Treasury Management half year review 2011/12 (Including 2nd quarter update)

Report: 4
Date: 1 December 2011
By: Treasurer

Summary

This report provides members with a review of Treasury Management activity for the period 1 April 2011 to 30 September 2011 and seeks approval for amendment to a prudential code borrowing indicator.

A. Recommendations

That members

1. Note the half year review of the Treasury Management function and the 2nd Quarter update;
2. Note the statement of assurance from the Treasurer and Director of Finance;
3. Approve an increase to the prudential code limit on variable rate borrowing from 30% to 50%, as set out in paragraph 30 of this report.

B. Supporting information

1. To satisfy the requirements of the Chartered Institute for Public Finance and Accountancy (CIPFA) guidelines for the monitoring of treasury management operations this half year report reviews treasury management and performance for the period 1 April 2011 to 30 September 2011.

2. The Resources and Productivity Sub Committee meeting of 12 September 2011 reviewed 1st quarter treasury management operations. This half year report now provides a review of the 1st and 2nd quarters combined but also gives Members a separate summary overview of 2nd quarter activity.

3. Activity throughout the period has been undertaken in line with the 2011/12 Treasury Management Strategy Statement, approved by Finance and Resources Committee on 14 March 2011. Members are reminded that the 2011/12 approved counterparty list for investments is the list recommended by MPA treasury advisors Arlingclose.

4. Following a series of downgrades to the credit ratings of financial institutions a number of counterparties, including the MPA banker Royal Bank of Scotland (RBS), were suspended from the lending list in October 2011. A report to Finance and Resources Committee of 20 October 2011 provided an update on the banking sector. Members noted amendments to the lending list and approved the continued use of RBS for temporary overnight balances.

5. Members are also provided with a statement of assurance by the Treasurer and Director of Finance about 2nd quarter treasury management activities. This is attached at Appendix 4.

2nd Quarter 2011/12 summary overview

6. The following is a summary of 2nd quarter treasury management activity:

• Average cash balances invested £182.0m
• Debt Management Office (DMO) portfolio balance was less than 1%. Call money balance 38%, held with RBS and Lloyds Banking Group (HBOS)
• Notional limit of £30.0m with RBS exceeded once by £24.0m for one night, due to late in the day receipt of funds. The excess funds were on lent the following day
• There were 81 investments with four UK banks, seven foreign banks, one building society and the DMO
• Investment income of £0.3m at a return of 0.67%
• Cash flow, borrowing requirements and the funding of the capital programme were kept under constant review. No new borrowing was undertaken during the period.
• One part maturing EIP loan of £0.25m was repaid

Half-Year Review 2011/12

7. The following is a review of treasury management activity for the period 1 April to 30 September 2011 combining the 1st quarter review previously presented to the Resources and Productivity Sub Committee with the 2nd quarter activity summarised at paragraph 6 above.

Average Investment Balances

8. The average size of the investment portfolio during the first six months of 2011/12 was £167.0m. These cash balances available for investment include balance sheet reserves and provisions, unapplied capital receipts and grant and cash arising from the timing of large receipts and payments.

9. The structure of the portfolio continues to reflect the investment instruments selected for investment purposes as defined by the 2011/12 Treasury Management Strategy. Appendix 1 provides an analysis of average investment balances for each counter-party sector. Funds in the two call accounts represent 39% of the portfolio. These call account funds in addition to the 24% invested with other UK banks, 5% with the Nationwide Building Society and 1% with the DMO means that 69% of the portfolio is invested within the UK. Non UK Banks represent the balance of 31%. This period has highlighted the opportunities to invest with a wider selection of banks as determined in the 2011/12 Treasury Management Strategy and in particular reducing the need to place funds with the DMO. However credit rating downgrades in September and October 2011, leading to the suspension of many institutions from the MPA lending list, will restrict investment opportunities in the second half of the year.

10. There were 147 deposits made during the first six months of 2011/12 (this does not include call money activity). Overall these deposits were made with five UK banks, seven foreign banks, Nationwide building society, the DMO and one local authority, a total of fifteen institutions. The average size of investments was £14.2m and the average term 7 days. A one year deposit with Lloyds Banking Group matured on 8 July 2011. All other investments during the period were very short term at less than one month.

