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ITEM EX5

EXECUTIVE – 3 APRIL 2002

TREASURY MANAGEMENT STRATEGY FOR 2002/03

Report by Director for Business Support & County Treasurer

Introduction

  1. In 1996, the Chartered Institute of Public Finance and Accountancy (CIPFA) published a revised Code of Practice on Treasury Management in Local Authorities, which was adopted by this Council in February 1996. One of the main requirements of the Code is to report on a Treasury Management strategy for each financial year.

    2. Forecast changes to the Council’s Debt Portfolio for the 2002/03 Financial Year.

  2. Annex 1 gives the Council’s debt financing requirement for 2002/03. The notes to the annex provide details of the forecast composition of the County Council’s debt at 1 April 2002 and show that the major source of funding is with the Public Works Loan Board (PWLB), is a Government Agency.

  3. The County Council’s overall debt is projected to increase from £197.9 million at 1 April 2002 to £225.2 million at 31 March 2003, which is a net increase of £27.3 million. In addition to the net increase in debt the Council has £5 million of PWLB loans and £5 million of money market loans maturing, which will need to be replaced.

    4. Points to consider in formulating the Council’s debt management strategy

  4. The County Council should borrow long term and at fixed rates of interest when rates are "low" and borrow short term or at variable interest rates when rates are "high".

  5. The Council’s percentage of debt that is fixed is projected to increase from 91% to 93% between 1 April 2002 and 31 March 2003. At 1 April 1993 the debt was 52% fixed and 48% variable. The Council has progressively increased its level of fixed debt since the second half of the 1990’s, a period of rapidly falling interest rates.

  6. The maturity debt profile should be reasonably smooth to avoid having to replace large amounts of maturing debt in any future year. There is also the possibility of debt being repaid early if this can be achieved on favourable terms. Annex 2 gives a breakdown of the Council’s long-term debt by year of maturity.

    7. Economic and Market factors expected to impact on interest rates

  7. Short Term Interest Rates. For the purposes of this report short-term interest rates are defined as being for 364 days or less.

  8. The Bank of England Monetary Policy Committee effectively determines the level of UK short-term interest rates. The Government has set the Bank of England an inflation target of 2½% (measured by the Retail Prices Index excluding mortgage interest). The underlying inflation rate has been below the Government’s 2½ % target for the best part of two years.

  9. During 2001/02 the UK bank base rate was cut from 5.75% to 4%. The last cut was made in the aftermath of 11 September and was a pre-emptive measure by the Bank of England to avoid the UK slipping into recession. This last cut brought rates down to the lowest levels seen in the UK for nearly forty years. The Bank will be paying close attention to domestic consumption figures over the next few months and will also want to assess the impact of the April budget on the economy. Continued strong consumption and a fiscally loose budget would probably leave the Bank of England with no alternative but to raise interest rates.

  10. The high value of sterling, particularly until recently against the euro, has helped reduce UK inflation. The strong pound has meant that imported goods have been cheaper but has made trading conditions difficult for exporters, particularly in the manufacturing sector. Industrialists would like interest rate cuts and sterling to fall to a more competitive level but the Bank of England will want to ensure that the currency does not weaken too quickly because of the inflationary implications.

  11. The sterling futures market is forecasting higher interest rates, 5% for the end of 2002 and 5.5% for the end of 2003. Most City economists are also forecasting higher short-term interest rates and these are shown in annex 3.

  12. The level for long-term interest rates is determined by short-term interest rates and expectations for inflation. Investors will only invest in longer term fixed interest bonds if they expect to receive a higher return than shorter-term investments. Investors are reluctant to invest longer term if they fear inflation may rise because the value of their tied up capital will be eroded more quickly.

  13. One of the main reasons why long term interest rates have fallen globally is that world central banks have taken a tough stance on controlling inflation. In 1997 the Bank of England was set an inflation target of 2½ %.

  14. Demand for 20-year plus UK long-term government stock (referred to as gilts) has increased in recent years and interest rates have therefore fallen. Long-term gilts have been in great demand by pension funds and insurance companies to comply with the Minimum Funding Requirement (MFR). This increase in demand has occurred at a time when Government finances have been in surplus and so there has been a reduction in the supply of gilts.

  15. However, this situation is unlikely to persist. Tax revenues are unlikely to be as buoyant as they were in the late 1990’s so the budget may move into deficit, which will result in a rise in gilt issuance. At the same time as the gilt supply is increasing, demand may diminish. MFR is to be abolished and the introduction of the accounting standard FRS17 may prompt many pension funds to switch from gilts to corporate bonds. This has already happened in the second half of 2001.

  16. During the last four or five years UK long-term interest rates (20 year plus) have been cheap historically and by international comparisons. Annex 3 compares the UK interest rate yield curve with the Eurozone. If the UK joined the Euro then these interest rates would converge, which would suggest lower short-term interest rates for the UK but higher long-term rates.

  17. The factors discussed in paragraphs 14 to 16 would all point towards higher long term interests rates, although this could change in a deflationary climate.

    18. The Council’s Debt Management Strategy 2002/03

  18. The County Council has a PWLB quota of £40.7 million in 2002/03, which is determined by credit approvals (£35.7 million) and maturing PWLB debt (£5 million). Credit approvals are the amount the Council can borrow in any one year to finance the capital programme (the notes to annex 1 explain credit approvals in more detail).

  19. PWLB interest rates continue to be the cheapest source of borrowing available to local authorities. It is intended to take up the whole of the PWLB quota in 2002/03 and we continue to favour fixed interest loans in the 15-year plus period. Taking the whole quota in 2002/03 will increase the Council’s percentage of fixed debt from 91% to 93%. Although this would still be within the existing agreed range of 75% to 95%, it is recommended that the range be increased to 75% to 100%.

  20. Opportunities to repay loans early will be taken if it is demonstrated that there are guaranteed savings and only where prematurely repaid debt is replaced with loans of a similar maturity period.

    21. Investment of Surplus Funds

  21. The County Council’s internal balances include provisions, reserves, capital receipts unapplied and the excess of creditors over debtors. Where these balances have not been required to fund the Council’s debts, they have been lent out short term in the London wholesale money market for periods up to 364 days.

  22. In addition to the wholesale cash market local authorities may invest surplus funds in Certificates of Deposit, gilt-edged stock or Supranational bonds (e.g. World Bank). Few authorities invest directly in such instruments. Exposure is normally achieved by appointing a specialist external manager.

  23. The County Council operates its own approved lending list, which is made up of financial institutions and other local authorities. Each institution is ascribed a maximum lending limit to ensure a spread of risk within the total lending portfolio. The County Council subscribes to the Fitch IBCA credit rating service, which evaluates the credit worthiness of financial institutions and assigns them an individual rating.

  24. The County Council only lends to top rated institutions, all of which are either authorised by the Bank of England or European Union to accept sterling deposits. In June 1999 the former Operations Sub-Committee extended the lending list to include foreign banks, provided they had the necessary authority to borrow sterling deposits.

  25. The Bank of England determines the interest rates in the wholesale money market. Most independent City forecasts (Annex 3) are predicting the Bank will increase short-term interests rates during 2002/03.

    26. Call Accounts

  26. The County Council currently operates three call accounts. These are with LloydsTSB and more recently opened accounts with the Abbey National and Bank of Scotland. A call account is where a cash deposit can be withdrawn with immediate notice. The operation of these accounts enables the smooth and efficient management of the Council’s day-to-day cash flow. They can also be used as a tactical management tool. The County Council has made significant interest savings in opening the two new accounts, which will be reported in more detail in the 2001/02 Treasury Management Review Report.

  27. The LloydsTSB account has a maximum historical limit of £25 million. However, under the Council’s existing approved lending criteria the maximum limit for the other two recently opened call accounts is only £10 million. In order to be consistent, it is recommended that the maximum deposit limits for each of the three call accounts be set at £15 million.

  28. Higher maximum limits can be justified on the call accounts because in the event of any credit downgrade funds can be called back immediately.

    29. Appointment of External Manager

  29. In March 2001 the then Operations Sub-Committee gave the County Treasurer delegated authority to appoint an external manager to manage up to £15 million, with the initial view of investing this sum over a minimum three year period. The decision was made on the basis of the desirability of diversifying risk and seeking to enhance the investment return on the County Council’s surplus cash balances.

  30. Alliance Capital were chosen, after an extensive tender exercise, on the strength of their consistently above average performance and low risk style. Meetings have been held to agree an appropriate performance benchmark; a composite of cash and gilts. Funds will be transferred and operations commenced shortly.

    31. New Flexible Investment Options for Local Authorities

  31. As this report was going to print we received news from the Department for Transport, Local Government and the Regions that local authorities would be given wider investment powers. These new powers will come into operation from 1 April 2002 and will be considered in a separate report.

    32. Revision of the County Council’s Approved Lending List.

  32. There is one new institution, recommended for inclusion on the County Council’s approved lending list as detailed in Annex 3. This bank is authorised by the Bank of England to accept sterling deposits and has been ascribed a top credit rating by FitchIBCA. Annex 3 also provides details of five institutions that have been removed from the list, under the County Treasurer’s delegated powers, for technical reasons or minor credit downgradings.

    33. Financial Implications

  33. The recommended Strategy should achieve lower debt charges and generate more income from external investments.

    34. RECOMMENDATION

  34. The Executive is RECOMMENDED to:

          1. agree the one addition to the Council’s approve lending list as set out in Annex 3;

          2. increase the range for fixed interest debt to 75-100%;

          3. set £15 million maximum limits for the LloydsTSB, Abbey National and Bank of Scotland Call Accounts.

CHRIS GRAY
Director for Business Support and County Treasurer

Background Papers: Nil

Contact Officer: Tony Wheeler Tel: Oxford 815287

February 2002

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