AGENDA ITEM 8 BOROUGH OF POOLE AUDIT COMMITTEE 15 September 2016 TREASURY REPORT REVIEW OF QTR1 2016/17 PART OF THE PUBLISHED FORWARD PLAN - YES STATUS STRATEGIC POLICY 1 Purpose and Policy Content 1.1 The Chartered Institute of Public Finance and Accountancy s Treasury Management Code of Practice (CIPFA s TM Code) requires local authorities to report on the performance of the Treasury Management function at least twice a year (mid-year and at year end). This report provides an additional quarterly update. 1.2 The Council s Treasury Management Strategy for 2016/17 was approved by Council on 23 February 2016. 1.3 As part of its normal treasury activity the Council has borrowed and invested substantial sums of money. This inevitably exposes the Council to some financial risk including the potential loss of invested funds and the revenue effect of changing interest rates. This report covers the Council s treasury activities and the monitoring and control of associated risk during the quarter ending 30 June 2016 (QTR1). 2 Decision Required Audit Committee is asked to note; a) The reported activity of the Treasury Management function for the quarter ending 30 June 2016 (QTR1). 3 Background 3.1 The following paragraphs provide a brief overview of the current economic conditions affecting the Treasury Management function both in the UK and major overseas economies. 3.2 As we entered QTR1, there was continued uncertainty over the outlook for global growth. The slowdown in the Chinese economy, uncertainty over the outcome of the US presidential election (and candidate nominations), and the impending referendum on the UK s future relationship with the EU all resulted in nervousness within the markets.
3.3 Fluctuations in the opinion polls on the EU referendum prompted pronounced volatility in exchange rates, gilts, corporate bonds and equities as the result became increasingly uncertain. Immediately prior to the result, financial market sentiment shifted significantly in favour of a Remain outcome - a shift that was swiftly reversed as the results came in. Between 23 June and 1 July the short-term volatility of sterling against the dollar increased significantly. Worldwide, markets reacted very negatively to the referendum outcome with a marked fall in equity prices. Government bond yields also fell sharply. 3.4 A week on from the result, however, the overall market reaction (although still significant) was less severe than some had feared. The FTSE Index, having initially fallen sharply on 23 June, had recovered its position by the end of the month. 3.5 The Bank of England raised the likelihood of a cut in interest rates later in the year (a measure ultimately not effected until August 2016). The door was also left open for increases in the Bank s asset purchase facility (Quantitative Easing). Local Context 3.6 To some degree the Council has been sheltered from market volatility and interest rate fluctuations. The Council s 85m external borrowing is at a fixed interest rate (3.78% for 82m PWLB loan and 0% for 3m other external loans). 3.7 At the end of QTR1 the Council held an investment portfolio of 30.8m - spread between Covered Bonds, Corporate Bonds, Deposits in Notice Accounts, and Cash invested in call accounts and Money Market Funds (MMFs). No investments were made in foreign currencies. Furthermore all investments were with counterparties with credit ratings of at least A- (above the minimum prescribed in the Council s Treasury Management Policy). This minimises the credit risk to the Council. The risk of exposure to interest rate fluctuations does however remain. Whilst the Bank of England Base Rate was maintained at 0.5% in QTR1, it was reduced to 0.25% mid-qtr2 (August 2016), with the possibility of a further 0.25% decrease later in the year. 3.8 The Council s current Treasury Management Strategy is to run down balances available for investment (reserves and working capital) by using them to fund its capital financing needs (rather than using new external borrowing). 3.9 Given the reduction in interest rates available for both investments and new external borrowing, this Strategy is in the process of being reviewed. As part of this, Officers are also working alongside Treasury Management Officers in Bournemouth Council to understand their operational cashflow needs, areas of common (and differing) practice and to identify new opportunities (for both investments and borrowing) across both Councils. 2
