Meeting documents

Cabinet
Tuesday, 18 July 2006

CA180706-06

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ITEM CA6

CABINET – 18 JULY 2006

TREASURY MANAGEMENT OUTTURN 2005/06

Report by Head of Finance & Procurement

Introduction

  1. The Chartered Institute of Public Finance and Accountancy’s Code of Practice on Treasury Management 2001, was adopted by Council on 1 April 2003. One of the primary requirements of the code is the receipt by Cabinet of an annual review of treasury management activity in the previous year. This report reviews the Council’s Treasury Management activity carried out during 2005/06.

    2. The Strategy for 2005/06

  2. Our original strategy for 2005/06 was based on the view that base rate would rise to 5% during the first quarter of 2005 and fall back to 4.50% by the end of the financial year. The growth of GDP in the UK economy was expected to weaken as a result of a slowdown in household spending and a weakening housing market. Inflation was expected to rise due to increases in oil and commodity prices. The 20-25 year Public Works Loan Board (PWLB) rate was expected to remain fairly stable around the 4.75% level for most of the year.

  3. The Council’s strategy was to maintain a stable longer-term debt portfolio by drawing predominantly long-term fixed rate funding. It was anticipated that LOBO (Lender Option, Borrower Option) loans would be cheaper than fixed rate debt. The Council approved the use of LOBO loans in 2005/6 to a maximum of 10% of the portfolio.

  4. Investments would include a mix of maturity periods, dependent upon cashflow requirements and market expectations for interest rates. Where the cashflow allowed longer period investments were to be arranged before anticipated drops in base rate.

    5. Market Background

  5. Base rate started 2005/6 at 4.75%, having been unchanged at this level since August 2004. It fell to 4.5% in August 2005 and remained at that level for the rest of 2005. The strong growth of consumer expenditure and housing prices in 2004 became anaemic during 2005 though the housing market did pick up to recover slightly later in the year and in quarter 1 of 2006.

  6. High oil prices and major increases in utility prices reduced spending power and negatively impacted sentiment. Unemployment claimant count increased each month during the year while manufacturing output was in recession for the first half of 2005 before staging a recovery.

  7. The 5-year gilt yield fell from about 4.68% at the start of the year to a low of about 4.05% on 1 September, before hitting two peaks of around 4.45% in early November and the end of March.

  8. The PWLB 25-30 year rate started the year at 4.75% and then fell into a range of 4.3% - 4.5% for most of 2005 after mid May. However, in late January long gilt yields plunged to levels unprecedented in recent history with the 25-30 year rate falling to a low of 3.85%, before rising back to a new peak of 4.25% at the end of the year.

  9. A major innovation in 2005/6 was the introduction by the Government of the 50 year gilt, (the longest maturity period since the 1960s). The first issue of £2.5bn on 26th May 2005 was followed by further similar sized tranches in July, December and February. The PWLB took its cue from the 7 December issue to introduce new PWLB borrowing maturity periods above the maximum 25 – 30 years. The longest band (45-50 years) started at a rate of 4.2% (compared to 4.3% for 25-30 year borrowing) and bottomed at 3.7% in late January before ending the year at 4.15%. The phenomenally low rates were widely interpreted as having been caused by unusually high demand for long-gilts from non-UK institutions including oil rich and Asian countries buying financial assets.

    10. Treasury Management Activity

    Debt Financing

  10. The Council’s debt financing for 2005/06 is analysed in Annex 1 (download as .doc file). This shows that the Council’s debt increased from £297.66m at 1 April 2005 to £348.06m at 1 April 2006, an increase of £50.4m. This was based upon the 2005/06 Capital Programme and the rules of repayment of debt laid down in the Local Government and Housing Act 1989.

  11. The Council borrowed £66million in longer-term loans during 2005/06 as part of its normal debt-financing programme. £20million was taken from the Money Market in the form of LOBO loans; the remaining £46million was arranged through the PWLB and taken at fixed rates. The average debt portfolio interest rate for the year was 5.098%.

