Treasury Management Financial Review 2005/06

Report: 11
Date: 20 July 2006
By: Commissioner and Treasurer

Summary

This report presents the Annual Review of Treasury Management for the 12 – month period ended 31 March 2006.

A. Recommendations

That the annual report of the Treasury Management function is noted.

B. Supporting information

Background Information

1. The MPA operates in accordance with 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 2005-06 approved by this Committee on 7 April 2005.

3. This report sets out:

• A review of investment operations during 2005/06
• A summary of interest rate movement and investment performance for 2005/06
• 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 2005/06

4. The average size of the investment portfolio during 2005/06 was £272 million. 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.

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 2005-06

6. During 2004/05 the increase in the counterparty limit with each UK bank to £40 million has increased activity in the sector to 32.1% of the portfolio with the level of activity with non UK banks decreasing to 35.7%. This has achieved the objective of securing a more evenly balanced portfolio between these two sectors. 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). Also Building Societies generally take longer term funds whereas the majority of placements have been at the short end.

7. A total of 436 investment transactions were undertaken (not including call money, see paragraph 8 below). The average size of investments was £7.5 million and average term 16 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. However, with the reduction to base rate in August 2005 (see paragraph 10 below) and the expectation of further reductions banks reduced the rates payable on call account balances. To achieve an enhanced rate the HBOS account was converted to a 30 day call account in November 2005. These balances are therefore no longer classified as call money. The RBS account remains at call to cover short term liquidity.

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 2005/06

10. At the beginning of the year base rate was 4.75% with a negative yield curve (downward sloping indicating lower future rates) that anticipated the base rate reduction to 4.5% in August 2005. The market priced in further base rate reductions until sentiment changed at year end with market indicators suggesting a base rate rise.

11. Accrued interest received on investments during 2005-06 was £12.8 million against the original budget of £12.6 million. On 20 October 2005 this Committee was advised of a budget adjustment due to the purchase of Marlowe House and also of estimated additional income of £0.8 million. The outturn position (with budget surplus of £1.2 million) is summarised below in Table 2.

Table 2 – Interest receivable outturn 2005/06

12. Performance is monitored against the British Bankers Association (BBA) LIBOR rate. The MPA return of 4.70% compares with BBA LIBOR (1 week) of 4.65% and BBA LIBOR (1 month) of 4.67%.

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 2005-06 strategy and in line with 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 was applied in 2004/05). 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. The 2005/06 Treasury Management Strategy suggested that up to £30 million could be invested for longer than 364 days. The average balance of these long-term investments for this period was £18 million with £40 million at year end. Exceeding the limit by £10 million was undertaken with regard to prevailing market conditions, cash flow requirements and risk. A proposal accepted by the Full Authority on 30 March 2006 set a higher limit of £40 million, which was incorporated into the 2006/07 strategy. This limit will not be exceeded with no additional long-term placements to be made during 2006/07.

17. All other transactions undertaken in 2005/06 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

18. In line with the 2005/06 Treasury Management Strategy no borrowing took place during the year. Maturing loans totalling £15 million were repaid reducing the balance of debt at 31 March 2006 to £70.84 million (of which £11.75 million is held on behalf of the former Inner London Magistrates Courts Service and the former Inner London Probation Service).

19. The average size of the portfolio during 2005/06 was £83.70 million with an average rate of interest paid on the portfolio of 6.10%. All debt is held in fixed rate maturity loans with the PWLB.

Treasury management Prudential Code indicators

20. 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 2005-06, 2006-07 and 2007-08 were presented as part of the 2005-06 Treasury Management Strategy.

21. The 2005/06 indicators and actual figures for the year are set out at Appendix 1. Investment activity has been maintained within indicator limits with the exception of the upper limit on variable rate exposure for gross outstanding investment. The limit of 40% was exceeded on two days in September 2005 as fixed rate investments maturing to cover payments resulted in higher a percentage of the portfolio held in the call accounts. It is not proposed to amend the limit from 40% but to review the amount of the portfolio maintained in the call accounts.

22. Additionally the maturity structure of borrowing shows that 38.4% of debt is due to mature over 10 years and above against a limit of 35%. Although no borrowing has taken place the maturity of debt in March 2005 resulted in a change to the proportions of the overall debt. It was not proposed to reschedule any debt this year with future additional borrowing adjusting these percentages.

Abbreviations

BBA

British Bankers Association

CIPFA

Chartered Institute of Public Finance & Accountancy

HBOS

Halifax Bank of Scotland

LIBOR

London Interbank Offer Rate

ODPM

Office of the Deputy Prime Minister

RBS

Royal Bank of Scotland

C. Race and equality impact

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 2005/06 – MPA Finance Committee Report 7 April 2005

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

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