HERTFORDSHIRE COUNTY COUNCIL
POLICY & RESOURCES CABINET PANEL
THURSDAY 12 MARCH 2009 AT 2.00 p.m.
CABINET
MONDAY 16 MARCH 2009 AT 2.00 p.m.
AUDIT COMMITTEE
WEDNESDAY 25 MARCH 2009 AT 10.00 a.m.
COUNTY COUNCIL
TUESDAY 31 MARCH 2009 AT 10.30 AM
Agenda Item No:
Policy & Resources
Cabinet Panel
7b
Cabinet
11
Audit Committee
Refer to agenda
County Council
10
TREASURY MANAGEMENT STRATEGY
Report of the Finance, Information and Commercial Services Director
Author: Nicola Webb (Tel: 01992 555148)
Executive Member: David Lloyd
1.
Purpose of report
1.1
To set out the requirements of the CIPFA Prudential Code for Capital
Finance in Local Authorities in respect of treasury management and to
recommend prudential indicators for the financial year 2009/10.
1.2
To recommend a treasury management strategy for 2009/10 including
a lending policy, in accordance with the CIPFA Code of Practice for
Treasury Management in the Public Services and the Department for
Communities and Local Government’s (formerly OPDM) Investment
Guidelines for Local Authorities.
1.3
This report will also need to be considered by the County Council on 31
March and Members are asked to bring this report with them to that
meeting.
2.
Summary
2.1
The context for treasury management continues to be challenging as
the problems in the banking industry continue and the UK economy has
entered recession. As a result a very cautious treasury management
strategy is being proposed for 2009/10.
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2.2
It is planned to reduce cash balances by not undertaking any new
borrowing during 2009/10. The proposed lending policy is more
stringent than in previous years and it reflects the recommendations of
the Price Waterhouse Coopers (PWC) phase 2 report on treasury
policy and procedures.
2.3
The treasury management prudential indicators are set out in the report
to reflect the proposed treasury management strategy. The financial
implications of the strategy are included in the County Council’s budget
agreed in February, but are also set out in this report. The most
significant movement in those figures from previous years is a
reduction in expected interest earned due to lower interest rates and
the plan to reduce cash balances.
3.
Recommendations
(1).
That the prudential indicators and limits set out in section 7 of
this report be agreed.
(2).
That the proposed Treasury Management Strategy for 2009/10
outlined in section 6 of the report be approved.
(3).
That the lending policy for 2009/10 set out in Appendix A be
approved.
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4.
Background
4.1
A report on the Prudential Indicators relating to capital financing was
presented to Cabinet on 16th February and to County Council on 24th
February. This report follows on from that to cover the indicators which
relate to treasury management and to set out the proposed treasury
management strategy, including the lending policy, for 2009/10.
4.2
The Prudential Code requires the Council to adopt the CIPFA Code of
Practice on Treasury Management. This was done on 14th February
2002 and a treasury management policy statement was agreed at the
same meeting.
4.3
The Council is also required to comply with investment guidance issued
by the then Office of the Deputy Prime Minister in March 2004. This
statutory guidance is being reviewed in the light of events in Iceland,
but no new guidance has yet been issued.
4.4
One of the requirements of the statutory guidance and the Code of
Practice is that an annual treasury management strategy be agreed by
the County Council in advance of the financial year. A report reviewing
activity in the year is also required and is presented to the June
meeting of the Audit Committee.
5.
Treasury and Economic Context
5.1
UK base rate has fallen from 5% to 1% since October 2008. This is the
lowest level in the Bank of England’s history and is a result of the
significant downturn in the economy. The downturn has affected global
markets and is expected to continue until at least 2010 and possibly
longer. The table below shows the forecast for base rate provided by
Butlers, the Council’s treasury management advisers for the next three
financial years.
Table 1: Expected base rate
Base Rate – Annual Average %
2008/09
2009/10
2010/11
2011/12
5.2
3.9
0.9
1.7
2.4
The banking crisis which started the economic downturn is on-going.
Many banks continue to have issues with bad debts and as a result
their credit ratings have fallen. The Council has removed 39
institutions from its lending list during 2008/09 reflecting the volatility in
the banking industry. This uncertainty around banking institutions is
expected to continue for the foreseeable future.
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5.3
The table below shows the treasury position at the end of 2007/08 and
what the position is estimated to be by the end of 2008/09. The
borrowing and lending have reduced during the year because although
new borrowing was taken during the year to fund the capital
programme, £67.6m of borrowing was repaid early at the end of
January.
Table 2: Treasury Position
2007/08
Actual
£000s
2008/09
Estimated
£000s
Borrowing at 31 March
377,000
340,000
Lending at 31 March
310,000
278,000
6.
Treasury Management Strategy
6.1
It is proposed that in the light of the economic context described above
the Council’s approach to treasury management in 2009/10 reflect the
increased risks that have arisen.
6.2
The Council’s cash balances result from day to day cash flows as well
as the need to ensure cash is available to cover all creditors and
reserves and from the longer term borrowing strategy for the capital
programme. However in the current environment of low lending rates
and higher borrowing rates, and a lack of secure institutions to lend to,
it is proposed to seek to reduce cash balances.
6.3
This can be achieved in two ways. Firstly, it is proposed to fund the
part of the 2009/10 capital programme which would have been funded
through borrowing by reducing cash balances. As reported to County
Council on 24 February, this amounts to £49.8m in 2009/10. Secondly,
it is proposed that the Council continue to seek opportunities to repay
borrowing early, on the advice of the treasury advisers. There are no
loans scheduled to mature during 2009/10.
6.4
It is proposed to make the lending policy more stringent. In preparing
the proposed policy set out in full in Appendix A, the recommendations
of the phase 2 Price Waterhouse Coopers (PWC) report have been
incorporated.
6.5
During 2009/10, it is proposed that only specified investments are
made. Specified investments are defined as sterling investments with
the UK government, a UK local authority or an institution with a high
credit rating. The Council is responsible for defining what a high credit
rating is. This is set out in the lending policy in Appendix A. Compared
to previous years, it is proposed that the minimum credit rating criteria
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are strengthened by raising the minimum acceptable Fitch Support
rating from 3 to 1. In addition to this, it is proposed that the Council
only lend to banks based outside the UK if the country they are based
in has a sovereign rating of AAA from all 3 of the credit rating agencies.
The policy also proposes automatically removing subsidiary banks
when the parent’s ratings fall below the minimum acceptable criteria.
6.6
Given the plans to reduce cash balances it is proposed to restrict the
period of time deposits can be placed for to 364 days. An additional
restriction of a 3 month maximum for banks based outside the UK is
also proposed. The application of group limits for banking groups
owning more than one bank is formalised in the policy. This is to
formalise current operational practice as recommended by PWC.
6.7
In the light of the reducing number of banks meeting the more stringent
criteria and the on-going issues in the banking industry, it is proposed
to remove the lending limit with the government guaranteed Debt
Management Deposit Account Facility (DMADF) to ensure there is
always somewhere to deposit the Council’s funds securely.
6.8
The proposed policy states how the Council will react to the credit
ratings of a bank falling below the minimum criteria and sets out how
officers will consider wider information than just credit ratings.
7.
Treasury Management Prudential Indicators
7.1
There are four treasury prudential indicators. The purpose of these
prudential indicators is to contain the activity of the treasury function
within certain limits, thereby reducing the risk or likelihood of an
adverse movement in interest rates or borrowing decisions impacting
negatively on the Council’s overall financial position. However if these
are set to be too restrictive they will impair the opportunities to reduce
costs.
7.2
The first indicator is the upper limit on fixed and variable rate exposure.
The table below shows the proposed indicator, which is a continuation
of current practice, that fixed lending or borrowing could be up to 100%
of the portfolios, but borrowing or lending at variable rates can only be
up to 30% of the portfolios.
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Table 3: Fixed & Variable Rate Exposure - Local Indicator
2008/09
Upper
100%
Limits on fixed
interest rates
Limits on variable
interest rates
7.3
30%
2009/10
Upper
100%
2010/11
Upper
100%
30%
30%
2011/12
Upper
100%
30%
The indicators above are local indicators i.e. they are set by the County
Council to enable effective control of treasury management, but are not
the required indicators to meet the requirements of the Prudential
Code. The indicators required by the Code are on the net borrowing
position and give misleading results. The results are provided below to
comply with the Code, and the local indicator above has been provided
as a clearer intention of the Council’s policy.
Table 4: Fixed and Variable Rate Exposure - Required Indicator
Limits on fixed interest
rates
Limits on variable
interest rates
7.4
2008/09
Upper
£433m
2009/10
Upper
£340m
2010/11
Upper
£340m
2011/12
Upper
£340m
£130m
£102m
£102m
£102m
The next indicator is the maturity structure of borrowing. These gross
limits are set to reduce the Council’s exposure to large fixed rate sums
falling due for refinancing, and are required for upper and lower limits.
The proposed limits are the same as the previous year, as they give
the Council enough flexibility to repay debt if the opportunity arises
while remaining within the parameters set by the indicators.
Table 5: Maturity Structure of fixed interest rate borrowing
Under 12
months
12 months
to 2 years
2 years to
5 years
5 years to
10 years
10 years
and above
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2008/09
Lower Upper
0%
25%
2009/10
Lower Upper
0%
25%
2010/11
Lower Upper
0%
25%
2011/12
Lower Upper
0%
25%
0%
40%
0%
40%
0%
40%
0%
40%
0%
60%
0%
60%
0%
60%
0%
60%
0%
80%
0%
80%
0%
80%
0%
80%
0%
100%
0%
100%
0%
100%
0%
100%
6
7.5
The final indicator is the total principal funds invested for greater than
364 days. As discussed in 6.6 above, it is proposed not to lend for
more than 364 days during 2009/10. However, the indicator needs to
reflect the deposits already placed, which mature more than 364 days
after 31 March 2009.
Table 6: Investments greater than 364 days
Maximum principal sums
invested > 364 days
2008/09
2009/10
2010/11
2011/12
£50m
£31m
£20m
£11m
7.6
The treasury prudential indicators will be monitored throughout the year
along with the ones relating to capital financing as part of the revenue
and capital budget monitor reports. A full statement of all the
indicators, including those agreed at County Council in February is
shown in Appendix B.
8.
Financial Implications & Sensitivity to interest rates
8.1
The financial implications of treasury management activity are included
in the Capital Financing & Interest on Balances budget which was
agreed as part of the County Council’s overall budget at County
Council on 24 February 2009.
8.2
This section highlights the financial implications of the treasury
management strategy described in section 6 above.
8.3
As described in 6.3 above, it is proposed not to do any borrowing in the
next 3 financial years to reduce cash balances. The borrowing is fixed
for long periods and therefore the interest payable does not vary.
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Table 7: Forecasts of interest payable on borrowing
Additional
borrowing
Interest already
committed as
at end of
2008/09
Estimated
interest from
new borrowing
Total estimated
interest
payable
8.4
2008/092
2009/10
2010/11
2011/12
Comparator
3
Estimate
Estimate
Estimate
N/A
£0m
£0m
£0m
£17.285m
£15.625m
£15.625m
£15.625m
N/A
£0m
£0m
£0m
£17.285m
£15.625m
£15.625m
£15.625m
The table below the interest the Council expects to earn in the coming
three financial years. It shows a large reduction in the interest
expected to be earned from 2008/09 to 2009/10. There are two
reasons for this; a reduction in cash balances and a much lower
interest rate. The cash balances have already reduced significantly
due to £67.6m of borrowing being repaid early at the end of January.
This coupled with the proposed plan to use cash balances to fund
capital reduces the expected cash balances and therefore the interest
earned. Interest rates have fallen to their lowest level in UK history and
this has also had an impact on the estimate of future interest earnings.
