TRAFFORD BOROUGH COUNCIL

Report to:Executive/ Council

Date:15 June 2009 / 17 June 2009

Report for: Decision

Report of: The Executive Member for Finance and the Director of Finance

Report Title

Treasury Management Annual Performance 2008/09 and Strategy 2009/12 Report

Summary

In accordance with the Code of Practice adopted by the Council, this report has been prepared to review treasury activities for the past financial year.
During 2008/09 the Council complied with its legislative and regulatory requirements, including compliance with all treasury management prudential indicators.
Throughout2008/09 the Council’s treasury operations faced exceptional operational circumstances resulting from the significant downturn in the UK and World economieswhich produced a near collapse of the banking sector. The main implication of this was asubstantial increase in counterparty risk resulting in both a tightening of the Council’s counterparty criteria and a reduction in available counterparties as institutions ratings fell below the Council’s acceptable minimum.
No new borrowings were undertaken during the year for capital purposes and £19.5m of existing debt was prematurely repaid.
At 31 March 2009, the Council’s external debt was £82.7m (£102.4m at 31 March 2008 and investments totalled £46.9m (£73.6m)
Investment interest savings of £0.9mcompared to budget were generated due to additional interest from pro-active investment decisions (para.5.2). Savings in external loan interest costsof (£0.25m) as a result of no new external debt being taken and £19.5m of existing debt repaid (para. 4.9) were also made.
In addition to the reporting of last year’s activity the report also recommends that the current investment credit criteria be expanded to include UK Eligible Institutions.

Recommendations

That the Executive be requested to:
  1. note the Treasury Management activities undertaken in 2008/09;
  2. note that new borrowings to provide permanent finance for 2008/09 capital expenditure will be undertaken at some future point when market conditions have stabilised;
  3. recommend to Council an additional criterion to the approved lending list in respect of Eligible Institutions includedunder the UK Government Credit Guarantee Scheme, with credit ratings as described in para 7.5 of the report.

Councillor John TolhurstIan Duncan

Executive Member for Finance Director of Finance

Contact person person for background papers:

Graham Perkins – Technical AccountantExtension: 4017

Background papers:Treasury Management Strategy 2008/09 – 2010/11

1.INTRODUCTION AND BACKGROUND

1.1The Council’s treasury management activities are regulated by a variety of professional codes, statutes and guidance and these are detailed in Appendix A. In accordance with these regulations this report provides a review of treasury management activity in 2008/09.

1.2 This report summarises:

  • Risk and Performance,
  • 2008/09 Economic background,
  • Borrowing position,
  • Investment position,
  • Prudential and compliance issues,
  • Strategy update for 2009/12,
  • Conclusions and Recommendations.

1.3Treasury management is defined as:

“The management of the local authority’s cash flows, its banking, money market and capital market transactions; the effective control of the risks associated with those activities; and the pursuit of optimum performance consistent with those risks. ”

1.4It should be noted that the accounting practice required to be followed by the Council (the SORP), changed in 2007/8 and required financial instruments in the accounts (debt and investments etc.) to be measured in a method compliant with national Financial Reporting Standards. The figures in this report are based on the amounts borrowed and invested and so may differ from those in the final accounts by items such as accrued interest.

2.RISK AND PERFORMANCE

2.1The Council has complied with all relevant statutory and regulatory requirements which limit the levels of risk associated with its treasury management activities. In particular its adoption and implementation of both the Prudential Code and the Code of Practice for TreasuryManagement means its capital expenditure is prudent, affordable and sustainable, and its treasury practices demonstrate a low risk approach.

2.2The Council is aware of the risks of passive management of the treasury portfolio and, with the support of Butlers, the Council’s advisers, has proactively managed its treasury position.

2.3In the course of its treasury management operations the Council has endeavoured to eliminate as much risk as possible from its operations relying on information obtained on a regular basis from its advisers and the credit rating agencies. Whilst adopting this course of action eliminates a great proportion of risk, Members must be aware that it is impossible to eradicate all risk from any transaction undertaken.