Income on Investments

11. Income on the investment portfolio for the first six months of 2011/12 was £0.6m at a return of 0.71%. Appendix 1 shows the rate of return and the income received by market sector. The call money account return is 1% and continues to show the most attractive return while also providing liquidity. The DMO is still the lowest rate of return at 0.25% for the period, but as described in paragraph 8 above, only 1% of the portfolio was placed with this sector.

12. The interest received of £0.6m is against an annual budget of £0.8m. Due to the anticipated low rate of future interest rates, lower cash balances and a restricted lending list due to suspensions from the counterparty list the estimated outturn for 2011/12 is currently maintained to budget of £0.80m.

Borrowing

13. In line with Treasury Management Policy the MPA Treasurer takes the decision on external borrowing ensuring compliance with the CIPFA Treasury Management Code of Practice. The Treasurer gives the approval for borrowing having reviewed the options available with MPA staff, MPS finance staff and treasury advisors Arlingclose. Full consideration is given to short term cash flow requirements and the ability of the MPA to meet its liabilities and the long term position of borrowing to support the capital programme.

14. No additional long term external borrowing was undertaken during the period, however two short term external loans were negotiated to smooth cash flow at month end.

15. Following the repayment of Equal Instalment of Principal (EIP) loan instalments of £0.8m the outstanding external debt portfolio balance at 30 September 2011 was £209.5m. All of this debt is with the PWLB of which £149.5m is fixed rate and £60.0m variable rate.

16. Expenditure on the debt portfolio during the first six months was £3.9m. A summary of the period’s expenditure on the debt against the 2011/12 budget of £14.3m is provided at Appendix 2. The estimated outturn for 2011/12 based on the current level of external debt (£209.5m) and the estimated interest on further borrowing to support the 2011/12 capital programme and support cash flow requirements is £10.8m.

17. The 2011/12 borrowing strategy included provision to borrow £108.0m (specifically £68.0m borrowing to support the 2011/12 capital programme plus carry forward from 2010/11). Within these limits it is recognised that the cash flow requirement will be a significant factor in determining the size, timing and type of new external borrowing, including the term of such borrowing. Cash flow scheduling predicted the pressure on cash balances towards the end of October 2011 and on this occasion temporary short term borrowing was undertaken to cover month end requirements prior to the receipt of grant income in early November.

18. This pressure on cash balances continues, in part due to the policing response to the August 2011 public disorder within London. Although these Operation Kirkin and Withern costs (estimated at £80m) are expected to be reimbursed by special grant, the timing of these remains uncertain. A further significant cash flow pressure will arise from the Riot (Damages) Act (RDA) with claims in excess of £250m received. Although the Home Secretary has confirmed that the Home Office will meet the costs of uninsured claims (about £16m) negotiations continue with regard to insured and under-insured claims. While the arrangements for the receipt of funding from the Home Office are yet to be determined the processing and settlement of claims has an immediate effect on cash flow with predictions that further borrowing will be required.

19. Mindful of the revenue implications arising from additional borrowing alternative options for the type of external borrowing must be considered. Borrowing short term from the market until the cash position is restored or the further use of variable rate loans from the PWLB avoids the commitment implicit in long term fixed rate loans. However the variable rate option needs to be seen in the context of the appropriate prudential code indicator and this is addressed at paragraph 30 below. All of the options around cash flow and borrowing will continue to be closely monitored by the MPS treasury team, the Treasurer, MPA staff and Arlingclose.

Interest rate movement and investment performance for 2011/12

20. The Bank of England maintained base rate at 0.5%, although in October 2011 they did add a further £75.0bn to the Asset Purchase Facility (Quantitative Easing) taking the total to £275.0bn. Further economic uncertainty across Europe resulted in analysts postponing the likelihood of an increase in UK base rate until at least mid 2012. Gilt yields fell to their lowest levels in five years, with PWLB borrowing rates similarly falling (although the PWLB maintains the +0.90% margin above the equivalent gilt yield for new borrowing).

21. Investment performance is monitored against British Bankers Association (BBA) LIBID rate, which is the rate at which banks are willing to pay for borrowing from other banks. The MPA return of 0.71% compares with BBA LIBID (1 week) of 0.43% and BBA LIBID (1 month) of 0.52%. The higher MPA return is attributable to the return received on the call accounts.

