MEDIUM TERM FINANCIAL PLAN - Appendix 5

BOROUGH OF POOLE

AUDIT COMMITTEE

20 JANUARY 2014

CABINET

11 FEBRUARY 2014

COUNCIL

25 FEBRUARY 2014

TREASURY MANAGEMENT STRATEGY STATEMENT 2014/15

PART OF PUBLISHED FORWARD PLAN:YES

STATUS – STRATEGIC POLICY

1.Purpose & Policy Content

1.1 The purpose of this report is to present to Members the Treasury Management Strategy Statement and Prudential Indicators for the 2014/15 financial year which is required annually by the Council’s Treasury Management Policy.

2.Decisions Required

It is recommended that the Audit Committee recommend to Cabinet and Council;

1)2014/15 Treasury Management Strategy for the Council including the Housing Revenue Account.

2)The Annual Minimum Revenue Provision statement explaining the policy for making a prudent minimum revenue provision in 2014/15.

3)The revised Prudential Indicators for 2013/14 and future years2014/15 to 2017/18, attached as Appendix A.

4)The revised approved Lending List attached as Appendix B.

3.Background

3.1The Council’s treasury activities are strictly regulated by statutory requirements and a professional code of practice. The Council adopted the CIPFA Treasury Management Code of Practice with effect from 1 April 2002 as amended by subsequent revisions of the Code. The Code sets out a framework of operating procedures for Members and Officers in order to reduce treasury risk and improve dialogue about the Council’s Treasury position. Treasury Management is defined as “the management of the organisation’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.”

3.2Local Authorities also need to comply with the requirements of The Local Government Act 2003, this states that the Annual Strategy Statement should provide details of the use of non-specified investments (See Section 9 below).

3.3The production of a Treasury Management Strategy Statement details the expected activities of the Treasury function in the forthcoming 2014/15 financial year. The proposed strategy is based upon existing policies and approved strategies including the Council’s Medium Term Financial Plan (MTFP) as wellas the Chief Financial Officer’s views on interest rates, supported with market forecasts from a variety of sources.

3.4The Independent Commission on Banking was a UK Government inquiry looking at structural and related non-structural reforms to the UK banking sector to promote financial stability and competition in the wake of the financial crisis. It was established in June 2010 and produced its final report and recommendations in September 2011. Its main recommendation was that British Banks should 'ring-fence' their retail banking divisions from their investment banking arms to safeguard against riskier banking activities, but it also made a number of other recommendations on bank capital requirements and competition in retail banking. The government announced the same day that it would introduce legislation into Parliament aimed at implementing the recommendations. The Financial Services (Banking Reform) Act 2013 gained Royal Assent, legislating for the separation of retail and investment banks, and for the introduction of mandatory bail-in in the UK.

3.5Countries around the world have vowed never to “Bail Out” failing banks again. As a result when a bank gets into difficulties in the future these will need to be resolved through a “Bail In” process whereby depositors and bondholders are expected to take a “haircut” on their investments. This has been witnessed in Cyprus where investors lost in excess of 40% and more recently with the Co-Operative where bondholders will swap their bonds for shares.

3.6Local Authority investments are currently with banks that have both retail and investment arms such as Barclays and HSBC. As a result of the Banking Reforms Local Authorities will have more choice on where to invest surplus cash when the retail banks are split from the investment banks. The reforms appear to be introducing significantly more risk for those investing in term deposits in the future.

a)Retail banks are required to retain much more capital to cushion against future losses, as a result they are likely to be considered safer institutions which are less likely to fail in the future. As such they are expected to pay a lower rate of interest in the short term. If any of these banks were to fail the investors would be far more exposed to the “Bail In” risk.

b)Investment banks are expected to be seen as higher risk institutions although they are likely to pay a higher rate of interest in the short term. If any of these banks were to fail investors would be less exposed to the “Bail In” risk.

3.7The graph below shows anticipated implications of The Financial Services (Banking Reform) Act 2013 for Local Authority investments.