3.2008/09 ECONOMIC BACKGROUND

3.1The 2008/09 financial yearwas one of the most testing and difficult economic environments in which to have undertaken treasury management activities since the 1930s. This was due to a combination of the main following events;

  • Significant changes to both the UKand global economies,
  • Increasing uncertainty and mistrust in the financial markets resulting in the collapse ofseveral major international banks the most prominent being Lehman Brothers,
  • Reduction in market liquidity making it extremely difficult for banks to function normally,
  • The failure of the entire Icelandic banking system in early October,
  • Ongoing effects of the “credit crunch” which started in 2007,
  • Monetary policy easing with the Bank of England cutting its Bank Rate from 5.25% to historically the lowest level of 0.5%,
  • Reduction in Worldwide interest rates to historically low levels and
  • Increases in inflation in the first part of the year (due to global commodity and food prices and rises in oil prices) and then falling substantially to potential a negative situation in the later part.

3.2The crisis in the financial markets deepened and threatened a complete ‘melt-down’ of the world financial system. This, together with evidence that economies had entered recession prompted a number of significant policy changes. In the UK these featured the following;

  • A major rescue package totalling as much as £400bn to recapitalise the banking system,
  • A fiscal expansion package, including a 2.5% cut in VAT and
  • Bank of England buying securities from investment institutions in exchange for cash which commenced in early March and is expected ultimately to amount to £150bn (Quantative Easing).

3.3The UKgovernment launched its second phase of support for the banking industry during the second half of Januaryalthough this failed to calm fears that more aid might be needed before the crisis was over. During the course of this quarter, two major banks, Royal Bank of Scotland and Lloyds Group, needed substantial cash injections from the government resulting in near public ownership. In addition to this, the Dunfermline Building Society was also rescued from bankruptcy by the Nationwide Building Society.

3.4A reflection on the impact the above events had on interest rates can be seen from the figures below;

1 April 200831 March 2009

%%

Investment Rates

3 month6.001.70

1 Year5.852.10

Loan Rates

20 Year4.704.25

50 Year4.454.65

4.BORROWING POSITION

4.1The Council’s loan position as at 31March 2009 reflects the level of capital expenditure financed by loan and the table below compares this figure with the previous year;

31 March 2009 / 31 March 2008
Principal / Average Rate / Principal / Average Rate
Fixed Interest Rate Debt / £ 66.7 m / 6.54% / £86.4m / 6.00%
Variable Interest Rate Debt / £16.0 m / 4.91% / £16.0m / 4.91%
Total Debt / £ 82.7 m / 6.18% / £102.4m / 5.83%

4.2A profile of the Council’s outstanding debt, as at 31 March 2009, can be found at Appendix B for reference.

4.3Of the £82.7m debt outstanding at 31 March 2009, £7.6m is administered on behalf of ManchesterInternationalAirport and £1.4m in respect of Greater Manchester Probation Service. This leaves £73.7m in respect of the Council’s own long term requirement.

4.4The Council’s underlying need to borrow is called the Capital Financing Requirement (CFR). It represents the level of capital expenditure in 2008/09 and prior years which has not yet been paid for by revenue or other capital resources, for example capital receipts or grants.

4.5The Director of Finance and the treasury management team manages the Council’s actual borrowing position by adopting one of the following methods:

  • Borrowing to the CFR requirement for that year;
  • Choosing to utilise some temporary cash flow funds instead of

borrowing (under-borrowing);

  • borrowing for future CFR requirements (borrowing in advance of

need).

4.6New borrowings– the CFR for 2008/09 indicated that borrowings of £19m could have been taken out to finance capital programme spending. However no new loans were taken in the year due entirely to the instability of the banking system. This is a temporary position and the decision on when loans will be taken up will depend on when the money markets have settled down.

4.7Repayment – As a consequence of economic situation, (detailed at section 3) and high counterparty risk during 2008/09the Council repaid £19.5m at an average rate of 4.40% with breakage costs of £114k. This was undertaken in order to reduce the potential exposure of counterparties defaulting on their investments. The Council repaidthe debt by temporarily applying some of its investments.New funds replacing those repaid will be taken in the future when markets have stabilised.

4.8Summary of Debt transactions - As a result of the above activities areduction in interest payableduring 2008/09 to the value of (£248k) occurred.

