14. The actual capital expenditure forms one of the required prudential indicators. The table below shows this for HRA and General Fund.

Transcription

1 EAST AYRSHIRE COUNCIL CABINET 24 SEPTEMBER 2014 ANNUAL TREASURY MANAGEMENT REPORT 2013/14 Report by Executive Director of Finance and Corporate Support 1. PURPOSE 2. To provide Cabinet with a summary of treasury management activity for the financial year to 31 March 2014, together with an update on treasury performance in the current financial year; and to seek approval for a change to the Annual Investment Strategy. 3. BACKGROUND 4. The Council is required by regulations issued under the Local Government in Scotland Act 2003 to produce an annual treasury management review of activity incorporating actual prudential and treasury performance indicators for 2013/14. This meets the reporting requirements contained within the Chartered Institute of Public Finance (CIPFA) Code of Practice on Treasury Management (the Code) as well as the CIPFA Prudential Code for Capital Finance in Local Authorities (the Prudential Code). 5. During 2013/14 the minimum reporting requirements were that Cabinet and/or Governance and Scrutiny Committee should receive the following reports: an annual treasury strategy (agreed by Cabinet on 27 March 2013); a treasury update report (Governance & Scrutiny Committee 5 December 2013); an annual review following the end of the year describing the activity compared to the strategy (this report). 6. In addition, regular performance information is included in the East Ayrshire Performs report throughout the financial year. 7. The regulatory environment places responsibility on Elected Members for the review and scrutiny of treasury management policy and activities. This report is important in that respect as it provides details of the outturn position for treasury activities and highlights compliance with the Council s policies previously approved by Members. 8. Treasury Management is a complex area with its own terminology and acronyms. In order to aid understanding a Glossary of Key Terms is appended to the report for information. 9. The report provides summary information in respect of: The Council s capital investment activity in 2013/14 Implications of capital activity on the Council s underlying level of debt the Capital Financing Requirement (CFR). Prudential and Treasury Management Indicators Overall treasury management position Interest rate and economic commentary Investment activity during the year

2 10. CAPITAL EXPENDITURE AND FINANCING 2013/ The Council incurs capital expenditure on the purchase and creation of long term assets, such as roads infrastructure; schools; housing improvements; and vehicles plant and equipment. 12. When capital acquisitions are fully financed, or paid for, through the application of capital receipts (e.g. from the sale of surplus assets); capital grants or from revenue contributions there is no impact of the Council s underlying need to borrow as the purchase cost is offset. 13. Where it is either not possible to use these financing streams, or a decision has been made not to apply them, then the capital expenditure will give rise to a need to borrow to fund the immediate cost of creating the assets. 14. The actual capital expenditure forms one of the required prudential indicators. The table below shows this for HRA and General Fund. General Fund 2012/ / /14 Actual Estimate Actual Capital expenditure Financed in year Unfinanced capital expenditure HRA 2012/ / /14 Actual Estimate Actual Capital expenditure Financed in year Unfinanced capital expenditure Table THE OVERALL BORROWING REQUIREMENT OF THE COUNCIL 16. The Council s underlying need to borrow for capital expenditure is termed the Capital Financing Requirement (CFR). This figure is an indicator of the Council s indebtedness. The CFR results from the capital activity of the Council and the resources that have been used to pay for the capital spend. It represents the aggregate of prior year and current year capital expenditure that has not been paid for, either by annual charges to revenue or one off sources such as grants and capital receipts. 17. Part of the Council s treasury management activity is to address the funding requirements for this borrowing need. Depending on the capital expenditure programme, the Finance Service organises the Council s cash position to ensure that sufficient cash is available to meet the capital plans and cash flow requirements. This may be sourced through borrowing from external bodies (such as the Government, through the Public Works Loan Board [PWLB] or the money markets), or utilising temporary cash balances within the Council.