4 Borrowing Activity Current Borrowing Arrangements 4.1 As a result of the Government s Self Financing proposals, the Council has adopted a Two Pool approach to debt management. The debts of the HRA and those of the General Fund have been separated. The HRA pool (Pool 1) (which includes its Self Financing debt) comprises 82m external debt with the Public Works Loan Board (PWLB). The General Fund Pool (Pool 2) consists of external debt of 3m. This comprises 1m forward funding from the Homes and Communities Agency (formerly the Regional Infrastructure Fund) for the Twin Sails Bridge (repayable from Community Infrastructure Levy receipts); and a 2m interest free Salix loan to contribute to the financing of its Street Lighting Project (repayable from anticipated savings in energy costs). (Table 1 below) Pool 1 - HRA Borrowing Balance at 01/04/16 m Balance at 30/06/16 m Interest Rate % PWLB loan 82.0 82.0 3.78 Pool 2 - General Fund Borrowing RIF 4.4 1.0 0 Salix 2.0 2.0 0 Total External Borrowing 88.4 85.0 Table 1 - Summary of QTR1 changes in External Borrowing across Two Pools 4.2 No new external borrowing was required in QTR1. When new external debt is required it should be taken out by the relevant Pool. The option to transfer existing debt between the General Fund and the HRA always remains. If activated, the debt transfer mechanism would, for example, allow for new external borrowing to be taken out by the HRA without breaching its debt cap limit of 99.8m. There is currently only 3.7m headroom between total HRA external borrowing of 82.0m + 14.1m (internal borrowing repayable to the General Fund) and its Government set debt cap limit of 99.8m. 4.3 The potential for new borrowing should be reviewed in the context of the cost of borrowing, which has continued to decrease over QTR1. For example on 1 April 2016 a standard 25 year PWLB loan to maturity would have attracted an interest rate of 3.30%. If taken out on 30 June 2016, the same loan would be at an interest rate of 2.83%. 4.4 In addition the Council qualifies for borrowing at the PWLB Certainty Rate (0.2% below the PWLB standard rate) for a 12 month period ending 1 November 2016. In April 2016 the Council submitted its application to the CLG (as part of the 2016/17 Capital Estimates Return) for continued access to this reduced rate for a further 12 month period until 1 November 2017. 3
4.5 Despite the reduction in borrowing rates, the premium charge for early repayment of debt remained relatively expensive for the 82m PWLB loans in the Council s portfolio and therefore unattractive for debt rescheduling activity in QTR1. Were the Council to refinance its debt at this time, its liability to PWLB would increase by 17m to 99m as a result of early redemption penalty charges. No rescheduling activity was undertaken as a consequence. Forward Look 4.6 The Council anticipates its Capital Financing Requirement (CFR) will increase by around 7.8m by 2019/20, as a result of the current capital programme. With regard to how this financing need is met, the Council s current strategy is to utilise reserves and working capital balances (that would otherwise have been available for investment), in preference to new external borrowing. This strategy reduces investment risk (from decreasing interest rates) and minimises the Cost of Carry from longer term borrowing. This position will be monitored closely over the year, in particular should long term borrowing rates continue to fall or new business cases for significant capital projects come forward. An updated Treasury Management Strategy (which will include reference to borrowing) will be presented to Audit Committee in January 2017. 5 Investment Activity QTR1 Activity 5.1 The Council s approach to Treasury Management continues to be Security of investments over Yield. Investment activity in QTR1 has been undertaken in the context of continued market volatility in the run-up to the EU Referendum, and the Bank of England maintaining Base Rate at 0.5% (reduced to 0.25% on 4 August 2016). Investment Duration Principal at 01/04/16 k Principal at 30/06/16 k Interest Accrued Q1 k Interest Rate % 2-3 Years 12,500 2,500 5 0.86 1-2 Years 9,955 10,000 20 0.79 Up to 364 Days 0 9,955 29 1.16 Call / Notice Accounts 10,300 4,230 9 0.62 Money Market Funds (MMFs) 5,000 4,100 5 0.46 Sub-Total Investments 37,485 30,785 68 Deferred Premium 89 Y/E Total Investments 37,573 30,785 68 Table 2 - Summary of QTR1 Investment Performance 5.2 During QTR1 daily cash surpluses on the Council s pooled bank accounts were invested in either interest earning accounts (Barclays FIBCA) or the Money Market Funds (MMF). Direct Dealing, with reference to the limits and boundaries prescribed in the Council s Treasury Management Policy, was used by Treasury Management 4
Officers for daily investments (or redemptions where required). This activity led to interest of 5k being earned from overnight deposits in MMF over QTR1, with a further 9k earned in QTR1 from deposits in interest earning accounts (including 4k interest at 0.9% on Santander 95 day notice account). Appendix A presents daily cash (i.e. bank + MMF) balances for QTR1. 5.3 The use of MMFs spreads the Council s overall investment risk. MMFs generally invest a maximum of 4-5% of their funds with any one specific institution (this may be higher on an overnight basis). The MMFs invest in a range of products, such as Term Deposits, Call Accounts, Corporate Bonds, Certificates of Deposit, Commercial Papers and Floating Rate Notes. The MMFs are rated as AAA by one or more of the main Credit Rating Agencies. It is anticipated that from time to time the MMFs will invest with the same banks that the Council is already investing with direct such as Barclays, Lloyds, Standard Chartered and HSBC. In these circumstances the total investment with the bank may potentially be higher than the individual direct limit as specified in the Treasury Management Policy. 