ANNUAL REPORT ON THE TREASURY MANAGEMENT SERVICE AND PRUDENTIAL INDICATORS 2008/09

THE EXECUTIVE AGENDA ITEM 5 28 July 2009 ANNUAL REPORT ON THE TREASURY MANAGEMENT SERVICE AND PRUDENTIAL INDICATORS 2008/09 Report of: Andrew Stokes, Executive Director & Chief Finance Officer Executive Member: Councillor E. Thrane Key Decision: No Call-in: Yes 1 PURPOSE 1.1 An annual treasury management report is a requirement of the Code of Practice on Treasury Management and Prudential Code for Capital Finance. The Council is legally required to comply with both Codes. 2 RECOMMENDATIONS 2.1 The Executive is recommended to approve the actual prudential indicators for 2008/09 as detailed in Appendix 1. 2.2 The Executive is recommended to note the treasury management stewardship report for 2008/09 and in particular that the Council has complied fully with all requirements. 3 ISSUES 3.1 The primary requirements of the Code of Practice are as follows: Creation and maintenance of a Treasury Management Policy Statement which sets out the policies and objectives of the Council s treasury management activities. Creation and maintenance of Treasury Management Practices which set out the manner in which the Council will seek to achieve those policies and objectives. Receipt by the Council of an annual treasury management strategy report (including the annual investment strategy report) for the year ahead and an annual review report of the previous year. Delegation by the Council of responsibilities for implementing and monitoring treasury management policies and practices and for the execution and administration of treasury management decisions. 5.11

3.2 Treasury management in this context 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. 3.3 This report therefore fulfils the third primary requirement of the Code being the requirement to produce an annual review report for the previous financial year. 3.4 Treasury management is an area of potential large financial risk for the Council with 2008/09 seeing some unique financial problems arising both nationally and internationally. The failure of the Icelandic banks occurred in October 2008 with the return of the Councils investments still unresolved. However, it is looking more and more promising that it will be a favourable outcome with current expectations that the Council will recover around 80% of one of the investments and between 90-100% of the other. 3.5 The credit crunch issues arising both in America and in the UK has considerable impact on the UK financial markets. Bank base rates have reduced to a historical low of 0.5%. 3.6 As part of the annual budget setting process the Council approves an Annual Treasury Management Strategy that determines specific financial and other controls for this function. Setting prudential indicators and monitoring performance of these indicators is part of this process. 3.7 During 2008/09 the Council complied with its legislative and regulatory requirements. The actual prudential indicators for the year are contained in Appendix 1 to this report. These confirm that borrowing was entered into in a managed and controlled way, with due regard to both the benefits of capital investment and the related revenue costs. 3.8 At 2009, the Council s external debt was 45.87m (compared with 35.3m at 2008). The figure at the 31 March 2009 includes 314k in respect of accrued interest. The investments totalled 12.17m (compared with 8.67m at 2008). This figure includes 609k in respect of accrued interest and an adjustment of - 535k for the impairment of the two Icelandic banks investments. 3.9 The increase in investment balances has arisen due mainly to the additional borrowing taken up to fund existing 2008/09 projects and also future projects in 2009/10. Some of the 2008/09 projects have been deferred until 2009/10 and therefore the funding wasn t required. The Investment interest income budget for 2008/09 had taken account of reducing interest rates. Even so, the original 5.22