3 18. The Council s underlying borrowing need (CFR) is not allowed to rise indefinitely. Statutory controls are in place to ensure that capital assets are charged to revenue over the life of the asset. The Council is required to make an annual charge to revenue, called repayment of Loan Fund Principal, to reduce the CFR. This is effectively a repayment of the borrowing need. This differs from the treasury management arrangements which ensure that cash is available to meet capital commitments. External debt can also be borrowed or repaid at any time, but this does not change the underlying CFR. 19. The Council s CFR at 31 March 2014, which is a key prudential indicator, can be calculated by direct analysis of the balance sheet as shown in the following table. Capital Financing Requirement (CFR) 2013/ /13 Movement Actual 'm Actual 'm (+/-) Property Plant & Equipment Heritage Assets Intangible Assets Assets Held for Sale Revaluation Reserve Capital Adjustment Account CFR - Per Prudential Code Less PPP - Deferred Liability Underlying Borrowing Requirement External Borrowing Short-term Long-term Total External borrowing Under borrowing Table The CFR derived from the balance sheet includes the notional borrowing requirement linked to the funding of the PPP schools scheme. As the contractual arrangement includes the repayment of capital costs within the annual unitary charge there is no physical borrowing undertaken in respect of these schools. As a result, and to aid comparison with external debt levels, this is excluded to show the underlying borrowing requirement of the Council. 21. The underlying need to borrow at 31 March 2014 was m, whilst the Council had external borrowing and long term liabilities, excluding PPP liabilities, of m. The difference of m represents the element of the CFR which has been funded, short term, by internal borrowing. This is a cost effective way to fund, reducing the cost of borrowing while also reducing the level of investments and therefore counterparty risk. 22. At 31 March 2014 the Council had useable reserves of m, compared to m at March The following table shows how these are utilised, together with the available working capital to support the short term internal borrowing requirement.

4 Reserves & Balances 2013/ /13 Movement Actual 'm Actual 'm (+/-) Amount available for Investment Investments Investments - Short term Cash & Equivalants Total Investments Internal Investments Table 3 Working Capital 2013/ /13 Actual 'm Actual 'm Movement (+/-) Debtors Creditors Inventories Net Working Capital (Surplus) Other Non Current Receivables (LT Debtor) Financial Instruments Adjustment Account Pension Liabilities Pensions Reserve Accumulated Absences Reserve Available for Sale Financial Instrument Other Long Term Working Capital Total Working Capital Surplus Internal Investments + Working Capital Surplus = Under borrowed position of Council The total CFR can also be reduced by: the application of additional capital financing resources (such as unapplied capital receipts); or increasing the annual revenue charge. 24. The borrowing activity is constrained by prudential indicators for gross borrowing and the CFR, together with the authorised limit. 25. In order to ensure that the Council s level of borrowing remains at a prudent level over the medium term, external borrowing must only be for capital investment purposes. This means that the Council is not permitted to borrow to support revenue expenditure. 26. As a result gross borrowing should not, except in the very short term exceed the CFR for the current year plus the forecast movement in CFR for the next 2 financial years. This provides flexibility to borrow in advance of an immediate need should economic conditions be advantageous. The Council has complied with the indicator as summarised in the next table.

5 2012/ / /14 Actual Estimate Actual Gross Borrowing (at Nominal Value) CFR Table The Authorised Limit is the maximum level of borrowing beyond which the Council does not have powers to borrow. It reflects a level which although not desirable could be afforded but which may not be sustainable. 28. The Operational Boundary is the expected borrowing position for the year. This is based on the forward projections of borrowing based on approved investment strategies. Periods where the actual position is either below or above the boundary are acceptable subject to the authorised limit not being breached. 29. Actual financing costs as a proportion of the net revenue stream is an indicator that identifies the trend in the cost of financing capital (borrowing and other long term obligation costs net of investment income) against the revenue streams for both the General Fund and the Housing Revenue Account. It is a direct measure of affordability for debt repayment. 2012/ /14 Authorised Limit Per Treasury Strategy Maximum Gross borrowing in year Operational boundary per treasury strategy Average gross borrowing position in year Financing costs as a proportion of net revenue stream HRA General Fund 13.56% 7.45% Table % 8.60% 30. TREASURY POSITION AS AT 31 MARCH The Council s debt and investment portfolio is organised by the Finance Service in order to ensure adequate liquidity for revenue and capital activities, security for investments and to manage risks within all treasury management activities. Procedures and controls to achieve these objectives are well established both through reporting to Members and through officer activity detailed in the Council s Treasury Management Policy and Practices guidance. 32. The Council s treasury position for the financial year to 31 March 2014 is set out in the following table:

6 2012/13 Actual 2013/14 Actual Rate of Principal Return % Principal Rate of Return % Fixed Rate PWLB % % Market % - - Variable Rate PWLB Market % % Total Debt % % Less - Investments (27.294) 0.47% (27.766) 0.46% Net External Debt Exposure to Interest rate volatility 2012/13 Approved 2012/13 Actual 2013/14 Approved 2013/14 Actual Fixed rate 100% 78.19% 100% 75.84% Variable rate 40% 21.81% 40% 24.16% Table The maturity structure of the fixed rate debt portfolio and performance against the approved limits was: Maturity of Fixed Rate Debt 31 March 2013 Actual 31 March 2013 Actual % 31 March 2014 Actual 31 March 2014 Actual % Approved Upper Limit 2013/14 % Under 12 months % % 10% 12 to 24 months % % 20% 24 to 60 months % % 50% 5 to 10 years % % 50% 10 to 20 years % % 50% 20 to 30 years % % 60% 30 to 40 years % % 70% 40 to 50 years % % 80% 50 years % Table THE 2013/14 TREASURY STRATEGY 35. The expectation for interest rates within the strategy for 2013/14 was that the Bank rate would remain low throughout the year, with little prospect of any short term increase. Given this assumption, the position adopted was that a flexible approach would be adopted to any borrowing decisions with the cost of carry (the difference between borrowing rates and investment returns) being considered against the requirement for certainty and affordability in respect of the longer term affordability of capital investment. 36. As a result the position adopted was to delay borrowing until March 2014 thus avoiding the cost of holding higher levels of investments and to reduce counterparty risk. Short term financing was provided through utilising internal balances and

7 reserves. New borrowing of 20m was taken from the PWLB in early March, with an average maturity of 15.5 years and an average interest rate of 3.99%. 37. THE ECONOMY AND INTEREST RATES 38. The original expectation for 2013/14 was that Bank Rate would remain at 0.5% throughout the year with no movement expected until This forecast rise has now been revised with an expectation that the base rate may start to rise, albeit slowly, from the first quarter of The timing of such a movement will depend on the strength of economic recovery. Economic growth (GDP) in the UK was virtually flat during 2012/13 but surged strongly during 2013/14. Consequently there was no additional quantitative easing during 2013/14 and Bank rate ended the year unchanged at 0.5% for the fifth successive year. While CPI inflation had remained above the 2% target during 2012, by January 2014 it had fallen below the target rate to 1.9% and then fell further to 1.7% in February. It is expected to remain slightly below the target rate for most of the two years ahead. 39. Gilt yields were on a sharply rising trend during 2013 but volatility returned in the first quarter of 2014 as various fears sparked a flight to quality. The Funding for Lending Scheme, announced in July 2012, resulted in a flood of cheap credit being made available to banks which then resulted in money market investment rates falling markedly in the second half of that year and continuing into 2013/14. The part of the Scheme which supported the provision of credit for mortgages was terminated in the first quarter of 2014 as concerns rose over resurging house prices. 40. The UK Government maintained its tight fiscal policy stance but recent strong economic growth has led to a cumulative (in the Autumn Statement and the March Budget) reduction in the forecasts for total borrowing, of 97bn over the next five years, culminating in a projected 5bn surplus in 2018/ The EU sovereign debt crisis subsided during the year and confidence in the ability of the Eurozone to remain intact increased substantially. Perceptions of counterparty risk improved after the ECB statement in July 2012 that it would do whatever it takes to support struggling Eurozone countries; this led to a return of confidence in its banking system which has continued into 2013/14 and led to a move away from only very short term investing. However, this is not to say that the problems of the Eurozone, or its banks, have ended. The zone faces the likelihood of weak growth over the next few years at a time when the total size of government debt for some nations is likely to continue rising. Upcoming stress tests of Eurozone banks could also reveal some areas of concern. 42. BORROWING AND RESCHEDULING 2013/ As reported at paragraph 36, new long term borrowing of 20m was taken in March During the year one temporary loan, from a local authority, was taken to provide short term cash flow financing; this was in the amount of 5m and had an interest rate of 0.45%. 44. No rescheduling was undertaken during the year as the average 1% differential between PWLB new borrowing rates and premature repayment rates made rescheduling unviable.

