Borrowing to support the capital programme and/or deferral of police property disposal

Report: 08
Date: 19 March 2009
By: Treasurer

Summary

This report outlines opportunities to consider additional financing for the capital programme and/or deferral of the disposal of police property.

A. Recommendations

That

1. members consider whether further borrowing over the next three financial years should support additional capital infrastructure and/or deferral of police property disposal; and
2. members consider the amount of any such additional borrowing.

B. Supporting information

Introduction

1. From 1 April 2004 the Authority is required by regulation to have regard to the Prudential Code when carrying out its duties in setting the revenue budget. In agreeing the capital programme members will be aware that under the Prudential Code the level of capital investment is determined locally, subject to formal approval of external borrowing limits by the Mayor.

2. In proposing the overall funding package of the capital programme in November, the MPS recognised the need to reduce its capital demands to reflect the changing funding environment and the reduced resources available to support previously agreed priorities. In reviewing the programme, many projects and programmes have been delayed or delivered over more years than originally anticipated. The overall funding package that was agreed by the Authority aimed to minimise as far as possible the operational and contractual impact of slowing down the programme over the next two years. Excluding Olympics and Counter Terrorism activity, a comparison between the new and previous capital programme is as follows:

3. The Chairman of the Finance and Resources Committee has called for a paper on the opportunities for additional borrowing to see whether there would be further scope within the terms of the Prudential regime to undertake any new capital investment and/or defer the sale of police property to avoid disposing of assets at this stage of the property cycle and for sales to provide effective value for money. The member led Estates Panel (Graham Speed and Dee Doocey) has also had discussion on the possibility of utilising additional borrowing to bring forward capital schemes.

Prudential code

4. As part of the revenue setting process the Authority must ensure that its capital programme is prudent, affordable and sustainable over the long term.

5. The fundamental objective in the consideration of the affordability of the capital programme is to ensure that the total capital investment of the MPA/MPS remains within sustainable limits, and in particular to consider the revenue impact on the “bottom line”. That is, affordability is determined by a judgement about the acceptable impact on the level of the Authority’s net expenditure (ultimately determining the MPA precept), or, if additional investment is now being considered, a view on the alternative savings that would have to be made to finance the capital financing charges (Minimum Revenue Provision, interest and any other net running costs arising from the capital investment) within the existing financial envelope.

6. In order to ensure the MPA is operating its capital programme prudently, it is a requirement of the Code that over the medium term, net borrowing will only be for a capital purpose. That is, the MPA should ensure that net external borrowing does not, except in the short term, exceed the capital financing requirement (CFR). Because of the MPA’s historically low levels of external debt, the calculated CFR is more than double the anticipated Prudential Limit for external borrowing. The requirement is therefore presently satisfied.

7. Any intended borrowing would need to be contained within the borrowing limits approved by the Mayor. The Authority would normally borrow from the Public Works Loan Board (a statutory organisation operating as an Executive body of HM Treasury and lending to local authorities and other prescribed bodies), or from the market, or its own internal funds. Such a decision depends on the level of cash balances available internally and the balance of financial benefit between the external costs of borrowing and the loss of interest on deposits.

Capital programme

8. The Authority will be asked at its meeting on 26 March 2009 to approve a base programme of £178.728M in 2009-10 with an assumed level of available funding of £178.728M. This means that there is no spare capacity to finance capital spend on further bids that would not require an increase in net expenditure or additional savings/budget reductions to finance the revenue costs of the additional investment.

9. The table below summarises the current implications of the proposed base 2009-10 capital programme of £178.7M and spending plans against likely funding sources, including the present borrowing requirement of £50M in 2009-10:

Capital 7 year programme 2009-10 to 2015-16 - funding sources

10. The key funding sources for the capital expenditure in the table above are therefore:

• Borrowing £50M – comprising supported borrowing (the revenue costs of which are supported by government grant) - £19M and unsupported borrowing through the Prudential Code - £31M
• New Capital receipts - £20M
• Capital Reserves - £37M
• MPS Management Board Investment Fund - £10.4M
• Other revenue contributions/Partnership Funds, etc - £22.9M
• Police Grant from government - £38.4M

11. Borrowing. The proposed programme assumed an increase in borrowing from £40M in 2008-09 to £50M in 2009-10 and £40M a year thereafter.