target of 800k was not achievable and was reduced to 700k in view of the dramatically falling rates. This new target was eventually exceeded by 52k. 3.10 The additional borrowing was in part undertaken to meet the approved shortfall in the capital funding available identified through the capital programme budget for 2008/09. The borrowing was also to meet the balance of funding from 2007/08, advanced funding was taken up for the 2009/10 programme. and securing loans to replace some 3m of debt owed to Manchester City Council. The borrowing was undertaken at this time due to favourable market conditions. 4 IMPLICATIONS 4.1 Resources: The subject of the report. However, should there be any losses as a result of the Iceland banks investments once the position has been determined, then this will impact on the Councils finances. 4.2 Legal: The relevant legal requirements are noted and have been complied with, notably the CIPFA 1 codes of practice for prudential borrowing and capital finance and for Treasury Management, as referred to in the Local Government Act 2003. 4.3 Human Rights Act: no implications 4.4 Equal Opportunities: no implications 4.5 Environmental Issues: no implications 4.6 Community Safety: no implications 4.7 Risk Management: The Prudential Code for Capital Finance and the Code of Practice on Treasury Management were set up to mitigate the risks associated with managing complex debt and investment portfolios. Compliance with the codes does not mitigate all risk, but ensures that key risks are identified and addressed. 4.8 Consultation: no implications 5 BACKGROUND PAPERS 5.1 All relevant papers held by the finance officers at Buxton Town Hall. 1 Chartered Institute of Public Finance and Accountancy 5.33

APPENDIX 1 ANNUAL REPORT ON THE TREASURY MANAGEMENT SERVICE AND PRUDENTIAL INDICATORS 2008/09 1 Introduction 1.1 The annual treasury report summarises: Confirmation of compliance with treasury limits and Prudential Indicators Capital activity for the year and how this was financed. Impact on the Council s indebtedness for capital purposes. The Council s overall treasury position. The reporting of the required prudential indicators. Summary of interest rate movements in the year. Debt activity and investment activity. 2 Regulatory Framework, Risk and Performance 2.1 The Council s treasury management activities are regulated by a variety of professional codes and statutes and guidance. These include the Local Government Act 2003, which provides the powers to borrow and invest as well as providing controls and limits on this activity. The Act permits the Secretary of State to set limits either on the Council or nationally on all local authorities restricting the amount of borrowing that may be undertaken (although no restrictions were made in 2008/09). Statutory Instrument (SI) 3146 2003, as amended, develops the controls and powers within the Act and requires the Council to undertake any borrowing activity with regard to the CIPFA Prudential Code for Capital Finance in Local Authorities. It also requires the Council to operate the overall treasury function with regard to the CIPFA Code of Practice for Treasury Management in the Public Services. Under the Act the Department for Communities and Local Government has issued Investment Guidance to structure and regulate the Council s investment activities. 2.2 The Council has complied with all of the above 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 Treasury Management means both that its 5.41

capital expenditure is prudent, affordable and sustainable, and its treasury practices demonstrate a low risk approach. 2.3 The Council is aware of the risks of passive management of the treasury portfolio and, with the support of the Council s advisers, has proactively managed its treasury position. The Council has continued to utilise historically low borrowing costs and has complied with its internal and external procedural requirements. There is little risk of volatility of costs in the current debt portfolio as the interest rates are predominantly fixed, utilising long-term loans. 2.4 Shorter-term interest rates and likely future movements in these rates predominantly determine the Council s investment return. These returns can therefore be volatile and, whilst the risk of loss of principal is minimised through the annual investment strategy, accurately forecasting future returns and more importantly the stability of the financial institution used can be very difficult. 2.5 The Icelandic banks failure has highlighted the risks involved in the investment of surplus funds. Although the Council had approved a robust Investment Strategy, adherence to the limits and controls within the strategy still failed to prevent the Councils exposure. A revised Investment Strategy was approved in November 2008 that further restricted investment opportunities. However, this restriction comes at a cost in terms of reduced income returns from the investments placed. 3 The Council s Capital Expenditure and Financing 2008/09. 3.1 The Council undertakes capital expenditure on long-term assets. These activities may either be financed through revenue, capital receipts, capital grants, or borrowing. 3.2 Part of the Council s treasury activities is to address this borrowing need, either through borrowing from external bodies, or utilising temporary cash resources within the Council. 3.3 The actual capital expenditure is a key prudential indicator. The table below shows how the capital expenditure was financed and the borrowing needed. 2007/08 2008/09 Revised Estimate 2008/09 GF capital expenditure 5,383 5,675 4,970 HRA capital expenditure 3,528 2,694 2,262 Total capital expenditure 8,911 8,369 7,232 Resourced by: Capital receipts 133 127 525 Capital grants 5,199 4,831 3,874 Capital reserves 32 597 602 Revenue 0 220 108 5.52