8 Rate (%) 45. INVESTMENT RATES 2013/ The Bank of England Base Rate remained at the historic low of 0.5% throughout the year; it has now remained unchanged for five years. Market expectations as to the timing of the start of monetary tightening remained unchanged with the forecast continuing to be for an upward move around the end of 2014 or the start of The Funding for Lending Scheme resulted in deposit rates remaining depressed during the whole of the year, although the part of the scheme supporting provision of credit for mortgages came to an end in the first quarter of The investment rates available during the year are illustrated in the following table Investment Rates Day LIBID 3 Month LIBID 6 Month LIBID Bank Rate 1 Year LIBID Table INVESTMENT OUTTURN 2013/14

9 49. Investment Policy The Council s investment policy is governed by the Scottish Government Investment Regulations, which was incorporated within the annual investment strategy approved by Cabinet on 27 March The strategy sets out the approach to selecting counterparties and permitted investment categories and was based on a number of criteria including credit ratings. 50. The investment activity during the year conformed to the strategy and there were no issues regarding liquidity. 51. Resources The Council s longer term cash balances are made up primarily of revenue and capital reserves, together with short term cash flow monies. The core cash resources were as noted in the next table.

10 Reserves and Balances 2012/13 Actual 2013/14 Actual Movement General Fund Balance (7.420) HRA Balance Repairs & Renewal (1.545) Capital Fund (4.259) Total (10.165) Table Investments held by the Council The Council maintained an average balance of m of internally managed funds, which earned an average rate of return of 0.48%. The comparable performance indicator is the average 7-day LIBID rate of 0.35%. 53. TREASURY ACTIVITY 2014/15 UPDATE 54. CAPITAL EXPENDITURE & FINANCING 55. The following table sets out the original and currently projected position for capital expenditure, associated financing and the consequential borrowing requirement. 2014/ /15 General Fund Estimate Projected Movement Capital expenditure (2.731) Financed in year (0.897) Unfinanced capital expenditure (3.628) 2014/ /15 HRA Estimate Projected Movement Capital expenditure Financed in year Unfinanced capital expenditure Table As a result of changes to the expected phasing of expenditure and related capital financing it is currently projected that the level of unfinanced capital expenditure will be lower than originally estimated by 1.768m. 57. As a result the forecast CFR and gross debt position as at 31 March 2015 is as noted in the following table:

11 Capital Financing Requirement 2014/15 Estimate m 2014/15 Projection m CFR Opening Balance Capital borrowing Principal Repaid (13.734) (13.586) PPP Repayments (1.839) (1.839) Movement in Year Closing CFR Less PPP Outstanding Liability (61.618) (61.360) Underlying Need to Borrow External Borrowing 2014/15 Estimate m 2014/15 Projection m Opening balance at 1 April (Nominal Value) Scheduled repayment of Principal (6.593) New borrowing in year Estimated Closing balance at 31 March Estimated Over /(Under) borrowed position (85.267) (49.736) Reserves and Balances 2014/15 Estimate m 2014/15 Projection m Opening balance at 1 April Projected Movement in Year (1.643) (1.294) Estimated Closing balance at 31 March Estimated net borrowing requirement (investment capacity Table BORROWING 59. New borrowing of 15m was taken in July and again in September at an average interest rate of 3.62% and 3.83% respectively. The table above demonstrates that there remains an underlying requirement to borrow m should no further external borrowing take place during the year. This can continue to be met through the application of internal reserves and balances to support cash flow requirements. This position will remain under regular review by the Head of Finance advised by Capita Asset Services. 60. INVESTMENT ACTIVITY 61. The Council has agreed that funds may be placed with counterparties domiciled in non UK countries, provided that the sovereign rating is AA+ or better, and that the counterparty has a minimum rating of A- (or equivalent). 62. During July a deposit 5m was placed with Commonwealth Bank of Australia, which as a result of earlier funds having been placed with National Bank of Australia, in aggregate breached the 15% of total portfolio country limit by approximately 1.65%. Each bank is rated AA-, whilst Australia has a sovereign rating of AAA. Therefore,