5.INVESTMENT POSITION

The Council’s investment policy is governed by ODPM (now CLG) guidance, which has been implemented in the annual investment strategy approved by Council on 19 February 2008.

5.1The Council’s main bank account, held with the Co-operative Bank, is non-interest bearing and consequently if no investments were undertaken, the Council would lose a substantial amount of income, which for 2008/09 would have amounted to £5.2m. The Council’s investment position as at 31 March 2009 and comparison to the previous year is shown in the following table.

31 March 2009 / 31 March 2008
Principal / Average Rate / Principal / Average Rate
Fixed Interest Rate Investments / £43.9m / 4.63% / £68.0m / 5.80%
Variable Interest Rate Investments / £3.0m / 4.44% / £5.9m / 5.34%
Total Investments / £46.9m / 4.63% / £73.9m / 5.76%

5.2From the table above it can be seen that a significant movement in the closing positions between 31 March 2008 and 2009 has occurred and this is due to funds being applied on a temporary basis, to repay £19.5m of existing debt and £19m to finance the 2008/09 Capital Financing Requirement.

5.3During 2008/09, the Council maintained an average balance of £93.1m and received an average return of 5.55% generating £5.2m of interest which was 1.88% or £1.75m above the comparable performance indicator of the average 7-day London Interbank BID (LIBID) rate, of 3.67%. This actual return compares with a budget assumption of £4.3m.

5.4The main reasons for the increase in the level of investment interest compared to estimates are:

  • Higher than anticipated interest rates obtained in the first half of the yearenabled a return of 5.55% to be achieved compared to budget of 5.25%,
  • Increase in balances available for investing as a result of improved collection rates for Council Tax / NNDR and Accounts Receivable and the timing of the several government grants being received ahead of requirement throughout 2008/09.

5.5During the year, the Council had no liquidity difficulties due to proactive cash flow management. Temporary borrowing was only required to assist in financing the premature repayment of debt and from which interest of £21k was incurred.

5.6The failure of the Icelandic banking system had a major impact on UK institutions including local authorities. In total 127 (26%) local authoritieshad deposits with Icelandic institutions totalling £954m and these investments are still at risk with the expected recovery rates ranging from 50% to 100% dependant on which banks funds were placed with.

5.7I can confirm to Members that at no time did this Council place any funds in any Icelandic banks or their U.K.subsidiaries.

5.8Arising from the collapse of the Icelandic banking system the Audit Commission produced a report Risk and return which made a number of recommendations for local authorities to adopt. The Council’s response is the subject to a separate report for Members’ attention.

6. PRUDENTIAL INDICATORS AND COMPLIANCE ISSUES

6.1Within the Treasury Management Strategy for 2008/09agreed by the Council on 19 February 2008 approval was given to the treasury management prudential indicators for the period 2008/09 – 2011/12. All indicators set for 2008/09 were complied with and details of the indicators are shown in Appendix C.

6.2The task of treasury management is approached differently by each Council, making the production of any national performance indicators for comparison purposes very difficult.A performance indicator set for the service is to achieve a return on investments above 7 day LIBID rate and for 2008/09 the outcome is detailed below;

Average Investment / Actual rate
of return / Benchmark
7 day LIBID / Additional interest
earned
£93.1m / 5.55% / 3.67% / £1,750k

6.3Another indicator demonstrating how the service is controlled is in the form of the outcome of the annual audit of the key controls by the Council’s Internal Audit, Scrutiny and Governance Services section. For 2008/09 the outcome of these tests resulted in the service receiving an opinion of “High Level of Assurance (Very Good)” with norecommendationsfor improvement being made.

7. STRATEGY UPDATE FOR2009/12

7.1As a consequence of the continuing credit crisis and continual review of the banks and building societiesrelative creditworthiness (by the 3 credit rating companies), a number of institutions have had to be removed from the Council’s approved list of investment counterparties due to their assigned credit rating no longer meeting the minimum required.

7.2Since the approval of the 2009/10 Investment strategy on 18 February 2009,the number of banks and building societies available to the Council which offer both security and a reasonable rate of return have fallen from 71 to 41. Of these remaining institutions, only 11 are actively taking funds from the Council due to the size of funds available.

7.3Attached for reference at Appendix Dis a list of those banks and building societies which have beenremovedfrom the Council’s counterparty list since 18 February 2009.