Unfinanced capital expenditure (additional need to borrow) 3,547 2,594 2,123 3.4 The above table shows that the revised amount of borrowing needed to finance the capital expenditure for 2008/09 was 2.6m. The actual funding required was 2.1m. Overall borrowing increased by a total of 10.5m. However, in addition to funding needed for the 2008/09 spend, that included funding outstanding from 2007/08, advanced funding for 2009/10 and also the refinancing of the Manchester City Council loan. It was decided to take a loan for three years and then to take up a longer-term loan when the markets have returned to more acceptable interest rate levels. The regulations allow Councils to borrow in advance to meet the current and the next two years expected requirements. 4 The Council s Overall Borrowing Need 4.1 The Council s underlying need to borrow is called the Capital Financing Requirement (CFR). This figure is a gauge for the Council s debt position. It includes expenditure for 2008/09 and prior years which has not yet been paid for by revenue or other resources. 4.2 The General Fund element of the CFR is reduced each year by a statutory revenue charge (called the Minimum Revenue Provision - MRP). 4.3 The Council s CFR for the year is shown below. This is a key prudential indicator, which shows the CFR increasing by 1.6m for capital expenditure that is to be funded from borrowing. Capital Financing Requirement 2008 2009 Revised Plan 2009 Opening balance 34,914 40,413 38,027 Add: unfinanced capital expenditure 3,547 2,905 2,123 Add: adjustments to prior years 0 0 0 Less: MRP (434) (518) (518) Closing balance 38,027 42,800 39,632 5 Treasury Position at 2009 5.1 Whilst the Council s gauge of its underlying need to borrow is the CFR, the Council s actual borrowing position is managed by either: 5.6 3

Borrowing to the CFR. Choosing to utilise some temporary cash flow funds instead of borrowing (under-borrowing). Borrowing for future increases in the CFR (over borrowing). 5.2 Additional borrowing may also need be taken up in 2009/10 depending upon the final capital programme spend. 5.3 The treasury position at the 2009 compared with the previous year was: Treasury position 2008 2009 Principal Average Rate % Principal Average Rate % Fixed Interest Rate Debt 23,255 5.78 33,755 5.33 Variable Interest Rate Debt 11,800 4.28 11,800 4.45 Total Debt 35,055 5.27 45,555 5.07 Fixed Interest Investments 8,000 5.62 10,000 5.29 Variable Interest Investments 62 5.49 2,103 3.77 Total Investments 8,062 5.61 12,103 5.07 Net borrowing position 26,993 33,452 6 Prudential Indicators and Compliance Issues 6.1 The prudential indicators provide an overview and specific limits on treasury activity. These are shown below: a) Net Borrowing and the CFR - 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 have exceeded the CFR for 2008/089 plus the expected changes to the CFR over 2009/10 and 2010/11. The table below highlights the Council s net borrowing position against the CFR. The Council has complied with this prudential indicator. 2008 2009 Original Indicator 2009 Net borrowing position 26,993 27,449 33,452 CFR 38,027 42,404 39,632 5.74