Prior to the reforms if the Bank were to get into difficulties and was forced to restructure its debts in the event that the bank was expected to make a 10% loss this would equate to a 10% “haircut” for Local Authority Investors.

After the reforms if the Bank were to get into difficulties and was forced to restructure its debts in the event that the bank was expected to make a 10% loss this would equate to a much more significant “haircut” for Local Authorities as certain creditors become preferred creditors and as such would not be affected by the “haircut”.

3.8The report covers:

• Debt and Investment Projections 2013/14 – 2017/18;

• Treasury Management Prudential Indicators;

• Objectives of the Strategy;

• Prospects for Interest Rates 2014/15;

• The Strategy for 2014/15;

• Approved Organisations for Investments;

• Annual Minimum Revenue Provision Statement (MRP) 2014/15;

• Treasury Management Policy, Practices and Schedules;

• External Fund Managers and Treasury Advisers.

4.Debt and Investment Projections 2013/14 – 2017/18

4.1The table below highlights the current debt and investment levels for the General Fund and the Housing Revenue Account (HRA) together with the anticipated changes over the next 3 years.

2013/14
Estimated
£m / 2014/15 Estimated
£m / 2015/16 Estimated
£m / 2016/17
Estimated
£m / 2017/18 Estimated £m
Pool 1 - General Fund
General Fund (GF) CFR / (47.9) / (47.5) / (45.6) / (47.2) / (44.3)
PWLB debt at 31 March / 0.0 / 0.0 / 0.0 / 0.0 / 0.0
Other debt (RIF) at 31 March / (9.0) / (7.5) / (4.4) / (1.0) / 0.0
Total GF investments at 31 March / 18.1 / 9.3 / 5.3 / 0.8 / 0.8
Pool 2 – HRA
HRA CFR (Maximum) / (99.8) / (99.8) / (99.8) / (99.8) / (99.8)
HRA CFR (Anticipated) / (98.5) / (98.1) / (97.7) / (97.3) / (96.9)
External debt at 31 March / (82.9) / (82.4) / (82.0) / (81.6) / (81.2)
Internal debt at 31 March / (15.6) / (15.7) / (15.7) / (15.7) / (15.7)
Total HRA investments at 31 March / 9.5 / 6.6 / 6.6 / 6.6 / 6.6

Note - future borrowing may be subject to amendment due to:

a)the presentation and agreement of business cases which can support Prudential Borrowing on an invest to save basis.

b)The Chancellors Autumn 2013 statement which identified that he will increase the National Debt Cap on HRA’s by £150m in 2015/16 and a further £150m in 2016/17. The actual allocation locally will depend on a competitive business case basis. All applications will require the support of their Local Enterprise Partnerships.

4.2It is currentlyestimated that the Council will not need to borrow significant additional long term finance from external sources during the life of the current MTFP. Balances held in the General Fund and HRA reserves together with school balances managed by the authorityare expected tofall over the life of the MTFP. It is anticipated that the fall in balances can be accommodated by borrowingon a short term basis during February and Marcheach year to cover any short term funding requirements. However, if the balances fall below the expected levels then it may become necessary to secure some borrowing on a longer term basis. The overall position will be continually reviewed during the course of the year to establish:

a)the exact financing requirements for 2014/15

b)the timing of any long term borrowing in the event that there are significant unforeseen cash flow events

4.3The Council’s Borrowing Strategy for 2014/15will be to maximise the use of Internal Balances and avoid borrowing externally until it is absolutely necessary. There are two reasons for this:

a)firstly, sums invested are subject to investment risk e.g. the risk of an institution failing.

b)secondly, the cost of borrowing currently significantly exceeds the value that the Council is currently able to earn on investment activity. This is known as the “cost to carry”.

4.4On 20 October 2010 the HM Treasury increased the PWLB rate by approximately 1% for all new loans, this has resultedin an increase in the cost of borrowing for Council’s. From the 1 November 2012 the HM Treasury have introduced a new “Certainty Rate” which is a discount of 0.2% for those authorities who provided them with future borrowing plans, it can be confirmed that the Borough of Poole has provided the relevant information and is on the Certainty Rate list.