Table 8: Forecasts of Interest earned
Forecast
Average
Balance
Forecast
Interest
Rate
Interest
committed
Interest to
be earned
in year
Total
Interest
forecast
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2008/09
2009/10
2010/11
2011/12
Comparator
Estimate
Estimate
Estimate
£344m
£248m
£257m
£266m
4.58%
0.9%
1.7%
2.4%
£15.76m
£1.611m
£0.38m
£0.17m
0
£1.970m
£4.230m
£6.293m
£15.76m
£3.581m
£4.606m
£6.463m
8
8.5
Changes to interest rates, which are outside the control of the Council
have an impact on all treasury management activity. The table below
demonstrates the impact of a 1% rise or fall in interest rates. A 1%
increase would not affect the interest payable on borrowing as the
loans are fixed except for one which the costs increase if rates fall
outside a certain range of market rates. The impact of a change in
rates is more significant on investment income, due to the mainly short
term nature of the lending.
Table 9: Sensitivity to a 1% increase/decrease in interest rates
2009/10
estimated +1%
2009/10
estimated -1%
£0m
+ £0.117m
Investment income
+ £2.189m
- £1.970m
Total impact on treasury
+ £2.189m
- £1.853m
Interest on borrowing
9.
Performance Indicators and Reporting
9.1
The Code of Practice on treasury management requires the Council to
set performance indicators to assess the treasury function over the
year. The PWC report recommended expanding the existing limited
range of indicators to give a wider view of operational as well as
performance matters. The indicators it is planned to measure are:
Financial Performance Indicators
 Return on lending compared to the 7 day LIBID rate
 Reduction in the average rate payable on the borrowing portfolio
Operational Indicators
 Any breaches of the lending policy
 Number of transactions carried out
 Number of counterparties used
 Any process errors
It is proposed to report on these indicators on a quarterly basis as part
of the revenue budget monitoring report.
9.2
Prior to 2008/09, the treasury management strategy was reported to
Cabinet and County Council in advance of the financial year and the
review report was taken to Audit Committee, but no other reporting to
members was in place. Since October 2008 a monthly report on
lending has been taken to Cabinet. It is proposed to report on treasury
management activity and the indicators above on a quarterly basis at
the same time as the budget monitoring report.
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APPENDIX A: LENDING POLICY 2009/10
1. Policy for determining which institutions should be on the lending list
The Council will lend to the following types of institutions:
 Debt Management Account Deposit Facility
 Local Authorities defined in section 2 below
 UK Banks & UK Building Societies meeting the credit rating criteria set out
below.
 Banks domiciled in other countries providing the country has a sovereign
rating of at least AAA from each of the three credit rating agencies and
the bank meets the credit rating criteria set out below.
 AAA rated Money Market Funds
 The Council’s bank if it does not meet the credit rating criteria below. To
be used for small balances up to £1m which it is uneconomic to invest
elsewhere.
No non-specified investments will be made and therefore no non-rated
institutions will be on the lending list.
Minimum credit rating criteria for banks and building societies
Fitch
Moody’s
Standard &
Poor’s
Short term
F1
P-1
A-1
Long term
A
A2
A
Individual/Financial
Strength
C
C
N/A
Support
1
N/A
N/A
When determining whether the Council should lend to a bank or building
society, it must have at least the minimum credit rating shown above from
each of the agencies which provides a rating on it.
If an agency removes one of the set of ratings it issues for a bank or building
society, the institution will be removed from the list.
If the ratings of a parent bank fall below the minimum criteria, no lending will
be undertaken with its subsidiaries even if their ratings continue to meet the
minimum criteria.
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2. Policy for determining monetary and time limits for deposits
Time
 Deposits will be made for a maximum of 364 days.
 Deposits to institutions not based in the UK will be limited to a maximum
of 3 months.
Monetary limits
 Debt Management Account Deposit Facility – No limit
 AAA rated Money Market Funds – Group limit of £35m, limit of £20m per
fund
 UK Banks, UK Building Societies & Overseas Banks – limits as per the
table below:
Upper Limit: £30m
Fitch
Moody’s
Standard &
Poor’s
Short term
F1+
P-1
A-1
Long term
AA-
Aa3
AA-
Individual/Financial
Strength
B
B
N/A
Support
1
N/A
N/A
Fitch
Moody’s
Standard &
Poor’s
Short term
F1
P-1
A-1
Long term
A
A2
A
Individual/Financial
Strength
C
C
N/A
Support
1
N/A
N/A
Lower Limit: £20m
Banking Group Limit
Where a number of banks are owned by a single institution, a group limit will
be applied as follows:
 The total which can be lent to any group of banks is £35m.