12 whilst the overall effect of the investment was to reduce the counterparty risk within the portfolio, it is a requirement that this is reported. 63. As a result of the sensitivity of the portfolio to movements in investment balances on a day to day basis, it is possible for country limits to exceed the 15% following either a repayment of, or a reduction in, overall investment levels. Consequently, it is proposed that revised country limits are approved that whilst still retaining a 15% operational limit will allow a maximum authorised limit of 25%. The adoption of these should allow fluctuations due to timing of portfolio movements to be managed, whilst at the same time retaining the counterparty risk within existing parameters. This will require a change to the Annual Investment Strategy as contained within the Treasury Management Strategy Statement, and as such requires Cabinet approval. 64. ICELANDIC BANKS 65. In October 2008 the Icelandic Banks Landsbanki, Kaupthing and Glitner collapsed, and the UK subsidiaries of the banks, Heritable Bank plc and Kaupthing Singer and Friedlander Limited (KSF) went into administration. East Ayrshire Council had the following investments at that time: 2m deposited with KSF that was due to mature on 27 March 2009; 2m with Heritable that was due to mature on 9 October 2008; and 1m with Heritable that was due to mature on 14 October In the case of KSF the administrators made two dividend payments during the financial year, with further payments and updates anticipated during 2014/15. A payment was received in August 2013 in respect of Heritable which brought the dividends received to 94%. This is expected to be the last payment, although this has still to be confirmed by the administrator. 67. The current position is summarised in the following table: KSF Heritable Total Principal at October Interest due Total Balance Due Less Payments Received (1.682) (2.856) (4.538) Net balance at 28 August Table FINANCIAL IMPLICATIONS 69. There are no immediate financial implications arising from this report 70. RISK MANAGEMENT IMPLICATIONS 71. The Council is required by the CIPFA Code of Practice to put in place Policies and Practices that assist in the delivery of treasury management activity and help to reduce the overall risk profile. These are published by the Head of Finance as an

13 Accounting Policy Bulletin and have been updated to reflect the 2014/15 Treasury Management Annual Strategy. 72. The setting and subsequent review of prudential indicators assists in the assessment of the Council s capital investment plans in terms of both affordability and sustainability. There is a significant financial risk attached to any failure to maintain robust control over the future cost of funding current capital commitments. 73. LEGAL AND POLICY IMPLICATIONS 74. In compliance with the CIPFA Code of Practice this report provides Members with a summary of the treasury management activity during the year. The treasury management policies and practices have been complied with during the year and the Head of Finance confirms that the Council complied with its Prudential Indicators for 2013/14, which were agreed in March 2013 as part of the Treasury Management Strategy Statement. A prudent approach has been taken in relation to investment activity with security and liquidity the primary concern over yield. 75. RECOMMENDATIONS 76. It is recommended that Members: i) Approve the introduction of an authorised limit boundary for non-uk investments of 25%, while retaining an operational limit of 15%; ii) iii) Remit the report to Governance and Scrutiny Committee for their information; and Otherwise note the contents of the report Alex McPhee Executive Director of Finance and Corporate Support 11 September 2014 LIST OF BACKGROUND PAPERS NIL Any person wishing further information on this report should contact Craig McArthur, Head of Finance, Tel:

14 Bank of England Bank Rate Capital Expenditure TREASURY MANAGEMENT - GLOSSARY OF COMMON TERMS Capital Financing Requirement (CFR) APPENDIX A The Central Bank for the UK with ultimate responsibility for setting interest rates (which it does through the Monetary Policy Committee or MPC ). The interest rate for the UK as set each month by the Monetary Policy Committee ( MPC ) of the Bank of England. Also commonly referred to as the Base Rate. Expenditure on or for the creation of fixed assets that meets the definition within the accounting rules as set out in the annual Statement of Recommended Practice (SORP) and for which the Council are able to borrow A Prudential Indicator that can be derived from the information in the Council s Balance Sheet. It generally represents the underlying need to borrow for capital expenditure CIPFA The Chartered Institute of Public Finance and Accountancy produces guidance, codes of professional practice, and policy documents for Councils and public sector organisations Consumer Prices Index Counterparty Credit Ratings European Central Bank (ECB) Eurozone The Consumer Prices Index ( CPI ) is a means of measuring inflation (as is the Retail Prices Index or RPI ). The Monetary Policy Committee of the Bank of England set the Bank Rate in order to try to keep CPI at or close to the target set by the Government, (currently the target is 2%). The calculation of the CPI includes many items of normal household expenditure but the calculation excludes some items such as mortgage interest payments and Council Tax An organisation or other body with whom the Council enters into a financial investment or borrowing transaction. E.g. if the Council enters a deal with a bank then the bank would be referred to as the Counterparty. Credit ratings are indicators produced by companies such as Fitch, Moody's or Standard & Poor s that aim to give an opinion on the relative ability of a financial institution to meet its financial commitments. Credit ratings are not guarantees they are opinions based on investigations and assessments by the ratings providers and they are regularly reviewed and updated. The Council makes use of credit ratings to determine which counterparties are appropriate or suitable for the Council. This is the central bank for the Eurozone and is the equivalent of the Bank of England. The European Central Bank sets interest rates for the Eurozone. The group of countries that have the Euro as their currency. The Eurozone comprises 17 countries: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.

15 Gilts Inflation Investment Regulations LIBID LIBOR MPC Net Borrowing Requirement Prudential Code Prudential Indicators PWLB PWLB Rates Quantitative Easing Gilts are bonds (i.e. debt certificates) that are issued (sold) by the UK Government. When they issue gilts, the Government sets the interest rate that applies to the gilt, sets when they will repay the value of the gilt, and it agrees to make interest payments at regular intervals until the gilt is repaid or redeemed. Gilts are traded in the financial markets with the price varying depending on the interest rate applicable to the gilt, when the gilt will be repaid (i.e. when it will mature), on base rate expectations, and on market conditions. Inflation is the term used for an increase in prices over time. It can be measured in various ways including using the Consumer Prices Index ( CPI ) or the Retail Prices Index ( RPI ). The Local Government in Scotland Act 2003 allows the Scottish Ministers to introduce Regulations to extend and govern the rules under which Scottish Councils may invest funds. The Local Government Investments (Scotland) Regulations 2010 came into effect on 1st April The London Interbank Bid Rate an interest rate that is used between banks when they wish to attract deposits from each other. The London Inter Bank Offering Rate an interest rate that is used as a base for setting interest rates for deals between banks. The Monetary Policy Committee of the Bank of England meets each month to agree and set the Bank Rate for the UK. This is the difference between the Council s net external borrowing and its capital financing requirement. Under the Prudential Code the Council s net external borrowing should not, except in the short term, exceed its capital financing requirement. The Net Borrowing Requirement should therefore normally be a negative figure. Councils are required to comply with the CIPFA Prudential Code for Capital Finance in Local Authorities. These requirements include the production of Prudential Indicators. The Prudential Code was revised in November 2009 with the revisions including the reclassification of some Prudential Indicators as Treasury Management Indicators covered by the Treasury Management Code. Indicators set-out in the Prudential Code that will help Councils to meet requirements in relation to borrowing limits or which will help Councils demonstrate affordability and prudence with regard to their prudential capital expenditure. The Public Works Loan Board is government agency and part of the Debt Management Office. The PWLB provides loans to local authorities and other specified bodies. These are the interest rates chargeable by the Public Works Loan Board for loans. The rates for fixed rate loans are determined by the day on which the loan is agreed. The rates to be charged by the PWLB for loans are set each day based on gilt yields at the start of business each day and then updated at least once during the day. The creation of money by a central bank (such as the Bank of England) in order to purchase assets from banks and companies and boost the supply of money in an economy.

16 Retail Prices Index Treasury Management Code The Retail Prices Index ( RPI ) is a means of measuring inflation (as is the Consumer Prices Index or CPI ). The calculation of the RPI includes most of the same items as the CPI as well as some items not included in the CPI such as mortgage interest payments and Council Tax whilst excluding items that are in the CPI such as charges for financial services. This is the Treasury Management in the Public Services: Code of Practice and is a code of practice for Council treasury management activities.