4.5The Government completed its reform of the Housing Revenue Account Subsidy system at the end of 2011/12. As a result of these reforms the Council has adopted a Two Pool approach to managing its debt. At the 1 April 2012 the Council notionally transferred all its external loans to the HRA which currently holds £82.9m of external long-term borrowing (against its debt cap of £99.8m), at an average fixed-interest rate of 3.78%. All future borrowings will be assigned to the relevant pool, although the Council retains the discretion to move debt between the pools.

4.6The Council’s current average cash investment balance for 2013/14 is £57.6m and the estimated average investment interest rate return in 2013/14 is 0.56%.

4.7The Council does not intend to use derivative instruments in order to manage its risks.

4.8It is anticipated that the majority of future Medium to Long Term funding requirements of the General Fund could be met by transferring external debt from the HRA as and when the HRA is in a position to repay this debt. The benefit of this would be to avoid the General Fund having to take any future borrowing at a significantly higher interest rate than that of the current HRA external debt. A further benefit would be that by transferring the debt any external Premium or Discount for repaying the debt would be avoided.

5.Treasury Management Prudential Indicators

5.1The revised CIPFA Treasury Management Code of Practice requires a number of treasury management prudential indicators to be compiled. These are attached to this report.

5.2With regard to Treasury Management the following indicators are relevant

• Authorised Limit - The authorised limit sets a parameter for the level of affordable debt. It should not be set so high that it would never in any possible circumstances be breached. It should reflect a level of borrowing which, while not desired, could be afforded but may not be sustainable. In this way it may include provision for additional borrowing that may be required for a short period in order to deliver the agreed treasury management strategy. The appropriate limit for 2014/15 will be set at £146m.

• Operational Boundary -This indicator is the focus of day-to-day treasury management activity within the authority. It is a means by which the authority manages its external debt to ensure that it remains within the self-imposed authorised limit. The appropriate limit for 2014/15 will be set at £144m.

• Interest Rate Exposure – This indicator sets out the maximum level of borrowing, as a proportion of total borrowing, that would be taken out at variable or fixed rates. The current limit for 2014/15 is for a maximum of 50% to be taken out as Variable Rate Loans or 100% Fixed Rate Loans.

• Fixed Rate Debt Maturity Structure – This indicator sets out the maximum levels of borrowing, as a proportion of total borrowing, that would be taken out over different maturity profiles.

6.Objectives of the Strategy

6.1The key objectives to be followed in 2014/15 are:

(a)Borrowing

i)To minimise the revenue costs of debt commensurate with exposure to future risk.

ii)To manage the Council’s debt maturity profile i.e. to leave no one future year with a disproportionately high level of debt principal repayments that could lead to difficulties in terms of re-borrowing (refinancing).

iii)To borrow in accordance with forecasted average future interest rates, (i.e. current best practice dictates that we borrow using short term and/or variable finance when rates are ‘high’, or use long term and fixed rate loans when rates are ‘low’. Similarly, maturity loans can be taken when rates are relatively low, to lock in the principal for the maximum period, annuity loans and equal instalments of principal loans when rates are considered higher). We remain in a period of uncertainty and as a result the Council may be asked to consider borrowing short term or variable rate loans at a time when it would normally elect to borrow longer term in order to manage day to day Treasury risks.

iv)To monitor and review the level of variable interest rate loans in order to take advantage of future forecasted interest rate movements.

(b)Investment

i)The Council’s investment priority is to maintain the security of capital.

ii)To maintain policy flexibility through liquidity of its investments.

iii)The Council will aim to achieve the optimum return on its investments commensurate with the proper levels of security and liquidity.

7.Prospects for Interest Rates 2014/15

7.1The UK continues to have the status of afinancial safe haven, the impact of this is that long term borrowing costs are being supressed.