  12. The borrowing strategy during the year was to draw a mix of longer-term fixed rate debt and cheaper semi-variable LOBO loans, to take advantage of low rates and minimise exposure to fluctuations in interest rates.

  13. Our view was that interest rates were likely to fluctuate around 4.75% throughout the year. The Council’s budget assumed average new borrowing costs of 5%. New borrowing was undertaken periodically during the year to coincide with temporary dips in the interest rates. The Council took advantage of low rates during the first quarter of the financial year borrowing £10million in LOBO loans in April, and taking £5million from the PWLB when the 25-30 year fixed rate dropped to 4.6% from 4.75% on 1 April. Further PWLB borrowing was undertaken in late May and June when interest rates temporarily dipped to 4.45% and 4.35%. The Council held off PWLB borrowing in July and August when the 25-30 year interest rate rose to 4.55%. Further borrowing was undertaken in September and November when the rate dropped back to 4.3% and 4.25% respectively. New borrowing undertaken during the year totalled £66million. All new planned borrowing had been arranged by 31st November.

    14. Restructuring Debt

  14. In November a loan of £6m was arranged with the PWLB as part of a proposed restructuring of an existing loan to achieve savings on the Council’s debt charges. Due to changes in market conditions it was not possible to repay the existing loan until April 2006. The restructuring has generated savings of £7,000 per year up to 2028.

  15. The Council has built into the Medium Term Service and Financial Plan the potential requirement to have to charge the net premiums arising from debt restructuring into the revenue budget for 2007/08. This has been anticipated due to changes in financial reporting Standards. As a result the Council policy has been not to restructure debt where premiums would have been charged, as this would have had the consequence of increasing the potential write-off of net premiums to revenue in 2007/08.

  16. The latest view is that authorities will have at least a dispensation from repaying premiums incurred before 31 March 2007 due in part to the potential impact on the level of Council Tax, where some authorities have significant premiums on their balance sheets. It is therefore proposed that the Council extend its scope to seek debt restructuring, to include being able to incur premiums up to a maximum agreed by the Head of Finance and Procurement, in order to achieve savings in its debt charges. This position would be reviewed for 2007/08 once the new financial reporting standards have been published. It is recommended that Council be asked to approve this change.

  17. Currently, the Council’s debt restructuring policy permits existing debt to be replaced with loans of the same type and similar maturity periods. It is possible that additional savings could be achieved by replacing some of the fixed-rate debt with variable debt or semi-variable LOBO loans. It is recommended that the Council allow debt restructuring to include different loan types and different maturity periods within a debt profile agreed by the Head of Finance& Procurement.

    18. Maturing Debt

  18. The Council repaid £6 million of maturing PWLB debt during the year. The annual interest rates on the matured loans averaged 7.66%. These are analysed in Annex 2 (download as .doc file).

    19. Investment Strategy

  19. The Council’s in-house cash balances are deposited with institutions on the Council’s approved lending list. The Council invests for a range of periods from overnight to 3 years, dependent upon the Council’s cash flows, its interest rate forecasts and the interest rates on offer.

  20. In-house Investments were initially kept short because longer-term rates were low as a result of the market pricing in expectations of a cut in base rate. During July, the Council arranged a longer-term £5million callable deposit to benefit from higher returns than those available for fixed term lending. Callable deposits generally offer higher returns, but give the borrower the option to repay the loan early on specified option dates. Additional callable loans were arranged in October and January. During January 2007 a total of £3million was deposited in 12-month fixed maturities with a view to maintaining higher returns during a falling interest rate environment.

    21. The Council’s Lending List

  21. The Council’s approved lending limits were increased in July 2005 to reflect the increase in the average daily in-house investment. The lending list is regularly updated during the year to reflect changes in bank and building society credit ratings. Annex 3 (download as .doc file) shows the amendments incorporated into the lending list during 2005-06, in accordance with the approved credit rating criteria.

