SUMMARY OF:A Special Review of the Department of Revenue, Mustang Operations Center 1 LLC Loan

Why DLA Performed This Audit

The audit reviews DOR’s tax credit-backed loan to MOC 1. Specifically, the audit evaluates DOR’s compliance with Alaska statutes, policies, and procedures, and the loan agreements. Additionally, auditors determine whether tax credit-backed loans were offered to other entities, whether the MOC 1 loan was accurately recorded in the State’s financial statements, whether there were any conflicts of interest related to the loan, and whether the legislature was notified of the loan.

Report Conclusions

The audit concludes that the MOC 1 loan was, in substance, an advance payment of MOC 1’s 2015 tax credits, legally permissible under DOR’s statutory investment authority. Although the loan was legal, DOR management did not comply with all statutes governing the investment function. The loan was not adequately collateralized for a period of 19 months. Additionally, the loan was made outside DOR’s established investment processes and not subject to procedures designed to meet investment objectives and minimize risk. Further, the loan was not properly managed, which led to inaccurate financial accounting and reporting.

Although DOR obtained an opinion regarding the legality of establishing a tax credit-backed loan program, a “program” was never created. DOR management could not explain why tax credit loans were only offered to MOC 1.

The MOC 1 loan created two conflicts of interest. The DOR commissioner’s interest in collecting payment on the MOC 1 loan conflicted with duties to represent the Alaska Industrial Development and Export Authority (AIDEA) in matters relating to MOC 1 as part of AIDEA’s board of directors. Secondly,
the DOR commissioner’s statutory duty to ensure the MOC 1 loan was collateralized conflicted with the commissioner’s authority over the valuation and approval of tax credits.

DOR recorded a gain of $4.29 million over the life of the MOC 1 loan, however, AIDEA’s assumption of the loan from DOR resulted in a decrease to AIDEA’s net income of $1.77 million. AIDEA management estimates the loss will decrease AIDEA’s FY 21 state dividend by $885.5 thousand.

Given the decline in oil prices, it is possible AIDEA will record a significant allowance for loan loss, write off, or substantially write down the amounts owed to AIDEA on the Mustang project by Caracol Petroleum LLC, independent of assuming the DOR MOC 1 loan. Any loss incurred will reduce net income and further reduce AIDEA’s dividend.

Overall, the audit found the DOR commissioner’s decision to loan up to $22.5 million to MOC 1 under the authority of the department’s investment statutes was inappropriate when compared with behavior that a prudent person would consider reasonable. In support of this conclusion, auditors noted the following: the loan was made outside of DOR’s established investment procedures and DOR management failed to adequately document consideration of the associated risks when making the loan; adequate internal controls were not implemented over the accounting, reporting, and management of the loan; and the loan created conflicts of interest that were not sufficiently mitigated. These facts demonstrate the need for additional oversight of DOR’s investment functions.

Findings and Recommendations

  1. DOR’s commissioner should ensure investments are made in accordance with established investment objectives and procedures.
  2. DOR’s commissioner should ensure collateral is required in accordance with AS 37.10.071(b)(5).
  3. DOR’s commissioner should ensure conflicts of interest are avoided or prevented when carrying out the department’s duties and responsibilities.
  4. The legislature should consider enhancing oversight of DOR’s investment functions.