HERTFORDSHIRE COUNTY COUNCIL
Agenda Item
No:
AUDIT COMMITTEE
THURSDAY 20 NOVEMBER 2014 AT 10.30AM
4
MID-YEAR REPORT ON THE TREASURY MANAGEMENT SERVICE AND
PRUDENTIAL INDICATORS 2014/15
Report of the Deputy Chief Executive
Author:
Patrick Towey, Head of Specialist Accounting
(Tel: 01992 555148)
Executive Member: Derrick Ashley
1.
Purpose of Report
1.1
The CIPFA Prudential Code and CIPFA Code of Practice for Treasury
Management in the Public Sector require the Council to set an annual Treasury
Management Strategy (TMS) and assess performance indicators and the
treasury function throughout the year.
1.2
This report fulfils the requirement to provide a mid-year report on performance
against the prudential indicators which were specified in the Integrated Plan,
Part C approved by the County Council on 25 February 2014.
1.3
The report provides a summary of treasury management performance and
activity for the period to 30 September 2014.
2.
Summary
2.1
The Council has been compliant with the prudential and treasury management
indicators set out in the Integrated Plan and there have been no breaches of the
Treasury Strategy in the period. The UK economy continues to recover but
globally recovery is uneven, with positive news from the US but concerns
regarding the Eurozone. UK monetary policy remains unchanged but a rate rise
is expected in 2015.
2.2
Legislation regarding bail-in means that credit ratings of UK banks are likely to
drop in late 2014 or early 2015 as the government support element is removed.
During the second quarter of the year the Council has diversified its investment
portfolio into UK government and corporate bonds to help mitigate this risk, these
new investments have also provided an increased return of 0.61% from 0.56%.
There has been no movement on the Council’s investments in Iceland. No new
borrowing has been taken and no borrowing has been repaid in the period.
1
3.
Recommendations
3.1
Members are invited to note the Treasury Management mid–year report.
4.
Background
4.1
The Council operates its treasury management function in accordance with the
CIPFA Prudential Code and the CIPFA Code of Practice for Treasury
Management in the Public Sector. The Codes require the Council to set
prudential indicators for its capital expenditure and treasury management
activities prior to the start of each financial year.
4.2
The Codes also require that regular reports are provided reviewing performance
and compliance at the end of each financial year and on a half-yearly basis. In
addition to these reports, performance against the prudential indicators and
treasury management activities are reported to Cabinet as part of the quarterly
budget monitoring report.
5.
Prudential and Treasury Management Indictors
5.1
The Prudential Code requires the Council to set and monitor a range of
prudential indicators relating to borrowing. The objectives of the Prudential
Code are to ensure, within a clear framework, that capital investment plans for
local authorities are affordable, prudent and sustainable, and that treasury
management decisions are taken in accordance with good professional practice.
5.2
The Council measures and manages its exposure to treasury management risks
using a range of indicators related to interest rate exposure, refinancing risk and
liquidity risk. In addition, treasury activity is measured against a range of
performance indicators related to security, liquidity and yield.
5.3
Appendix A provides evidence of compliance with the prudential and treasury
management indicators and reports on treasury activity performance indicators.
6.
Economic Review
6.1
The Council’s treasury activities have been undertaken within an improving
economy in the UK but globally the economic recovery has been uneven. The
UK economy has grown in the first half of this financial year by 0.8% in quarter 1
and 0.9% in quarter 2. The UK Monetary Policy Committee (MPC) has forecast
Gross Domestic Product at 3.4% in 2014 reflecting their view that the recession
was not as deep and the recovery was earlier than initially estimated. Inflation
has been forecast to remain at, or slightly below, 2% and the Annual Consumer
Price Index for August 2014 fell to 1.5% from 2.7% in August 2013.
6.2
The labour market has continued to improve, with the headline unemployment
rate falling to 6.2%. However, earnings growth has been weak rising 0.6% for the
three months May to July 2014 when compared to the same period in 2013. The
2
growth in employment has been masked by a large number of zero-hour
contracts and involuntary part-time working.
6.3
There was no change to UK monetary policy with official interest rates and asset
purchases remaining at 0.5% and £375bn respectively. There has been some
speculation that interest rates might rise sooner than financial markets are
expecting but the MPC has emphasised that when the bank rates do rise it is
expected to do so gradually and is likely to remain below average historical levels
for some time. The following graph provides Arlingclose’s (the Council’s treasury
adviser) interest rate forecast for the period December 2014 to June 2017 which
indicates rates gradually rising from 0.50% in June 2015 to 1.50% in June 2017.
6.4
The housing market has been impacted by a range of measures to avert the
potential of spiralling house prices impacting on a sustainable economic
recovery. Key recommendations included lenders stress-testing mortgage
applicants, putting a 15% cap on mortgages that are more than 4.5 times the
borrower’s income.
6.5
Eurozone inflation continued to fall towards zero and there is increasing evidence
that the already weak recovery is losing pace. The unemployment rate has
remained high at 11.5%. The European Central bank (ECB) lowered its official
benchmark interest rate from 0.15% to 0.05% and the rate it pays on commercial
bank balances held with the ECB, fell further into negative rates from -0.1% to
-0.2%. The ECB has announced a programme of acquiring Asset Backed
Securities from banks in an effort to encourage lending, which is viewed as being
similar to quantitative easing that has been introduced by the UK, US and
Japanese central banks. There are concerns that weakness in the Euro area may
have global implications in damaging confidence and disrupting financial
markets.
6.6
The US economy has seen strong growth in quarter 2 of 2014 annualised at
4.6%. There has been no change from the US Federal Reverse as the bank kept
policy on its current track with a reduction in asset purchases by $10 billion per
3
month. Asset purchases are expected to end by October 2014 when it is
forecasted that rates will begin to rise.
6.7
During the first half of the year the economic market has seen gilt yields continue
to decline with a financial year low at the end of August. The primary driver has
been the escalation of geo-political risk within the Middle East and Ukraine
alongside the slide towards deflation within the Eurozone.
7.
Treasury Management Strategy
7.1
In setting the 2014/15 Treasury Management Strategy, the Council approved a
Lending Policy that increased flexibility to enable greater diversification of
investment instruments and counterparties while recognising the Council’s
appetite for risk.
7.2
The Lending Policy continued to reflect the on-going risks in the wider economy
and banking institutions. The primary considerations when placing investments
continues to be the security and liquidity of the Council’s funds and only once
both of these factors have been taken into account will the yield on investment be
considered. Long term borrowing is only considered when it becomes necessary
to avoid a prolonged short term overdraft position.
7.3
The European Parliament approved the EU Bank Recovery and Resolution
Directive (BRRD) on April 15, 2014. Taking the view that potential extraordinary
government support available to banks' senior unsecured bondholders will likely
diminish within its two-year rating horizon for investment-grade entities, in April
and May, Standard & Poor’s and Moody’s changed the outlook from stable to
negative for a number of European Banks. In August Moody’s changed its
outlook for the UK banking system from stable to negative, citing the reduction of
government support for systemic banks as the reason. Although the agency
believes that the stand-alone financial strength of UK institutions is improving
they believed that this is more than offset by the potential bail-in risk now faced
by investors. It is expected that downgrades may occur for UK banks before the
end of the year as bail-in legislation comes into place in the UK on 1st January
2015. Bail-in is a particular risk for the Council as after shareholders and junior
bondholders have been bailed-in, senior bondholders and wholesale depositors,
such as the Council, will be next to take a hit to their deposits. The Council is
therefore working to diversify the investment portfolio to address this new risk.
7.4
During the six months to 30 September 2014, investments have been made in a
range of instruments detailed in Table 1.
Table 1: Counterparties and investment instruments used
to 30 September 2014
Investment
Instruments
Counterparty
Local Authorities
Fixed Term
DMADF and Treasury Bills
Fixed Term
4
7.5
UK Banks
Call / Notice Accounts
UK Banks
Fixed Term
UK Banks
CDs
Overseas Banks with AA+ Sovereign Rating
Fixed Term
AAA-rated Money Market Funds
Call
Corporate Bond Issuers
Fixed Term
Table 2 provides a summary of the value of investment instruments outstanding
as at 30 June 2014 and 30 September 2014 and the percentage of investment
instruments compared to the overall investment portfolio.
Table 2: Investment Activity as at 30 June 2014 and
30 September 2014
Counterparties
Investment
Instrument
As at 30/6/2014
As at 30/9/2014
£ 000s
£ 000s
%
%
Local Authorities
Fixed Term
29.5
18.4
24.5
13.7
UK Government
Treasury Bill
5.0
3.1
15.0
8.4
UK Banks
Call / Notice
14.7
9.2
15.0
8.4
UK Banks
Fixed Term
15.0
9.4
26.0
14.6
UK Banks
CD
10.0
6.2
10.0
5.6
Overseas Banks
Fixed Term
40.0
25.0
30.0
16.8
Overseas Banks
Call
10.0
6.2
10.0
5.6
Money Market Funds
Call
36.0
22.5
35.5
19.9
Corporate Bonds
0.0
0.0
12.5
7.0
TOTAL
160.2
100.0
178.5
100.0
Corporate Bond Issuers
7.6
Table 2 shows that cash balances have increased by £18.3m between the first
and second quarter as a result of cashflow timings. Investments have continued
to be made in the banking sector for durations from immediate access to 364
days. During the second quarter, £12.5M investments were made with Corporate
Bond issuers and a two year fixed term investment was made with a Local
Authority.
7.7
Interest rates for investments have ranged between 0.40% to 0.84% for fixed
terms up to 364 days and 1.08% for the two year investment. Interest rates on
variable investments have varied in the range 0.34% to 0.75% throughout the
period.
7.8
Table 3 provides a summary of the treasury activity in the period April to
September 2014.
5
Table 3: Treasury Activity - 1 April to 30 September 2014
April to
September 2014
Measure
Average size of portfolio (excluding Iceland investments)
Weighted average term (fixed term only)
Average rate earned
203.9M
85
0.59%
Interest earned
0.587M
7.9
During the first quarter, the Council had an average investment portfolio of
£200.5m and received interest of £0.282M. The average rate of return was
0.56% which exceeded the 7-day LIBID benchmark of 0.34%. During the second
quarter, the Council had an average investment portfolio of £207.3M and
received interest of £0.304m. The average rate of return was 0.61% which
exceeded the 7-day LIBID benchmark of 0.35%. The forecast for annual interest
earned is £1.042m exceeding the budget of £0.785m.
7.10
The rate of return for the second quarter, 0.61% was higher than the rate
achieved of 0.56% in the first quarter of 2014/15. The increase in the rate
achieved is the result of increased better yielding fixed term investments which
have been achieved by improved cashflow management. In particular, this is the
result of officer decisions to place some of these fixed term investments in the
form of corporate bonds which provide a different risk exposure to traditional
banking related investments and also a better rate of return.
7.11
All treasury management activity undertaken during the period complied with the
approved treasury management strategy, the CIPFA Code of Practice for
Treasury Management and the relevant legislative provisions.
8.
Icelandic deposits
8.1
There has been no movement in the Icelandic deposits since 31 March 2014. Of
the original four Icelandic banks with which HCC had deposits, the outstanding
claim against the insolvent estate of Landsbanki was sold in 2013/14 and
resulted in a total recovery of 92% of the amounts originally deposited.
8.2
The claims in regard of Glitnir were paid out in full in March 2012; however this
payment was made in a basket of currencies which included Icelandic krona.
Icelandic Krona is subject to currency restrictions by the Icelandic Central Bank
and therefore this element is held in an interest bearing escrow account. Lawyers
acting on behalf of the LGA continue to negotiate for the repatriation of these
funds from Iceland.
8.3
Heritable distributions made to date are the total distribution expected by Ernst
and Young; however, the claim cannot be closed as a small balance has been
held back to cover administration costs which are yet to be resolved. For
Kaupthing, Singer & Friedlander, Ernst and Young expect that there will be a
further distribution of 3.5-5.0p in the £ by the end of 2014, which will be the final
distribution except for admin costs, but this is yet to be confirmed.
6
8.4
Table 4 provides details of dividends received to 30 September 2014 together
with current information about the anticipated value and percentage recovery for
Icelandic investments.
Table 4:
Icelandic bank deposits at 30 September 2014
Original
deposits
Recovered
at 30/09/14
£m
£m
£m
Heritable Bank
7.00
6.60
6.60
94.29
Kaupthing, Singer & Friedlander
4.00
3.34
3.43
85.75
Glitnir
7.00
5.99
7.00
100.00
Landsbanki
10.00
9.23
9.23
92.30
TOTAL
28.00
25.16
26.26
93.79
Bank
Total expected
distribution
%
9.
Borrowing
9.1
Long Term Borrowing
Table 5 shows total long term borrowing outstanding at 30 September 2014, the
future maturity profile of borrowing and an analysis of sources of borrowing
shown as a percentage of total borrowing.
Table 5:
Borrowing maturity profile at 30 September 2014
Total
£m
258.8
103.3
39.9
155.5
60.1
Maturing in 2014/15
0.0
0.0
0.0
0.0
0.0
Maturing in 2015/16
0.0
0.0
0.0
0.0
0.0
258.8
103.3
39.9
155.5
60.1
Borrowing at 30 September 2014
Maturing later
Average interest rate
1
2
9.2
Sources of Borrowing
PWLB 1
LOBO 2
£m
%
£m
%
4.78%
5.36%
4.39%
PWLB = Borrowing sourced from the government’s Public Works and Loans Board
LOBO = Borrowing sourced from commercial banks
At 30 September there was a total of £258.8m long term borrowing outstanding.
£103.3m (40%) was sourced from the government’s Public Works and Loan
Board and £155.5 (60%) was sourced from commercial banks. The average rate
of interest for total borrowing was 4.78%, the average rate for PWLB borrowing
was 5.36% and the average rate for borrowing from commercial banks was
4.39%.
7
9.3
The long term borrowing portfolio is kept under review in consultation with the
Council’s treasury adviser; Arlingclose to identify opportunities to reduce
borrowing costs by restructuring existing loans.
9.4
Short Term Borrowing
No short term borrowing has been required or undertaken in the first half of the
year.
10.
Hertfordshire Police and Crime Commissioner – Treasury Management
10.1 The Police and Crime Commissioner contracts with Hertfordshire County Council
to deliver its Treasury Management services.
10.2 A separate treasury management strategy is maintained for the Police and Crime
Commissioner. Data concerning the Police’s cashflow is provided to the
Council’s treasury officers and any surplus cashflow is invested in accordance
with the investment criteria outlined in the Police and Crime Commissioner’s
Treasury Management Strategy. The Police’s cashflow and investment portfolio
is maintained separately from the Council’s funds.
10.3 The reporting arrangements for the Police and Crime Commissioner are similar
to the Council’s. An annual treasury management strategy is prepared before
the start of each financial year. An annual report on the previous financial years’
treasury management activity is also provided as well as a mid-year report on
treasury management activity for the current financial year. Quarterly reports are
provided according to the schedule of meeting dates provided by the Police and
Crime Commissioner.
8
Appendix A:
1.
Prudential and Treasury Management Indicators
Capital financing Indicators
Indicator
Integrated
Plan Ref.
Description
2014/15
Budget
£M
2014/15
Q1
£M
2014/15
Q2
£M
2014/15
Q3
£M
2014/15
Q4
£M
Indicators 1 to 3 demonstrate the affordability and sustainability of the capital programme. The projections for
financial years 2014/15 to 2016/17 are set out in the Integrated Plan at the reference shown in the table below.
1 Capital Expenditure
Monitors capital expenditure
for 2014/15 against the
projections set out in the
Integrated Plan.
2 Capital Financing
Monitors the Council’s
Requirement (CFR)
underlying need to borrow
for capital purposes for
2014/15 against the
projections set out in the
Integrated Plan
3 Ratio of financing costs to Monitors the percentage of
net revenue stream
revenue budget set aside to
service capital financing
costs (borrowing costs net of
lending income) for 2014/15
against projections set out in
the Integrated Plan.
9
2.4 Table 1
226.62
251.49
244.53
2.5 Table 2
541.06
541.35
541.35
2.11 Table
4
1.44%
1.40%
1.40%
Indicator
Integrated
Plan Ref.
Description
2014/15
Budget
£M
2014/15
Q1
£M
2014/15
Q2
£M
2014/15
Q3
£M
2014/15
Q4
£M
Treasury Position:
The Treasury Management Prudential Indicators are set to contain lending and borrowing activities within approved
limits. The indicators are set at a level that will provide enough flexibility for effective treasury management whilst
managing the risk of a negative impact on the Council’s overall financial position in the event of adverse movements
in interest rates or borrowing decisions. The indicators are also used to demonstrate that Net Borrowing does not
exceed the Capital Financing Requirement. The projections for financial years 2014/15 to 2016/17 are set out in the
Integrated Plan.
Monitors actual borrowing
4 A Net Borrowing
58.3
51.1
less actual lending
Net Borrowing Less than
Comparison of net borrowing


4B
CFR
to CFR
Borrowing:
Indicators 5 and 6 control the overall level of borrowing. The limits for 2014/15 to 2016/17 are set out
in the Integrated Plan.
5 Authorised Limit (against
maximum position)
6 Operational Boundary
Monitors the borrowing limit
for 2014/15 beyond which
borrowing is prohibited
without Member approval.
Monitors the estimated
external debt for the financial
year 2014/15. This is not a
limit and actual borrowing
can vary. This estimate acts
as an indicator to ensure the
authorised limit is not
breached.
10
6.5 Table
11
400
400
400
6.5 Table
11
370
370
370
2.
Treasury Management Indicators
Indicator
Integrated
Plan Ref.
Description
2014/15
Budget
£M
2014/15
Q1
£M
2014/15
Q2
£M
2014/15 2014/15
Q3
Q4
£M
£M
Interest Rate Exposure:
Indicators 7 and 8 limit the Council’s exposure to both fixed and variable interest rate movements.
The limits for 2014/15 to 2016/17 are set out in the Integrated Plan.
7 Upper limit on fixed interest Monitors the limits set for
6.6 Table
300.00
141.29
122.77
rates (against maximum
2014/15 for the volume and
12
position)
value of the (lending)
/borrowing portfolios that
may be committed for fixed
interest rate investments or
borrowing
8 Upper limits on variable
Monitors the limits set for
6.6 Table
90.00
(42.69)
(42.42)
interest rates (against
2014/15 for the volume and
12
maximum position)
value of the (lending)
/borrowing portfolios that
may be committed for
variable interest rate
investments or borrowing
Maturity structure of fixed rate borrowing (against maximum position):
Indicator 9 limits the Council’s exposure to large fixed rate sums falling due for refinancing in the same period.
The indicators are set relatively high to give the council enough flexibility to respond to opportunities to repay or
reschedule debt during the financial year, while remaining within the parameters set by the indicators.
11
Integrated
Plan Ref.
2014/15
Budget
£M
2014/15
Q1
£M
2014/15
Q2
£M
9 A Under 12 months
6.7 Table 3
35%
0%
0%
9 B 12 months to 2 years
6.7 Table 3
40%
0%
0%
9 C 2 years to 5 years
6.7 Table 3
60%
0%
0%
9 D 5 years to 10 years
6.7 Table 3
80%
3%
3%
9.E 10 years to 20 years
6.7 Table 3
85%
9%
9%
9.F 20 years to 30 years
6.7 Table 3
90%
10%
10%
9 G 30 years and above
6.7 Table 3
100%
78%
78%
Indicator
Description
2014/15 2014/15
Q3
Q4
£M
£M
Investments greater than 364 days (against maximum limit):
Indicator 10 measures the Council’s exposure to investing for periods greater than one year.