7.2Bank Base Rate is currently 0.5% and has been since the 5th March 2009. In July 2013 Mark Carney started his new role as the Governor of the Bank of England. Within his first few weeks in post, the Bank of England’s Monetary Policy Committee (MPC) issued forward guidance for the first time in which it made a commitment to keeppolicy rates low for an extended period using the Labour Force Survey unemployment rate of 7% as a threshold for when it would consider whether or not to raise interest rates, although this is still subject to inflationary pressure. Unemployment was 7.7% in August 2013 andwas not forecast to fall below the threshold until 2016, due to the UK’s flexible workforce.

7.3Stronger growth data in 2013 (0.4% in Q1, 0.7% in Q2 and an initial estimate of 0.8% in Q3) alongside a pick-up in property prices mainly stoked by government initiatives to boost mortgage lending have led markets to price in an earlier rise in rates than warranted under Forward Guidance and the broader economic backdrop. However, with jobs growth picking up slowly, many employees working shorter hours than they would like and benefit cuts set to gather pace, growth is likely to only be gradual. Arlingclose forecasts the MPC will maintain its resolve to keep interest rates low until the recovery is convincing and sustainable.

7.4Credit outlook: The credit risk of banking failures has diminished, but not dissipated altogether. Regulatory changes are afoot in the UK, US and Europe to move away from the bank bail-outs of previous years to bank resolution regimes in which shareholders, bond holders and unsecured creditors are ‘bailed in’ to participate in any recovery process. There are also proposals for EU regulatory reforms to Money Market Funds which may mean that the funds lose their ‘triple A’ credit rating status in addition the funds may move to a VNAV (variable net asset value) basis. These factors mean that diversification of investments between creditworthy counterparties will become even more important in the future.

7.5The expected movements in interest rates are highlighted in the table below.

8.The Strategy for 2014/15

Capital finance

8.1To utilise all existing supported borrowing, all usable capital receipts and to maximise the use of capital grants. In addition to existing allocations financing on-going schemes, the Council plans to use Prudential Borrowing to finance the Fleet Replacement Programme.

Borrowing

8.2At the start of the current financial year the Council’s total HRA external debt stood at £83.3m. The Council, including its HRA has a significant underlying requirement to borrow over the coming years, however, it is anticipated that this requirement will be offset by Internal Balances and Reserves during the current MTFP period.

8.3The Chief Financial Officer continues to monitor rates and is keen to ensure that borrowing occurs at the most advantageous time whilst also considering the impact on the MTFP and not unduly increasing investment risks.

Temporary investments

8.4The Council continues to invest its temporary surplus funds prudently in accordance with its Treasury Management Policy. Priority is given to security and liquidity rather than yield, although it is reasonable to seek the highest rate of interest consistent with the proper levels of security and liquidity.

8.5The Council is currently placing funds on call, in term deposits and Certificate’s of Deposit with various Financial Institutions as per the agreed Investment Policy.

8.6The Council may place large amounts of money with the Debt Management Office at the Bank of England when overall market risks increase to unacceptable levels.

8.7The Authority Banks with Barclays Plc, which currently meets the minimum credit criteria of A- (or equivalent) long term rating. It should be noted that even if the credit rating falls below the authority’s minimum criteria there will continue to be a requirement to continue using Barclays Plc for short term liquidity requirements (overnight and weekend investments) and business continuity arrangements whilst the Council considers its position in the longer term.

9.Approved Organisations for Investment

9.1The Chief Financial Officer continues to construct the Council’s lending list on the basis of the latest Long Term ratings from Fitch IBCA, Moody’s and Standard and Poor’s using a lowest common denominator method for selecting counterparties and setting individual investment limits. All credit ratings are checked and updated regularly, this is supplemented by up to date counterpartyadvice information received from the Council’s appointed Treasury Advisers.

9.2Following advice from our Treasury Advisers, the Chief Financial Officer will no longer use the Short Term ratings as a key criteria when constructing the Council’s approved Lending List. Short term ratings will however continue to be reviewed as part of the overall package of risk management tools and where appropriate will influence whether specific institutions appear on the list and the maximum duration of those investments.

9.3In the main the Council intends to use Specified investments, which are relatively short-term investments up to one year which offer high security and high liquidity. To qualify automatically as Specified Investments the investment must be: