Treasury management financial review 2004/05

Report: 08
Date: 23 June 2005
By: Commissioner and Treasurer

Summary

This report presents the Annual Review of Treasury Management for the 12-month period ended 31 March 2005.

A. Recommendation

That members note the Annual Review of the Treasury Management function

B. Supporting information

Background information

1. The MPA operates in accordance with the Chartered Institute of Public Finance and Accountancy’s (CIPFA’s) Code of Practice on Treasury Management which requires that the Authority receives an annual report on treasury management after the year’s close.

2. Additionally, under Part 1 of the Local Government Act 2003, the Authority is required to have regard to the Prudential Code for Capital Finance including the setting of Prudential Indicators. Relevant treasury management indicators were incorporated into the Treasury Management Strategy 2004-05 approved by this Committee on 19 February 2004.

3. This report sets out:

• A review of investment operations during 2004/05
• A summary of interest rate movement and investment performance for 2004/05
• A review of risk and compliance issues
• A review of debt management operations
• A review of the treasury management Prudential Code indicators

Investment operations during 2004/05

4. The average size of the investment portfolio during 2004/05 was £349million. The 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.

5. The structure of the portfolio continues to reflect the investment instruments selected for investment purposes as defined by the Treasury Management strategy. Table 1 provides an analysis of average investment balances for each counter-party sector.

Table 1 – Portfolio average sector size 2004-05

6. The non UK banks share of the portfolio had been increasing reflecting the larger number of opportunities with these banks. To create a more evenly balanced portfolio the Treasurer agreed in November 2004 to increase the counterparty limit with UK banks to £40 million. This move has increased the 2004-05 share of the portfolio with UK banks (excluding call accounts) to 22.7% (compared with a 14.6% share during the first six months only). Opportunities with Building Societies are limited by the number of counter-parties within both the specified sector (with credit ratings) and the unspecified sector (no credit ratings).

7. A total of 431 investment transactions were undertaken (not including call money, see paragraph 8 below). The average size of investments was £8.8 million and average term 31 days.

8. The call money sector represents instant access funds held with Halifax Bank of Scotland (HBOS) and Royal Bank of Scotland (RBS). The average return in excess of base rate on these accounts has been attractive so high balances have been maintained and the liquidity used to cover short-term cash flow requirements.

9. Although available as approved investments since November 2002, Money Market Funds remain uncompetitive and have not been used. Similar liquidity with a higher yield is achieved from the call accounts.

Interest rate movement and investment performance for 2004/05

10. Following nine successive reductions to base rate by the Monetary Policy Committee this trend was reversed in November 2003. This was the turning point of the interest rate cycle with four subsequent upward moves during 2004 increasing base rate to 4.75%. During this period money market and base rate diverged as the market priced in a further increase. However, 4.75% now appears to be the plateau of the current cycle and since March 2005 there has been a negative yield curve out to 364 days.

11. Accrued interest received on investments during 2004-05 was £15.7 million against budget of £11.1 million. On 21 October 2004 this Committee was advised of additional income resulting from a strengthening of balance sheet reserves and provisions in 2003/04, the timing of large receipts and payments and opportunities to enhance yield as interest rates increased.

12. Performance is monitored against the British Bankers Association (BBA) LIBOR rate. The MPA return of 4.52% compares with BBA LIBOR (1 week) of 4.64% and BBA LIBOR (1 month) of 4.71%. The LIBOR returns reflect the upward yield curve so are expected to be higher than the return on fixed term, fixed rate investments.

Risk assessment and compliance with agreed limits

13. The Treasury Management Policy restricts lending to institutions with a high credit rating or, as set out in the 2004-05 strategy and in line with the Office of the Deputy Prime Minister (ODPM) guidance, to building societies that are not credit rated but are in the top 20 in terms of asset size.

