453.795 € 1.406.167 € 70.308 € 171.584

GEROSKIPOU € 4.333.368 € 3.341.605 € 991.763 € 49.588 € 57.195

PEYIA € 5.660.121 € 1.671.785 € 3.988.336 € 199.417 € 45.756

SOTIRA € 939.598 € 2.326.036 € 0 € 0 € 45.756

PARALIMNI € 15.387.671 € 5.838.786 € 9.548.885 € 477.444 € 0

AGIA NAPA € 11.053.655 € 1.277.867 € 9.775.788 € 488.789 € 0

37


DERYNEIA € 2.432.085 € 2.603.398 € 0 € 0 € 251.657

The bottom line through the implementation of the Debt Reduction Fund and of the Equalization Fund as a vertical contribution vehicle from the central government for the first and an horizontal contribution method among the local government entities for the second, is for the Cyprus government to set in its central and local organizations a new financial philosophy that allow the municipalities to reduce their debt constrains in a fixed time period and to guarantee a more equal distribution of the financial resources among the local administration entities.

In addition, the central government, by introducing the Debt Reduction Fund, in substitution of the today grant mechanism, will save a total 550.775.862 €, because considering ten years of timeframe in which the Debt Reduction Fund will have to operate, the total cost the central government should have to support for the municipalities in both cases are:

Keeping the existing grant support program: 859.342.614 €

Utilizing the Debt Reduction Fund: 308.566.752 €

It is also important to underline in Germany, since 2005 these two mechanisms have already been positively implementing; this approach helped the sixteen Länder and the over twelve thousand municipalities to reduce their debts in a fixed time period, without increasing the taxes or cutting the services. The German fiscal equalization among the federal states, Länderfinanzausgleich, is based on article 107 of the German constitution and it was improved in 1991 and recently in 2005 with Finanzausgleichgesetz ,

38


instead for the debt reduction fund the referred law is Gleichvertigkeit der Lebensverhätnisse Gesetz.

ADMINISTRATIVE COUNCILOn the other hand, it is also important to focus the attention on the endogenous causes; causes already previously indicated in this working paper. To limit the shortcomings produced by these internal negative sources, the proposal is to establish in each District an independent authority, called Administrative Council having, for the debt reduction specific topic, the responsibility for:

Being an independent supervisory authority on budgeting

Implementing an Early Warning System on budget/debt matters

Being a state commissioner for the municipalities

The duties of these three proposed organizations, inside Administrative Council, are described in the following chapters.

Independent supervisory authority

To avoid a possible entanglement of the lower levels of the local supervisory authority with the local politicians, phenomenon that also contributes to the municipal debt problem, a truly independent supervising authority should be created. Its role consists in monitoring investment activities and to put a cap on investment loans, in according to the real financial resources of the municipalities.

39


In essence this authority will exercise on the local communities a pressure to spend prudently and operate efficiently; in addition the presence of this budgeting control & monitor function, permit the municipalities to be, on budgeting matters, more transparent and comparable.

In addition, the supervisory authority has to act, for the municipalities and communities, as an external consultant that through its professional expertise and recommendations should guide and suggest the local government institutions on financial and budgeting matters.

The Supervisory Authority don’t have any authority to sanction deviations from their recommendations; its duties is just to monitor the local bodies and report their behaviors.

Early Warning System

The Early Warning System is just a set of different benchmarks and indicators, defined by the supervisory authority, to assess the financial situation of a local authority.

The responsibility of this steering committee is to detect problematic situations much earlier, to communicate them more openly and, hence, to solve them more quickly. In this way the worst debt trouble can be averted and municipal scope of action preserved. In other words the Early Warning System creates transparency, which in returns generates a sense of urgency to act upon the identified problem, avoiding the creation of future debts.

State Commissioner

40


With the objective to work altogether to overcome the existing economic crisis, it is very important to adopt a solidarity approach among all the government structures, than to be draconian on those bodies that will not respect the agreed pacts.

Based on this philosophy, the Central Government must have the option to delegate an external expert to over indebted communities; this should be done thorough the State Commissioners. This professional figure, in case a municipality’s administration doesn’t respect their expenditure limits, linked to its real financial resources, allowing the generation of an uncontrolled debt, can effectively substitute the mayor and the municipal council.

The State Commissioner is authorized to make all the necessary financial decisions for the community, even against the will of the local executives, in order to consolidate the budget. However, this is an instrument of last resort and has never been utilized.

41


A scheme of the Administrative Council is represented below.

IMPLEMENTATION SCHEDULINGOur proposal is based on three main pillars: process improvement and debt reduction, clustering and consolidation. These phases have been thought to be in sequence; now considering the need to accelerate the events, we think it is possible to set the following schedule:

First six months o Process optimization with specificity on Waste Management,

Road Lighting and Building Permits.

42


o Clustering as best practices identification, setting up the governing rules, structure the cluster's composition and roll out implementation plan determination.

o The setting-up of: Debt Reduction Fund and Equalization Fund.

Next six months o Process optimization, covering other areas, with the

objective to set the bases to achieve 24,5 M€ in savings. o Clustering setting up for some specific realities as a test

driver; for instance three test cases: one urban cluster, one rural cluster and one mixed cluster.

o Responsibility transfer from the Districts to the Municipalities and clusters.

After one year from project's kick off o Process optimization with the objective to set the bases to

achieve savings of 43,3M€.o Cluster implementation in accordance to the master roll out

plan and consider the experiences collected through the previously test drivers. The objective of this phase is to set the basis to achieve 70,5M€ of savings.

o Responsibility transfer from the Districts to the Clusters After three-five years from project's kick off

o Administrative Councils setting up with a specific focus on budgeting supervisor and financial early warning system.

o Consolidation of the Town Planning in the Administrative Councils.

o Consolidation of water and sewerage boards in the Administrative Councils; these action is important to:

Improve the today decision process Render more transparent the actions of the boards Increase the efficiency and the efficacy of their actions Better synchronize the actions of the boards

throughout the territory Adhere to the real needs

o Single Human Resources office, responsible for managing the local government employees, leaving to the single municipalities/communities the responsibility for the appraisal process, for the job assignment and for the workload control.

43


o Single purchasing and payment office for the overall local administration, having the objective to set standard prices for any goods needed by the administrations.

The actions we have identified to solve the problems associated to the inefficiencies of the administrative processes

44

Documents

Debt analysis