Risk assessment and compliance

22. All investment and borrowing activity has been undertaken within the guidelines and objectives set out in current treasury management policy and strategy. Liquidity has been maintained to ensure that obligations have been discharged. All investments were compliant with the requirements of the strategy and achieved a rate of return consistent with the opportunities available.

23. Using information supplied by rating agencies, Reuters and financial updates from Arlingclose the lending list is monitored to ensure all institutions met the required minimum credit quality criteria. Furthermore, the institutions on the 2011/12 lending list, as set out in the strategy, are those institutions recommended as suitable by Arlingclose.

24. The lack of progress in resolving the sovereign debt crisis in Europe began to affect even the stronger Eurozone nations and their banking systems. Having reviewed all credit indicators the MPA, advised by Arlingclose, believed that although there were no solvency issues with the banks on the recommended lending list a prudent response to the tensions and negativity in the markets was required.

25. This led to the initial suspension in August and September 2011 of French banks in response to concerns over funding and their sovereign exposure to peripheral European nations. This was followed by the downgrade to UK institutions with Clydesdale Bank, RBS, Nationwide Building Society and Lloyds Banking Group all suspended from the lending list because they now failed to meet the MPA’s minimum credit rating criteria as set out in the 2011/12 Treasury Management Strategy. A fuller update on the banking sector and details of these suspensions were provided in the report to Finance and Resources Committee on 20 October 2011.

26. The suspension from the lending list of RBS and Lloyds Banking Group, both providing call accounts, has had implications on maintaining liquidity. This has been addressed by placing sufficient funds overnight but also to negotiate the opening of a call account facility with Santander UK, an institution which currently does meet the MPA minimum credit rating criteria.

27. Furthermore the treasury management strategy has provision for the use of Money Market Funds and three such funds, from a list recommended by Arlingclose, are being considered. These funds provide instant access to funds thereby providing liquidity and are higher yielding than the DMO.

28. Based on current cashflow projections and, given the uncertainty regarding the timing and scale of Government funding for RDA and Operation Withern costs, there is a risk that the Authority’s prudential indicator for external debt will be exceeded before the end of 2011/12. The Service will keep the position under review and work with the MOPC and the GLA to ensure action is taken on amending the prudential code indicators for external debt in as timely a manner as appropriate.

Treasury management Prudential Code indicators

29. Prudential Code indicators specific to treasury management are designed to ensure that treasury management is carried out in accordance with good professional practice. Indicators for 2011/12 and the following two years were presented as part of the 2011/12 treasury management strategy. The indicators for borrowing are presented at Appendix 3, including the maturity profile of the debt portfolio at 30 September 2011.

30. The prudential code indicators that refer to gross outstanding borrowing set out the upper and lower limits for fixed rate and for variable rate borrowing. The existing portfolio of £209.5m includes £60m (that is 29%) at variable rate, and is within the prudential code limit of 30%. In order to provide sufficient flexibility to allow consideration of further variable rate borrowing, as discussed at paragraph 19 above, the upper limit for variable rate borrowing has to be increased. This proposed change, which will give access to funds that are currently cheaper than longer term fixed rate loans, has been discussed with the Treasurer and Arlingclose. It is therefore recommended that members approve an increase to the upper limit on variable rate exposure for borrowing from 30% to 50%.

Landsbanki update

31. On 28 October, the Supreme Court of Iceland upheld the earlier District Court judgment that local authorities’ claims are deposits that qualify in full for priority in the bank administrations. Securing priority status means that deposits in Landsbanki are estimated to recover 98%. These decisions are now final and there is no further right of appeal. Now that the Courts have determined that local authorities’ deposits qualify for priority, it is expected the Winding Up Boards will apply the Supreme Court decisions to the non-test claims, which includes the MPA. Cash held and available for distribution to priority creditors currently comprises around one-third of the total assets; other assts held by the Winding Up Board are not readily convertible into cash and it will take a number of years for them to be realised; and around 5% of the available cash is held in Icelandic Kronur. Continuing involvement by the Local Government Association (LGA) and their legal team with the Landsbanki insolvency process will therefore be essential in order to maximise the total value of recoveries and ensure that sterling proceeds are made available as quickly as possible.