    22. Investment Outturn

  22. The average daily investment of temporary surplus cash invested in-house was £153m in 2005/6. The Council achieved an in-house return of 4.69%, producing a gross in-house investment return of £7.17million for 2005/6. Temporary surplus cash balances include pension fund cash (approximately £8.5m at year-end), developer contributions, trust fund balances and other funds to which the Council pays back the interest earned on the average fund balance.

  23. The Council uses the seven-day inter-bank sterling rate as its benchmark to measure its own in-house investment performance. This is considered the most appropriate rate taking into account the Council’s average level of deposits and cashflow considerations. During 2005/06 the average seven-day interbank sterling rate was 4.53% and the Council’s average in-house lending rate was 4.69%, which exceeded the benchmark by 0.16%.

  24. The Council operates a number of call accounts to deposit short-term cash surpluses with banks on its approved lending list. During 2005/6 the average balance available on call was £20.8million.

  25. The Authority took advantage of the more favourable returns offered by Money Market Funds during 2005/6 and began investing in the Standard Life Sterling Liquidity Plus Fund in June 2006. The account, which was opened in September 2004, had not previously been used, as higher returns were available for cash deposits. However, Money Market Funds became more attractive during 2005/6 as they outperformed cash deposits. From June 2006 the Council invested an average daily balance of £20.8million in the Money Market Fund and achieved an investment return of £761,980, 4.65%p.a.

  26. No temporary borrowing was undertaken during 2005/06.

    27. External Fund Manager

  27. At the beginning of the financial year the Council had £16.7million invested externally and managed by Alliance Capital. The fund manager’s performance was regularly monitored and meetings were held to discuss performance and strategy. As a result of disappointing performance, and following discussions with the fund manager and the Council’s investment advisors, Sector Treasury Services, the decision was taken to terminate the agreement with Alliance Capital. The externally managed funds were returned and invested in-house from 30th September.

  28. Two external fund managers were appointed to replace Alliance Capital, each to manage £10m of the Council’s cash balances. Investec Asset Management and Scottish Widows Investment Partnership were selected as the new fund managers with briefs to invest in certain financial instruments for which there is no in-house expertise. The managers are expected to out-perform the returns on cash over a three year period.

  29. The agreement with Investec Asset Management has been signed and the funds were transferred in April 2006. It is anticipated that the agreement with Scottish Widows Investment Partnership will be in place by the end of June 2006.

    30. External Performance Indicators and Statistics

  30. The County Council is a member of the CIPFA Treasury and Debt Management Benchmarking Club and completed returns for the financial year 2005/6. The results of this exercise have not yet been published.

  31. The results of the 2004/5 return were reported in the 2006/7 Treasury Management Strategy Report on 17 January 2006, and showed that the Council’s average in-house investment returns of 4.68% for 2004/5 was the third highest of all shire counties.

  32. The average interest rate paid for the Council’s long-term borrowing in 2004/5 was 5.31% compared to a benchmarking club average of 6.27%.

    33. Prudential Indicators for Treasury Management

  33. During the financial year the Council operated within the treasury limits and Prudential Indicators set out in the Council’s Treasury Management Strategy Report. The outturn for the Prudential Indicators is shown in Annex 4 (download as .doc file).

    34. Financial and Staff Implications

  34. The combined activities of debt management and investments form the strategic measures element of the Council’s budget. The revenue outturn for 2005/06 exceeded the budgeted net income by some £2.67m. This is due to a combination of unutilised capital resources, improved returns on investments and taking PWLB borrowing below budgeted rates.

    35. RECOMMENDATIONS

  35. The Cabinet is RECOMMENDED to:

          1. note the Council’s Treasury Management activity carried out in 2005/06;

          2. RECOMMEND the Council:

            1. to agree debt restructuring in 2006/07 where premiums will be generated; and

            2. to approve the use of different loan types and maturity periods for debt restructuring.

SUE SCANE
Head of Finance and Procurement

Background papers: Nil

Contact officer: Mike Petty: 01865 815622/Donna Ross: 01865 815684

July 2006

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