AUDIT COMMITTEE
WEDNESDAY 30 JUNE 2010 AT 10.30 AM / Agenda Item No:
5
ANNUAL REPORT ON THE TREASURY MANAGEMENT SERVICE AND PRUDENTIAL INDICATORS 2009/10
Report of the Director of Resources and Performance
Author: Patrick Towey (Tel: 01992 555148)
1. Purpose of Report
1.1 The annual treasury report is a requirement of the CIPFA Prudential Code and CIPFA Code of Practice for Treasury Management in the Public Sector, and covers the treasury activity for 2009/10. This report reviews the prudential indicators specified in the County Council report of 31 March 2009 in accordance with the requirements of the Prudential Code.
2. Summary
2.1 The Council’s Capital Financing Requirement, which represents its underlying need to borrow, is higher at the end of the financial year than originally anticipated. This is due to an increase in approved capital spending in the year relating to the purchase of the Stevenage site (see section 8 for further details).
2.2 The context in which treasury management was carried out during 2009/10 was unprecedented, as the economy continued to slow and there remained uncertainty in the financial markets. A reduced interest rate climate and a prudent approach to investment strategy had substantially reduced yields earned on investments.
2.3 The Price Waterhouse Coopers (PWC) report, following their review of the circumstances leading to the Council’s Icelandic investments, made a number of recommendations. In response, the Council adopted a more stringent Treasury Management (TM) Strategy for 2009/10 that introduced a stricter lending policy as well as a frequent reporting process to those charged with stewardship of the TM strategy.
2.4 The Council earned £2.0m of interest in 2009/10. The Council’s deposits were placed primarily with the Debt Management Office in their deposit account facility, and with UK approved counterparties that met the counterparty criteria of the TM strategy.
2.5 The amount of long term borrowing reduced during the year by £48.8m, in the main through early repayment of debt. This means that the Council remains under-borrowed and is effectively funding capital expenditure from cash balances.
2.6 Ernst & Young, the administrators for Heritable Bank and Kaupthing, Singer & Friedlander, Icelandic Banks in administration, made dividend distributions totalling £3.7m to the Council during the year. The value of the original deposits placed with these individual banks was £11m. Bevan Brittan, which acts for the LGA representing the interest of affected member authorities, has filed claims against the insolvent Icelandic banks Landsbanki and Glitnir for preferred creditor status. These actions will now be determined by the Icelandic Courts with a trial date expected in November 2010.
3. Conclusions
3.1 The Council has complied with the treasury management prudential indicators throughout the year. The capital expenditure and capital financing requirement were higher than anticipated when the original indicators were set. The net costs of borrowing and lending were lower than anticipated following the repayment of long term borrowing.
4. Suggested Resolution
4.1 That the Annual Report on the Treasury Management Service and Prudential Indicators 2009/10 be approved.
5. Background
5.1 The CIPFA Prudential Code requires the Council to set Prudential Indicators for its capital expenditure and treasury management activities and to report on them at the end of the financial year. In addition the indicators are monitored on a quarterly basis as part of the quarterly budget monitor report to Cabinet.
5.2 This Council has adopted the CIPFA Code of Practice for Treasury Management in the Public Sector and operates its treasury management service in compliance with this Code. The Code requires a report reviewing the treasury management activity for the previous financial year be presented to members.
6. Prudential Indicators
6.1 The Council is required by the Prudential Code to report the actual prudential indicators after the year end. Appendix A provides a schedule of all the mandatory prudential indicators.
6.2 The table below shows capital expenditure in the year on long term assets and how it has been financed.
Table 1: Capital Expenditure
2009/10Actual
(£000s) / 2009/10
Original Indicator
(£000s)
Total Capital Expenditure / 191,296 / 159,725
Resourced by:
Capital Receipts / 8,871 / 12,000
Capital Grants / 55,759 / 61,645
Revenue / 12,962 / 10,827
Other Contributions / - / 2,761
Unfinanced Capital Expenditure (additional need to borrow) / 113,704 / 72,562
6.3 The amount to be funded from borrowing is higher than expected due to the addition to the 2009/10 Capital Programme of the purchase of Farnham & Robertson House in Stevenage.