b) The Authorised Limit - The Authorised Limit is the Affordable Borrowing Limit required by s3 of the Local Government Act 2003. The Council does not have the power to borrow above this level. The table below demonstrates that during 2008/09 the Council has maintained gross borrowing within its Authorised Limit. c) The Operational Boundary 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 is acceptable subject to the Authorised Limit not being breached. d) financing costs as a proportion of net revenue stream - This indicator identifies the trend in the cost of capital (borrowing and other long-term obligation costs net of investment income) against the net revenue stream. 2008/09 Authorised Limit (revised) 62,732 Maximum gross borrowing position 45,555 Original Indicator - Operational Boundary 45,555 Average gross borrowing position 40,018 Minimum gross borrowing position 35,055 Financing costs as a proportion of net revenue stream Council Tax Rent 12.37% 12.93% 7 Economic Background for 2008/09 7.1 All treasury activity is directed by both the current market interest rates and expectations of future movements, which are influenced by inflation and demand and supply considerations. 7.2 The 2008/09 financial year featured a trend in the reduction of short and long term interest rates as the Bank of England responded to the effects of worsening economic climate. Of particular concern was the effect of the credit crunch impact generally on the money markets. This impacted on the Councils ability to undertake borrowing as funds could only be secured from the Public Works Loans Board. Bank base rates fell dramatically throughout the course of the year from 5.25% in April 2008 to 0.50% in March 2009. 5.8 5

8 The Strategy Agreed for 2008/09 8.1 The strategy provided for 2008/09 expected that the growing uncertainty over future interest rates increases the risks associated with treasury activity. As a result the Council would take a cautious approach to its treasury strategy by investing funds only for the short term and borrowing over periods in excess of 40 years. Despite adopting this strategy for investments, there were some investments made prior to this decision for longer periods with one of these investments being made (in November 2006 well before any indications of the current difficulties) in one of the Icelandic banks. 9 debt management activity during 2008/09 Borrowing 9.1 Loans were drawn to finance the net capital spend and naturally maturing debt. The loans drawn were: Lender Principal Type Interest Rate Maturity Average for 2008/09 PWLB 10.5m Maturity 3.82% 22/08/2011 3.82% 9.2 The above loan was included in the revised budget and equated to interest payments in 2008/09 of 187k. Although it had been intended that borrowing would be for periods in excess of 40 years, the prevailing market conditions meant that this strategy was not financially beneficial. Accordingly, the loan was taken out for a period of three years with the expectation that interest rates and the current turmoil would have settled by the and enable the loan to be replaced with a longer term loan. 9.3 Rescheduling During 2008/09 the Council rescheduled 3m of debt that it had been holding relating to Manchester City Council. As a result the interest cost saved equated to 16k for the General Fund in 2008/09. This is equivalent to a full years interest saving of 37k for the General Fund. 9.4 Repayment There were no other significant repayments of debt during 2008/09. 10 Investment Position 10.1 Investment Policy The Council s investment policy is governed by DCLG Guidance, which has been implemented in the annual Investment Strategy. Executive approved the original strategy on 12 February 2008. However, a revised, more restrictive strategy was approved in November 2008 after the collapse of the Icelandic banks. The investment activity during the year conformed to the approved strategies and the Council had no liquidity difficulties. But officers are monitoring the position on the return of the funds invested in the Icelandic banks as this will inevitably impact on its cash flow position. 5.96

10.2 Resources The Council s longer-term cash balances comprise primarily revenue and capital resources, although these will be influenced by cash flow considerations. The Council core cash resources comprised as follows, which meet the expectations of the budget: Balance Sheet Resources 2008 2009 Balances 3,658 3,318 Earmarked reserves 4,469 3,196 Usable capital receipts 357 61 Total 8,484 6,575 10.3 Investments Held by The Council The dramatic reduction in bank base rate reduced the cost of borrowing but also had a detrimental impact on the Councils investment returns. The Council maintained an average balance of 14.835m for the financial year 2008/09 and received an average return of 5.07%, which was 1.38% higher than the comparable performance indicator for the average 7-day LIBID rate of 3.69%. Investment interest received during the year was 752k compared with a revised budget assumption of 700k and an original budget of 800k. These sums include the effects of the investments in two Icelandic banks and at this stage assume both principal and interest will be recovered. 11 Performance Indicators set for 2008/09 11.1 This service has set the following performance indicator of securing investment returns above the 7 day LIBID 2 rate. As indicated at 10.3, the performance was 1.38% higher than the target rate. 2 London Interbank Bid Rate 5.10 7