This indicator is required to ensure that the Council is aware of the cashflow implications for long term investments.
This includes deposits at risk in Icelandic Banks.
Investments greater than
6.8 Table
10
40M
2.07M
7.07M
364 days (Maximum Limit)
14
12
3.
Treasury Management Performance and Activity Measures
Indicator
Description
Integrated
Plan Ref.
2014/15
Q1
2014/15
Q2
2014/15
Q3
2014/15
Q4
The CIPFA Treasury Management Code of Practice requires the Council to set performance indicators to assess the
treasury function. Group A measures performance for “Security, Liquidity and Yield” and Group B measures the
performance of “Operational Activities”
GROUP A: Security, Liquidity and Yield
Average Investment Portfolio
Monitors the average amount
7.3 Table
200.51
207.26
HCC has had invested in third
16
parties.
Average borrowing portfolio
Monitors the average amount
6.3 Table
258.78
258.78
HCC has as long term borrowing
10
during the quarter
Security Indicator: Average
Measured on a 1 to 10 scale,
9.1 to 9.3
4.33
4.12
Credit Rating of Investments held where 1 is a very good Credit
Rating, i.e., government
guaranteed
Liquidity Indicator: Weighted
Measures the
9.1 to 9.3
122
85 days
Average Maturity of investments liquidity/accessibility of
days
held
investments in average days
Yield Indicator: Interest Earned
Monitors the interest earned on
7.3 Table
0.56%
0.61%
HCC investments. Shown as both
16
an actual amount and a
0.282M 0.304M
percentage of amount invested
13
Security, Liquidity and Yield
Exposure to Risk
The Treasury Management Strategy was approved on 25 February 2014 as Part C of the Integrated Plan. This introduced additions
to the types of investment used following on from changes already made in 2013/14 to enable greater diversification of the
investment portfolio. These changes introduced greater flexibility in use of investment instruments whilst continuing to maintain
security and liquidity of investments.
The following diagrams illustrate the credit rating breakdown of all investment instruments by credit rating grade and investment type
for the Council’s investment portfolio as at 30th September 2014.
Diagram 1:
Summary of Credit Risk of Investment
Portfolio as at 30th Sept 2014
Diagram 2: Summary by Investment type
as at 30th Sept 2014
Key:
AAA and AA
Very High Credit Quality
AA-, A+ and A High Credit Quality
The greatest percentage of deposits are held in fixed term investments of 6 months to 1 year, with one 2 year investment of £5m to a
local authority also included in this category. These are diversified over a number of local authorities, UK and Overseas banks, one is
with Nationwide building society and £1m is invested with an unrated building society. The bonds shown on this illustration are UK
government treasury bills intended to be held to maturity and corporate bonds with Network Rail (Government Guaranteed),
Volkswagen and American Express. Other investments are liquid investments held in UK and overseas bank call accounts and
money market funds.
14
Liquidity
The majority of the investment portfolio is held in instant access Money Market Funds and call accounts. In light of falling
performance of MMFs and the high level of cash that is not required for immediate commitments, the Council has undertaken a
number of fixed term deposits with high quality counterparties. While there is less liquidity for these investments, it has been
possible to secure a higher yield.
Diagram 3 provides a graph showing the liquidity of the Council’s investments portfolio as at 30th Sept.
15
Yield
The benchmark used for assessing the performance of return on lending is the 7-Day London Interbank Bid Rate (LIBID). Diagram 4
shows yield against the benchmark for the last four quarters.
The increase in rate of return is in excess of the small increase in LIBID, giving a rate of return 26bps over the LIBID target. This is
the result of increased better yielding fixed term investments which have been achieved by improved cashflow management. In
particular, this is the result of officer decisions to place some of these fixed term investments in the form of corporate bonds which
provide a different risk exposure to traditional banking related investments and also a better rate of return.
16