7.4As a result of this and the continuing market uncertainties a review was undertaken into the number of suitable counterparties available for investment purposes. From this review it is recommended that the Council includescertain UK counterparties which are deemed “Eligible Institutions” under the UK Government Credit Guarantee Scheme. The scheme does not provide a guarantee for wholesale deposits, but it does provide the institutions with a facility to raise liquidity by issuing marketable securities with a government guarantee. This should help alleviate funding issues the organisations may have in the future. In addition some of the Eligible Institutions are part nationalised.

7.5In total there are 57 institutions classified as “Eligible”, and rather than include them all, it is recommended the Council only undertakes investments with those Eligible institutions which have at least the following credit ratings:

Short Term: F1 / P-1 / A-1

Long Term: A- / A3 / A-

Support: 1 (Fitch only)

7.6The above criteria for short and long term are in line with the minimum acceptable ratings for all other institutions on the Council’s list. The category not covered in the above criteria is Individual / Financial Strength ratings. These look at organisations on a stand-alone basis – i.e. not taking any account of any implied or explicit support offered to an organisation from outside sources. To counter this, the Council would impose a Support rating criteria of 1 (the highest rating) from Fitch. This is defined as follows:

“A bank for which there is an extremely high probability of external support. The potential provider of support is very highly rated in its own right and has a very high propensity to support the bank in question.”

7.7In addition, the Council will also apply money and time limits of £3m and maximum 3 months for these institutions.

7.8A list of those “Eligible Institutions” which would be included onto the Council’s approved list of investment counterparties can be found at Appendix E.

8.CONCLUSIONS AND RECCOMMENDATIONS

8.1All relevant statutory guidelines were complied with during 2008/09, including the prudential indicators.

8.2In response to market conditions no new borrowing wasundertaken in the yearand £19.5m of existing loans were repaid generating revenue savings of (£248k).

8.3The return on investments was £0.9m higher than originally anticipated as a consequence of earlier receipt of income and initially higher rates of interest obtained.

8.4The Executive is recommended to;

  • note the Treasury Management activities for 2008/09.
  • note that new borrowings to provide permanent finance for 2008/09 capital expenditure will be undertaken at some future point when market conditions have stabilised;
  • recommend to Council an additional criterion to the approved lending list in respect of Eligible Institutions included under the UK Government Credit Guarantee Scheme, with credit ratings as described in para 7.5 of the report.

Financial Implications: / In 2008/09 the Council paid loan interest of £5.5m and received £5.2m from money market investments.
Gershon Efficiency Savings / Not applicable
Legal Implications: / None arising out of this report
Human Resources Implications: / Not applicable
Asset Management Implications: / Not applicable
E-Government Implications: / Not applicable
Risk Management Implications / The monitoring and control of risk underpins all treasury management activities. The main risks are of adverse or unforeseen fluctuations in interest rates and security of capital sums.
Health and Safety Impact: / Not applicable

Other Options

This report has been produced in order to comply with Financial Regulations and relevant legislation and provides an overview of transactions undertaken during 2008/09.

Consultation

Advice has been obtained from Butlers, the Council’s external advisers.

Reasons for Recommendation

The report meets the requirements of both the CIPFA Code of Practice on Treasury Management and the CIPFA Prudential Code for Capital Finance in Local Authorities. The Council is required to comply with both Codes through Regulations issued under the Local Government Act 2003.

Finance Officer Clearance ……ID……

Legal Officer Clearance ….…BD.…

Director’s Signature

Appendix A

Regulatory Framework

The 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 and other relevant statutes and guidance. These require that the prime objective of the treasury management activity is the effective management of risk, and that its borrowing activities are undertaken on a prudent, affordable and sustainable basis.

The Code requires, as a minimum, the regular reporting of treasury management activities to:

  • Forecast the likely activity for the forthcoming year (in the Annual Treasury Strategy Report );
  • Review actual activity for the preceding year (this report).

This report meets the requirements of both the CIPFA Code of Practice on Treasury Management and the CIPFA Prudential Code for Capital Finance in Local Authorities. The Council is required to comply with both Codes through Regulations issued under the Local Government Act 2003.