C. Other organisational and community implications

Equality and Diversity Impact

1. Consideration is given to the requirements of equality legislation through the Ethical Investment Policy whereby best practice standards are promoted.
The MPS Ethical Investment Policy was considered and approved by Resources Sub Committee on 16 March 2009.

Consideration of MET Forward

2. The Treasury Management Strategy 2011/12 defines MPA treasury management activities as ‘the management of the organisation’s investments and 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. The achievement of optimum performance from treasury management activities, by maximising yield from cash balances invested and minimising the cost of borrowing while effectively controlling associated risk, supports the objective of achieving better value for money.

Financial Implications

4. The financial implications have been discussed in the report. The 2011/12 estimated outturn for interest on investments is to budget at £0.8m. The 2011/12 estimated outturn for expenditure on the current debt portfolio of £209.5m and the estimated interest cost on additional borrowing to support the capital programme and cash flow requirements is £10.8m. This includes any additional borrowing during 2011/12 discussed above.

Legal Implications

5. This is a financial monitoring report which is submitted as part of the governance process.

6. The Treasurer’s responsibilities are set out in the Financial Regulations under Part E of the MPA standing orders. In accordance with those standing orders, the Treasurer is responsible for advising the Authority on all matters relating to treasury management, investments and borrowing, and for ensuring that treasury management arrangements are in compliance with the CIPFA Code of Practice for Treasury Management in Local Authorities. This report fulfils this requirement.

7. The Resources and Productivity sub-committee has authority in accordance with its terms of reference to receive and review the MPS Treasury Management report on a quarterly basis. The report will also be referred to the Finance & Resources Committee for final approval as the recommendations have significant financial implications.

Environmental Implications

8. There are no direct environmental impacts arising from the treasury management activity discussed in this report. However the MPA ethical investment policy seeks to avoid the investment of funds in organisations whose core activity contributes to significant negative environmental impacts the MPA will not invest funds in any organisation involved in animal testing, the fur trade and blood sports.

9. It should be noted that the MPS Corporate Social Responsibility (CSR) Strategy is currently awaiting review by the MPA. This Strategy takes into account a broader scope of issues than the current MPS Environmental Strategy, extending also to social/ethical and economic issues. Consequently, the "Environmental Implications" section will, in due course, be replaced by a section that addresses these broader issues.

10. With this in mind, there are no corporate social responsibility issues directly arising from this report. The consideration of environmental, social/ethical and economic issues arising from MPS investment is appropriately directed by the MPA ethical investment policy.

Risk Implications

11. The risks associated with treasury management activity are addressed by the CIPFA Code of Practice and set out in Treasury Management Practices. Furthermore the Treasury Management Strategy 2011/12 sets objectives to identify, monitor and control risk. Specifically the objectives and the associated areas of risk covered are:

• To undertake treasury management operations with regard for the security of capital invested (Credit and Counterparty Risk)
• To ensure that sufficient cash is available such that the MPA is able to discharge its financial obligations in accordance with approved spending plans (Liquidity Risk)
• To minimise the cost of borrowing and to maximise the yield from investments consistent with the security and liquidity objectives identified above (Market or Interest Rate Risk)
• To minimise the amount of borrowing to be replaced at any one time by maintaining an evenly spread maturity profile (Refinancing Risk)
• To undertake treasury management activity with regard to Prudential Code Indicators (All areas of Risk)

Roles and responsibilities for treasury management are clearly established and set out in the Treasury Management Policy Statement 2011/12 and includes regular review, reporting and scrutiny of treasury management activity.

D. Background papers

• Banking and RBS Update: Finance and Resources Committee 20 October 2011

E. Contact details

Report authors: Paul Daly, Director of Exchequer Services, MPS

For more information contact:

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

Appendix 4

Treasury Management 2nd Quarter 2011/12

Certificate of Assurance

We confirm that the Treasury management report for the first quarter of 2011/12 is an accurate record of the treasury management activity of the Metropolitan Police Authority for the period ended 30 June 2011 and that all activity has been undertaken in accordance with the agreed policies and strategy.

Bob Atkins, Treasurer, MPA

Nick Rogers, Director of Finance, MPS

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