The limit for each bank within the group will apply according to the credit
rating table above.
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
Local Authorities – Group limit of £35m; individual authority limits
according to size of authority:
Monetary Limit
Time Limit
County Councils
£5m
3 months
Metropolitan District Councils
£2m
1 month
Scottish Unitary Councils
£2m
1 month
English Unitary Councils
£1m
1 month
English District (non
Metropolitan) Councils
£1m
1 month
London Councils
£1m
1 month
Welsh Unitary Authorities
£1m
1 month
Northern Ireland Authorities
£1m
1 month
3. Policy to be followed when credit ratings change
Negative Watch
 If an institution is on a £20m limit when it is put on negative rating watch, it
will be removed from the list.
 If an institution is on a £30m limit when it is put on negative rating watch,
the limit will be reduced to £20m.
Downgrading
 If an institution is downgraded below the minimum credit rating criteria,
then it will be removed from the list with immediate effect. If the
downgrade reduces the limit per this policy, this will be done with
immediate effect.
 If funds are on call with an institution when a downgrade happens, they
will be withdrawn or the balance reduced as appropriate, at the earliest
possible opportunity, which may be the following working day.
 If there are outstanding fixed term deposits with an institution which has
been removed from the list, terms for repayment will be sought and, if
offered, fully considered and documented by officers in their weekly
meeting (see section 4 below).
 Downgradings and the action taken will be reported in the quarterly
reports to members discussed in section 9 of the report above.
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4. Other matters to be considered by officers
In applying the policy set out above, officers should refer to the following
sources of market information on a regular basis:
 Credit Default Swap Rates
 Outlook reports from credit agencies
 Financial Times and other news sources
A meeting of all officers involved in the dealing function plus either the
Director of Performance & Resources or one of Finance Assistant Directors,
will be held on a weekly basis to review all relevant information and take
decisions within the policy about how to react to it. By its very nature the
information will not be definitive and therefore although officers will do all they
can to react to these sources of information with the primary objective of
security in mind, it will not be possible to pick up on everything. The
frequency of these meetings will be kept under review and the Director of
Performance & Resources will alter this if appropriate.
On a daily basis, officers receive quotes for fixed term deposits over a range
of periods from a minimum of 3 brokers to consider when making decisions.
The minimum deposit size to be used when placing funds for fixed terms is
£1m, as this is the minimum amount to make an investment worthwhile at
current interest rates taking into consideration transaction costs. The
maximum amount is £10m in order to spread risk. The only exceptions to this
are deposits with the DMADF and movements in and out of call accounts.
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APPENDIX B: PRUDENTIAL INDICATORS SUMMARY
1. Capital Financing Indicators (in February report)
1.
2.
3.
4.
5.
6.
7.
Capital Expenditure
Capital Financing
Requirement (CFR)
Treasury Position
Borrowing
Investments
Net Borrowing
Net Borrowing Less than
CFR
Authorised Limit (against
maximum position)
Operational Boundary
Ratio of financing costs
to net revenue stream
2009/10
2010/11
2011/12
£158.794m
£139.211m
£67.035m
£535.417m
£539.493m
£542.913m
£340m
£248m
£340m
£257m
£340m
£266m



£362m
£377m
£372m
£345m
£345m
£345m
1.72%
1.43%
1.01%
2. Treasury Management Indicators (in this report)
8.
9a.
9b.
10.
11.
Upper limited on fixed
interest rates (against
maximum position)
Upper limits on variable
interest rates (against
maximum position)
Limits on Fixed Interest
Rates
Limits on Variable
Interest Rates
Maturity structure of
fixed rate borrowing
(against maximum
position)
Under 12 months
12 months to 2 years
2 years to 5 years
5 years to 10 years
10 years and above
Investments greater
than 364 days
(Maximum Limit)
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2009/10
2010/11
2011/12
100%
100%
100%
30%
30%
30%
£340m
£340m
£340m
£102m
£102m
£102m
25%
40%
60%
80%
100%
25%
40%
60%
80%
100%
25%
40%
60%
80%
100%
£31m
£20m
£11m
14