6.4 The Council’s underlying need to borrow is called the Capital Financing Requirement (CFR). This figure is a gauge of the Council’s debt position and represents capital expenditure up to the end of 2009/10 which has not yet been charged to revenue. The process of charging the capital expenditure to revenue is a statutory requirement and is done by means of the Minimum Revenue Provision (MRP). The Council’s CFR is shown below and is a key element in the calculation of the prudential indicators. The table shows that the CFR is higher than anticipated due to an increased amount of capital needing to be funded through borrowing.
Table 2: Capital Financing Requirement (CFR)
31 March 2010Actual
(£000s) / 31 March 2010
Original Indicator
(£000s)
Opening Balance 1 April 2008 / 504,464 / 485,617
Plus unfinanced capital expenditure / 113,704 / 72,562
Less MRP / (20,384) / (19,425)
Closing Balance 31 March 2009 / 597,784 / 538,754
6.5 While the Council’s gauge of its underlying need to borrow is the CFR, the Chief Finance Officer can manage the Council’s actual borrowing position by either:
§ Borrowing to the limit of the CFR;
§ Choosing to utilise some temporary cash flow funds instead of borrowing (under borrowing); or
§ Borrowing for future increases in the CFR (borrowing in advance of need).
The County Council began 2009/10 in an under-borrowed position. This under-borrowed position increased further during 2009/10 because the amount of borrowing reduced during the year. Further details of the borrowing transactions in 2009/10 are in section 9 below. The overall treasury position at 31 March 2010 is in the table below compared with the previous year.
Table 3: Treasury Position at 31 March 2010
31 March 2010 / 31 March 2009Principal
(£000s) / Average
Rate (%) / Principal
(£000s) / Average
Rate (%)
Total Debt / 290,785 / 4.66 / 339,573 / 4.66
Total Investments / 59 ,513 / 2.60 / 247,880 / 4.61
Net Borrowing / 231,272 / 91,693
6.6 It should be noted that the accounting practice required to be followed by the Council changed from 2007/08 and required financial instruments in the accounts, i.e. debt and investments, to be measured in a method compliant with national Financial Reporting Standards. The figures in this report are based on the actual principal amounts borrowed and invested, and so may differ from those in the Statement of Accounts by items such as accrued interest.
6.7 In order to ensure that borrowing levels are prudent over the medium term, the Council’s external borrowing, net of investments, must only be for a capital purpose. Net borrowing should not therefore, except in the short term, exceed the CFR for 2009/10 plus the expected changes to the CFR over 2010/11 and 2011/12. The table below shows that the Council has complied with this requirement.
Table 4: CFR compared to Net Borrowing Position
31 March 2010Actual
(£000s) / 31 March 2010
Original Indicator
(£000s)
Net borrowing position / 231,272 / 92,000
Capital Financing Requirement / 597,784 / 535,417
6.8 In addition to ensuring that the net borrowing position is lower than the CFR, the Council is required to set gross borrowing limits. These are detailed below with the actual positions during the year.
Table 5: Borrowing limits
2010/11(£000s)
Original Indicator - Authorised Limit / 362,000
Actual maximum gross borrowing position during the year / 339,573
Original Indicator - Operational Boundary / 345,000
Actual average gross borrowing position during the year / 298,408
Original indicator – financing costs as a proportion of net revenue stream / 1.72%
Actual financing costs as a proportion of net revenue stream / 1.66%
6.9 The Authorised Limit is the ‘Affordable Borrowing Limit’ required by section 3 of the Local Government Act 2003. The table above demonstrates that during 2009/10 the Council has maintained gross borrowing within its Authorised Limit.
6.10 The Operational Boundary is the expected borrowing position of the Council during the year, and periods where the actual position is either below or over the Boundary are acceptable subject to the Authorised Limit not being breached. The Council has maintained borrowing within the operational boundary throughout 2009/10.
6.11 The indicator ‘financing costs as a proportion of net revenue stream’ identifies the cost of capital (borrowing costs net of investment income) as a proportion of the Council’s total budget. The actual figure in 2009/10 was 1.66% and this is lower than the original indicator estimated in February 2009 of 1.72%, due to the reduction of borrowing and hence borrowing costs.
7. Treasury Management Context in 2009/10
7.1 By the start of the financial year in April 2009, UK GDP had already contracted by 5.3%, due to a sharp fall in private sector spending. The financial crisis in late 2008 had prompted the Government to implement a number of extraordinary government measures, including capital injections in banks such as RBS and the Lloyds Group, and the Credit Guarantee Scheme. These extreme measures were required to keep the banking system afloat amidst a wave of mistrust in the financial markets.