12. The level of capital receipts is vital in determining the size of the capital programme and represents a significant, though sharply declining, element of funding. The proposed receipts for 2009/10 are estimated at £20M. Receipts are crucial, as failure to materialise will result in the MPA having to find alternative sources of finance. As members will be aware, the downturn in the property market is seriously affecting the level of capital receipts that will be available to finance expenditure. From a budget estimate of £84M only £20M receipts are now expected in 2008/09, and indeed the forecast has been reduced to £20M in 2009-10 and 2010-11 and to £40M a year thereafter.

13. Capital reserves. These reserves have been built up over a number of years and it was agreed in order to manage the capital programme that capital reserves be reduced over the next two years. These are a one off application of capital reserves, they cannot be used again.

14. The forecast revenue underspend of £22M this year is to be transferred to balance sheet reserves and £13M utilised in 2009-10 and £9M in 2010-11.

Additional capital borrowing

15. The MPA could, if members support the proposal, increase the current level of borrowing to finance additional capital expenditure and/or delay property disposal under the Prudential Code rules. This can be done through increasing unsupported borrowing. Any additional borrowing would involve additional revenue costs. These costs comprise (i) the annual charge to the revenue account which effectively makes annual provision for the repayment of the loan – the Minimum Revenue Provision (ii) annual interest payments on the loan (these can vary with the type of loan taken out – including equal instalments of principal, annuity or maturity) and (iii) there may be some residual effect from interest earned on cash balances if the loan is received before the additional capital expenditure is actually spent.

16. There is a distinction between borrowing to replace the existing capital receipts assumptions and borrowing to provide additional spending capacity. Substituting capital receipts with borrowing will give no increased spending ability, but if members support deferral of property disposals, when the market recovers any capital receipts then generated can either be used to supplement future years’ capital programmes or reduce the unsupported borrowing requirement. Borrowing to provide additional spending capacity would allow either new schemes to be added to the programme, or to bring forward existing schemes. The new borrowing will attract both the annual cost of capital (MRP and interest) together with the net running cost arising from the investment.

17. The Service comments that in terms of the organisation’s capacity to accelerate capital expenditure, there are a number of opportunities that exist for acquisition and lower priority programmes where work has already begun that is currently outside the agreed programme. In terms of the agreed programme, over-programming will be required to ensure that the agreed level of investment is undertaken in 2009/10 therefore increasing the 2009/10 programme would be challenging. At this stage full consideration has not been given to the option of accelerating the programme due to time constraints. However, this issue will continue to be considered by the Service.

Options

18. The differing advantage between types of borrowing and length of the loan are complex. However, accounting rules require that revenue provision (MRP) is chargeable to the revenue account independently of the loan period of the external borrowing actually taken out. This MRP charge is based on the estimated life of the asset (similar to depreciation) plus interest. If an asset is purchased from capital receipts, there would be no MRP charge to the Revenue Account, however if an asset is purchased through borrowing, irrespective of the loan period, MRP would be charged for the life of the asst, or as and when the asset is sold.

19. As an example, the option below models the additional capital financing costs (repayment of annual charges for principal and interest), that would be borne by the revenue budget if the Authority borrowed a total of £60M over three financial years – £30M in 2009-10, £20M in 2010-11 and £10M in 2011-12 to cover the possibility of a combination of additional capital investment and/or avoid disposing of property assets in the present market. Using a 20 year average asset life (reflecting a mix of new property investment and IT capital infrastructure) this option would result in the additional revenue costs shown below, which would add an extra £5.2M by 2012-13. A further option is also shown at the bottom of the table below - showing a 40 year repayment period (which would reflect a higher proportion of property assets compared to shorter life IT assets.) This produces lower annual costs, rising to £4.2M in 2012-13.