14. The MPA uses Fitch Ratings to assess counterparty risk and the minimum selected standards include ‘short term’ of F1, indicating the strongest capacity for timely payment of financial commitments and ‘long term’ of A+ indicating a low expectation of credit risk.

15. Institutions meeting the credit rating criteria have an individual lending limit determined by the financial size of the institution. The highest limit is £40 million and applies to all UK banks on the lending list (Section 6 explained this limit has been applied since November 2004). The highest limit for other banks is £30 million and the limits for building societies range from £30 million for the largest society to £2 million for the smallest.

16. All transactions undertaken in 2004/05 were conducted within the criteria described above. Constant monitoring of the lending list against Fitch Ratings information ensured that all specified institutions met the prescribed credit ratings.

Debt management operations

17. In line with the 2004/05 Treasury Management Strategy no borrowing took place during the year. Maturing loans totalling £18.6 million were repaid reducing the balance of debt at 31 March 2005 to £85.84 million (of which £12.37 million is held on behalf of the former Inner London Magistrates Courts Service and the former Inner London Probation Service).

18. The average size of the portfolio during 2004/05 was £103.13 million with an average rate of interest paid on the portfolio of 6.26%. All debt is held in fixed rate maturity loans with the Public Works Loans Board (PWLB).

Treasury management Prudential Code indicators

19. 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 2004-05, 2005-06 and 2006-07 were presented as part of the 2004-05 treasury management strategy.

20. The 2004/05 indicators and actual figures for the year are set out at Appendix 1. The upper limit on fixed interest rate exposure for gross outstanding investment was raised to 95% after the original limit of 90% was exceeded due to the use of call account balances to meet short term cashflow requirements. Otherwise all activity has been maintained within indicator limits.

C. Race and equality impact

Consideration is given to the requirements of the Race Relations (Amendment) Act through the MPS Environmental Strategy whereby environmental liabilities and risks arising from MPS financial investments are investigated. As part of the MPS's ethical strategy the Treasury Management function are reviewing the ethical policies of organisations they invest funds with.

D. Financial implications

The outturn figures discussed in this report are consistent with those previously advised.

E. Background papers

• Treasury Management Strategy 2004/05 – Finance Committee report 19 February 2004

F. Contact details

Report author: Stephen Skirten, Treasury and Control Manager, MPS

For more information contact:

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

Appendix 1: Treasury Management Prudential Indicators for the Metropolitan Police Authority

Treasury Management Indicators – Comparison of 2004-05 estimate to actual position for the 12 months to 31 March 2005

Gross Outstanding Borrowing

Limits in interest rate exposure calculated with reference to net outstanding borrowing sums

Gross Outstanding Investment

Limits in interest rate exposure calculated with reference to outstanding investment sums

*Revision approved by Full Authority on 28 October 2004

Maturity Structure of Borrowing – Upper and Lower Limits

Amount of projected borrowing that is fixed rate maturing in each period as a percentage of total projected borrowing that is fixed rate 

Principal sums invested for periods longer than 364 days.

No sums have been invested for longer than 364 days.

The MPA has adopted the CIPFA Code of Practice for Treasury Management in Public Services.

External Debt Indicators

Authorised Limit for External Debt

*Revision approved by Full Authority 28 October

This is the maximum amount that the authority allows itself to borrow in each year. They are based on the estimate of the most likely, prudent but not worst-case scenario, with in addition sufficient headroom over and above this to allow for operational management, for example unusual cash movements. Risk analysis and risk management strategies have been taken into account, as have plans for capital expenditure and estimates of cashflow requirements.

Operational Boundary for External Debt.

*Revision approved by Full Authority 28 October

The Operational Boundary for external debt is based on the same estimates as the Authorised Limit but reflects directly the estimate of the most likely, prudent, but not worst case scenario, without the additional headroom included within the Authorised Limit to allow for example for unusual cash movements and equates to the maximum of external debt projected by this estimate.

Actual External Debt

The actual external debt for 2004/05 is £104,466,000.

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