7.2 In an attempt to avoid a more severe recession and possible deflation, the Bank of England cut base rate to 0.5% in March 2009, where it remained for the whole year. To loosen monetary policy, the Bank initiated a policy of quantitative easing. By using newly-created central bank reserves to purchase £200bn of government and commercial financial assets, policy makers hoped to stimulate spending and economic activity.
7.3 As the Financial year progressed and the effects of the fiscal and monetary stimulus were more widely felt, the economic environment improved, house prices recovered following the 20% fall from the 2007 peak, and the rate of unemployment slowed. As a consequence consumer confidence started to recover, albeit slowly. However, despite improving survey evidence, the UK economy continued to contract until quarter four. Confidence in the financial sector also improved as credit markets thawed; however, bad debt write-offs led to losses being reported by some banks. In light of this uncertain economic climate the Council was prudent in the placement of its deposits with counterparties with the emphasis on security and liquidity as opposed to yield.
7.4 The prevailing Bank of England outlook at the end of the year saw the UK economy undergoing a slow recovery, as weak domestic demand persisted into the medium term. High levels of spare capacity in the economy are expected to reduce inflationary pressure, giving the Bank flexibility to maintain loose monetary policy. This could prove useful because the UK and other sovereign states are under intense pressure
to engage in fiscal consolidation, cutting spending and raising taxes to address national debt levels. Although fears of a double-dip recession may eventually prove unfounded, austerity measures introduced by national governments will weigh on future economic activity.
7.5 During 2009/10 the Council complied with the relevant statutory requirements for treasury management and applied the CIPFA Code of Practice for Treasury Management in its activities. The Council did, however, breach its own lending policy in the case of its limit with its banker Nat West: this was due to unexpected funds received too late in the day to be invested. There was also a one-off transaction limit breach with the Nationwide Building Society when a deal was placed for £11m, breaching the limit by £1m. The counterparty limit with the Nationwide was not breached. Further controls and additional training have been put in place to prevent such occurrences happening in the future. The aforementioned breaches were reported to the Policy & Resources Cabinet Panel and then to Cabinet as part of the quarterly treasury management report that forms part of the quarterly budget monitoring report.
8. Lending Strategy
8.1 The County Council approved the treasury management strategy including the lending policy for 2009/10 on 31 March 2009.
8.2 The table below summarises the Council’s investment position at the end of 2009/10:
Table 6: Investment position at 31 March 2010
31 March 2010 / 31 March 2009Principal (£000s) / Average Rate (%) / Principal (£000s) / Average Rate (%)
Fixed interest investments / 32.200 / 2.75 / 208,380 / 4.60
Variable rate investments / 3,000 / 1.00 / 11,500 / 4.83
Icelandic investments at risk / 24,313 / - / 28,000 / -
Total investments / 59,513 / 2.60 / 247,880 / 4.61
8.3 The table below summarises the lending activity for the financial year 2009/10 compared to 2008/09.
Table 7: Lending activity statistics for 2008/09 & 2009/10
2008/09 in total / 2009/10 in totalNumber of deals / 295 / 307
Average size / £5.2m / £10m
Average term (days) / 58 / 13
Number of counterparties used / 39 / 5
Average rate earned / 4.61% / 1.20%
Table 8: Top Counterparties used during 2009/10
Country / No. of Deals / Value of Deals(£m)
Debt Management Account Deposit Facility / UK / 294 / 2,976
Nationwide Building Society / UK / 7 / 48
Barclays / UK / 4 / 33
Lloyds / UK / 1 / 5
Dansk / Denmark / 1 / 5
8.4 The tables above illustrate the treasury management dealing activity during 2009/10, and the reduction in number of counterparties used by the Council. In addition there has been a fall in yield earned on Council deposits reflecting the low interest rate climate prevalent during 2009/10. The average term of investment reflects the reduction in time limits for deposits implemented through the TM strategy for 2009/10, and the fall in cash available for long term investment as a result of the repayment of debt over the last two financial years.
8.5 In addition to the specific fixed term deals in the tables above, use was also made of UK bank call accounts and money market funds during the year, because they provided instant access to funds while paying base rate or better. The Council stopped using the a call account with Abbey when its credit ratings were withdrawn following its merger with Santander and no longer complied with our counterparty list. On average £19m was held on call during 2009/10.