5.4 Following advice from the Council s independent Treasury Management advisers, the Council has invested a greater proportion of its available funds in fixed term Covered Bonds. Covered Bonds are a more secure form of Corporate Bond as they are backed by a pool of assets held by the lending institution. At the start of the quarter the Council had invested 20m in fixed term Covered Bonds and 2.5m in fixed term Corporate Bonds with highly rated institutions. None of these deposits matured in QTR1 and no new fixed term investments were made in the period. The Council accrued 54k interest in QTR1 from fixed term deposits, with an average net yield of 0.94%. 5.5 Appendix B of this report provides a graphical analysis of investments outstanding as at 30 June 2016 by Institution, by Sector and Country, by the Lowest Common Denominator (LCD) Long Term Rating of the three main Rating Agencies, by duration and by type of investment. 5.6 The formal list of Counterparties that the Council can use is under constant review, there are no changes required to the list at the present time. Forward Look 5.7 The 2015/16 full year Treasury Management Report (considered by Audit Committee June 2016), suggested the potential to invest a greater proportion of Poole s daily cash surpluses in higher yielding fixed term investments rather than in instantly accessible MMF / interest earning accounts. Daily operational cash needs ( Liquidity of funds) would continue to be met with use of short term borrowing as and when required. The need to maximise investment return is of increasing importance in light of the Bank of England s reduction in Base Rate to 0.25% in August, and resulting impact on the interest earned in the Council s MTFP. This was actioned early in QTR2 - a new 2.5m fixed term bank deposit has been invested with Lloyds Bank, maturing May 2017 and earning fixed interest rate of 0.8%. 5.8 Officers are also working with colleagues in Bournemouth Council to build a shared understanding of both Councils daily, monthly and annual cashflow needs. When 5
completed, this exercise will allow for a more informed, strategic view to be taken on investment and borrowing opportunities across both Councils. 6 Interest Earned and Payable during QTR1 6.1 A summary of accrued interest earned on investments and paid on borrowing in the quarter, with comparison to budget for the same period is provided in Table 3 below. Interest Paid on Borrowings QTR 1 Budget k QTR 1 Actual k Interest Rate % Benchmark 7 Day London Interbank Bid Rate % General Fund Borrowing 0 0 0 0 HRA External Borrowing (PWLB) (778) (778) 3.78 HRA Internal Borrowing (24) (24) 0.75 Total Interest Paid (802) (802) Interest Earned on Investments Fixed term deposits 54 0.94 0.45 Call / Notice 9 0.62 0.45 Money Market Funds 5 0.46 0.45 Total Interest Earned 66 68 Table 3 - Summary of QTR1 Accrued Interest earned and payable in comparison with budget 6.2 Interest payable on PWLB loan is fixed for the period of the loan. Interest earned on investments in QTR1 is in line with expectations and continues to be at a higher yield than the 7 day London Interbank Bid Rate 1 (LIBID) benchmark for QTR1 of 0.45%. 6.3 The Bank of England s decision to reduce Base Rate to 0.25% came into effect on 4 August 2016, after the end of QTR1. We have seen a subsequent decrease in interest rates offered on all floating rate investments in QTR2. 7 PRUDENTIAL INDICATORS 7.1 There are no known changes to the Council s Prudential Indicators which will lead to amendments to the approval limits that need to be reported. 1 The LIBID rate is the rate at which major London banks borrow from other banks. 6
7.2 Capital expenditure to be financed by Prudential Borrowing in 2016/17 is currently projected to include the Street Lighting project, the vehicle replacement programme, and leisure centre improvements. 8 FINANCIAL IMPLICATIONS 8.1 The financial implications are as outlined within the report. 9 LEGAL IMPLICATIONS 9.1 There are no known Legal implications. 10 RISK MANAGEMENT IMPLICATIONS 10.1 The Treasury Management Policy seeks to consider and minimise various risks encountered when investing surplus cash through the money markets. The aim (in accordance with the CIPFA Code of Practice for Treasury Management) is to place a greater emphasis on the security and liquidity of funds rather than the return gained on investments. The main perceived risks associated with treasury management are discussed below. 10.2 Credit Risks Risk that a counterparty will default, fully or partially, on an investment placed with them. There were no counterparty defaults during the last year, the Council has taken steps to minimise credit risk by the use of AAA rated Money Market Funds and invest in highly rated Corporate and Covered Bonds. The current minimum Long Term rating is BBB+ or equivalent (with the exception of the Council s own Bank where for practical reasons the rating may be slightly lower for overnight investments). 10.3 Liquidity Risks Aims to ensure that the Council has sufficient cash available when it is needed. This was actively managed throughout QTR1 and there are no liquidity issues to report. The Council had no need for short term borrowing in QTR1. 10.4 Re-financing Risks Managing the exposure to replacing financial instruments (borrowings) as and when they mature. The Council s re-financing risk for the short to medium term is very low. The longer term re-financing risk increased as a result of the Council borrowing the 43.9m for 50 years (part of the 82m PWLB loan in HRA Debt Pool). We expect there to be opportunities over the remaining life of the loan to either prematurely repay the debt, transfer some or all of this debt between the HRA and the General Fund or to reschedule part of the debt to reduce the long term refinancing risk. 10.5 Interest Rate Risks Exposure to interest rate movements on its borrowings and investments. 7