1. Interest rate of 3.68% for a 20 year loan
2. Interest rate of 4.31% for a 40 year loan
3. The loan is taken out mid year, therefore the first year of the loan includes interest for six months, with MRP payable the following first full financial year.
4. Assumed the additional interest from investments/cash balances (para 15 above) is minimal

Using a rule of thumb, for a £1 million investment, using a 20 year average asset life for MRP purposes and a 20 year PWLB maturity loan, the additional first full year revenue cost is £87,000. It would be possible to borrow short term to cover deferral of receipts for a few (three to five) years only. However, as mentioned in paragraph 17 above the burden of a short loan repayment period is not directly linked to the Revenue Account. The MRP and interest charge to the revenue account for a £1M investment with a 20 year asset life would still be £87,000. The Prudential controls around the maturity structure of external debt would have to be adhered to, to avoid a need for large refinancing of debt in a particular future year, by ensuring a spread of maturity dates.

Savings/budget reductions

20. Extra revenue costs would place an additional burden on the revenue account with a need to find additional savings/budget reductions (in the example above starting at £0.6M, but rising to a full year cost of £5.2M in 2012-13.) This should be seen in the context of (a) the need to maintain a balanced budget in 2009/10, and (b) adding to the existing requirement for savings yet to be identified in the budget to find further savings of £67.6m in 2010/11 and £141.8m in 2011/12.

21. To maintain a balanced budget next financial year it would be necessary to find additional savings/budget reductions immediately (or commit to finding them) in 2009-10, but the sum of £0.6M must surely be viewed as achievable on a gross revenue budget of £3.6bn. In the following two financial years we would need to add the additional savings requirement to the £67.6M in 2010-11 and the £141.8M in 2011-12 which we are already committed to achieve. In the example used above this would add £3M and £4.5M to the existing requirement plus any increased running costs. However, there is the possibility that if the additional borrowing were to finance new, more modern building works, there could be cashable savings on running costs, repairs etc, to offset some of these costs.

22. The Service comments that the additional revenue costs of keeping properties that have been earmarked for disposal includes two options:

1. Keep the properties and mothball the facilities.
2. Keep the properties and continue to occupy and use the facilities.

In terms of costings in 2009/10, the costs for the two options would be as follows:

1. Revenue costs (e.g. rates, security etc) £1.97m. plus minor costs of £17,000 – disconnection of facilities, boarding up of buildings etc.
2. Revenue costs as option 1 plus utility costs of £436,000, maintenance costs for Health and Safety requirements of £970,000, plus longer term maintenance costs over the next 5 years and beyond on £2.29 m.

Efficiencies resulting from further investment

23. The work undertaken by the member led Estates Panel will inform views on whether any additional capital financing costs from further investment are likely to be, in part, offset in the medium term by reduced running costs from more modern premises when inefficient buildings are eventually replaced. In considering an option for additional borrowing the Authority would need to be mindful that it would also be incurring costs for the maintenance and upkeep of properties, declared surplus in terms of operational need, pending any future sale.

Formal approval of amended borrowing limits

24. External borrowing limits have still to be approved by the Mayor for the current capital spending round, but those submitted are considered likely to have enough headroom to accommodate additional borrowing of £30M in 2009/10 without further recourse to the Mayor. However, this would need careful monitoring during the year. Any in year amendment to external borrowing limits will need the Mayor’s approval.

Capital project prioritisation

25. If members are supportive of increasing the amount of the borrowing for new investment and/or deferral of property disposal then members will need to consider, in conjunction with the MPS, the prioritisation of the capital programme for the new works.

Property disposal

26. If members are minded to consider deferral of some property disposals, then it will be necessary to receive regular updates from MPS Property Services Department to indicate when the property market is recovering and when marketing should recommence.

Conclusion

27. The Authority would be able to increase the funding of the capital programme/defer sale of police property by approving additional unsupported borrowing. Key tests which need to be passed are that the borrowing is affordable (both next year and over the medium term) and that borrowing is used over the medium term for expenditure of a capital nature. A clear decision to find additional savings/budget reductions for both next year and the following two years will be necessary to support the affordability test.

C. Race and equality impact

None specific to this report.

D. Financial implications

Contained in the report above

E. Background papers

• Budget Submission 2009-10

F. Contact details

Report author(s): Ken Hunt, MPA

For more information contact:

MPA general: 020 7202 0202
Media enquiries: 020 7202 0217/18

Send an e-mail linking to this page

Feedback