The Council is susceptible to upward movements in long term interest rates given the amount of borrowing still required over the next 5 to 10 years. However, the Council (in particular the HRA) currently benefits from the use of Internal Borrowing which significantly reduces the overall cost of borrowing. It is currently assumed that the Council will continue to make enhanced repayments to the Homes and Communities Agency (Regional Infrastructure Fund - Forward Funding) in order to maintain its interest free status. 10.6 Price Risk Relates to changes in the value of an investment due to variations in price. The Council does not currently invest in Gilts or any other investment that is likely to lead to a reduction in the principal value repaid on maturity. However, as part of the Council s overall Treasury Risk Management Strategy the Council now invests in Covered Bonds, Corporate Bonds and Certificates of Deposit with high quality counterparties. In the event that the Council were in a position that it decided to sell one of these instruments prior to maturity then there is a possibility that the Council would not get back the full value of its investment. Were the instrument held to maturity, then the Council would expect to get back the full value of these investments. 10.7 Foreign Exchange Risk Risk changes in exchange rates will alter the value of the Council s assets or liabilities. The Council does not have any assets or liabilities denominated in foreign currency. There is therefore no exposure to risks arising from movements in exchange rates. 11 EQUALITIES IMPLICATIONS 11.1 The Treasury Management Policy does not directly impact on any of the services provided to the Council s stakeholders or how those services are structured. However the success of the policy will have an impact on the extent to which sufficient financial resources are available to fund services to all members of the community. 12 SUMMARY AND CONCLUSION 12.1 The Council has continued to invest surplus funds prudently in QTR1 in accordance with the Treasury Management Policy, which prioritises the security and liquidity of funds over the return achieved. 12.2 The Council generated investment interest of 68k for the General Fund through its treasury activities in QTR1. 12.3 Officers continue to explore new opportunities for investments and borrowing (capital financing) and are working alongside colleagues at Bournemouth Council to better understand Treasury Management potential across the two Councils. A RICHENS CHIEF FINANCE OFFICER & HEAD OF FINANCIAL SERVICES 8
Contact Officers Adam Richens Chief Finance Officer and Head of Financial Services Telephone: (01202) 63.3183 email: a.richens@poole.gov.uk Mandy May Finance Manager Telephone: (01202) 63.3178 email; m.may@poole.gov.uk Shirley Haider Management Accountant Telephone: (01202) 63.3528 email: s.haider@poole.gov.uk Background Papers: Nil Date: 30 August 2016 9
Appendix A QTR1 Daily Investment Balance - showing instantly accessible funds (cash + MMF) balance for each day of QTR1. 22500000 Daily Cash + MMF balance 1 April 2016 to 30 June 2016 20000000 17500000 15000000 12500000 10000000 7500000 5000000 2500000 28 April 2016 5.7M 27 May 2016 3.3M 28 June 2016 4.5M 0 10
Investments as at 30.06.16 ( 000) Investments as at 30.06.16 ( 000) Appendix B Analysis of 30.8m Combined Investments held at 30 June 2016 - fixed term deposits (dark blue), 95 day notice account (mid blue) and instantly accessible funds (pale blue). 18000 16000 14000 12000 10000 8000 6000 4000 2000 0 Investments by Type as at 30.06.16 Covered Floating Rate Covered Fixed Bond Fixed Corporat e Bonds Notice Accounts Money Market Funds Call Accounts 000 17455 2500 2500 2500 4100 1730 Investments by LCD Long Term Rating as at 30.06.16 20000 18000 16000 14000 12000 10000 8000 6000 4000 2000 0 AAA AA+ A AAA A- 000 19955 2500 2500 4100 1730 11
Investments as at 30.06.16 ( 000) Investments as at 30.06.16 ( 000) Bank of Scotland Network Rail Lloyds Bank Abbey National Nationwide Barclays Bank Bank of Nova Scotia Leeds Building Soc Royal Bank Canada Santander UK Standard Life MMF Barclays (FIBCA) 4500 4000 3500 3000 2500 2000 1500 1000 500 0 Investments by Institution as at 30.06.16 Investments by days to maturity as at 30.06.16 10000 9000 8000 7000 6000 5000 4000 3000 2000 1000 0 2-3 years 1-2 years 6-12 months Notice Accounts Overnight or Call Accounts 000 2500 10000 9955 2500 5830 12
UK - Banks UK - Building Societies UK Corporates Spain - UK subsidiary Canada - Bank Spain - UK subsidiary Money Market Funds Investments as at 30.06.16 ( 000) UK - Banks 7500 6000 4500 3000 1500 0 Investments by Sector and Country as at 30.06.16 13