Treasury management – 1st quarter 2009/10 update

Report: 4
Date: 3 September 2009
By: Treasurer

Summary

This report invites members to review Treasury Management activity for the period 1 April 2009 to 30 June 2009.

A. Recommendations

that Members

1. Decide whether institutions with ratings under review should be removed from the counterparty list;
2. Approve raising the prudential code limit on variable rate investments to 100%;
3. Note the reduced interest earned and the limited investment opportunities available under the current strategy and agree to the Treasurer undertaking a review of the current investment strategy reporting back to members as part of the next quarterly update report.

B. Supporting information

1. In line with CIPFA guidelines for the monitoring of treasury management operations this quarterly report reviews treasury management and performance for the 1st quarter 2009/10.

2. At the meeting of 30 April 2009 this Resources Sub-Committee reviewed the 4th quarter 2008/09 report and members felt that there was too much detail by itemising each investment. Appendices have now changed in this report to omit individual investments, but provide a summary of investment activity during the 1st quarter 2009/10. The report also provides a summary of the MPA borrowing position.

3. Members also received on 30 April 2009 treasury management training with a presentation provided by Peter Morley, Treasurer Management consultant.

Average Balances

4. Cash balances have reduced from the previous quarter with an average investment balance of £102 million. The £30 million of MPA funds currently frozen by the Icelandic government has now been transferred to an impairment account as the MPA awaits recovery of funds, so is not included in the portfolio. Included in cash balances is £30 million of new borrowing undertaken in May 2009 from the PWLB.

5. Appendix 1 provides a breakdown of average balances by market sector. The largest percentage (42%) is call money held with RBS and provides instant access to meet short term commitments while providing an attractive return. The balance with the DMO is an average of 40%; this is higher than the previous quarter and reflects a reduced lending list. The balances with British banks (other than RBS) and building societies make up the remaining 18%, although the investment with the building society sector has now matured.

6. During the quarter 68 deposits were placed. Members should note that although there are 8 banks on the MPA’s approved lending list only 2 are currently active, along with 1 building society and the DMO. The limited opportunities available will have a continued impact on the 2009/10 final outturn for income on investments as a larger proportion of funds will be placed with the DMO at lower rates.

Income on Investments

7. Income on investments for the quarter is £0.173 million at a return of 0.88%. The average rate of return has declined by 1.2% from the previous quarter as longer term higher yielding investments matured and the remaining £10 million Icelandic investment was taken from the portfolio and placed in the impairment account. The Bank of England maintained Base Rate at 0.5% during the quarter. The average length of investments is again short at 7 days reflecting the need to cover short-term cash flow commitments.

8. Appendix 1 also shows the % return and income by sector. The 6% shown against Building Societies (non specified) is a one year deposit that matured on 1 May.

9. The interest on investments budget for 2009/10 is £2.1 million. The estimated outturn for 2009/10 was reduced in May 2009 to £0.75 million. The budget was set when interest rates were much higher, with income of £0.173 million achieved in quarter 1 and interest rates at all time lows, £0.75 million is a more realistic outturn for the year. A summary of investment income against budget is set out at Appendix 2.

Borrowing

10. As mentioned in paragraph 4 above cash balances have reduced during the period and in May 2009 the Treasurer approved borrowing of £30 million from the PWLB. This is made up of two loans of £15 million; both are equal instalment repayments over 25 and 30 years. Total MPA borrowing at 30 June 2009 is £77.34 million. An annual maturity profile for all MPA borrowing is set out at Appendix 3

11. To assist with decision making on approving external borrowing the Treasurer and officers of MPS finance meet monthly to discuss all treasury management matters which includes an assessment of borrowing requirements. While consideration is given to short term cash flow requirements and the ability of the MPA to meet its liabilities a longer term approach is taken when assessing borrowing needs and particularly the status and funding of the capital programme.

12. A key factor in setting the capital programme is the level of borrowing that is regarded as affordable, sustainable and prudent in accordance with the requirements of the Prudential Code. Over recent years the borrowing element of the capital programme has not been translated into external debt due to the high level of cash balances held by the Authority. In effect the Authority has ‘borrowed’ from itself (internal borrowing) which is why the underlying need to borrow (i.e. the capital financing requirement) is significantly higher than actual external debt.

13. Recent cash flow predictions show our ability to fund capital from internal balances is no longer sustainable and we may need to borrow externally. To ensure that external loans are secured on advantageous terms it is prudent that a longer term view is taken of the Authority’s borrowing needs. The 2009/10 treasury management strategy, approved by the Finance and Resources Committee on 19 March 2009, includes the provision that £50m of external borrowing may be undertaken to support the borrowing element of the 2009/10 capital programme. This is in addition to the approved £20m for 2008/09 (as yet not taken) and the approved £50m to support the purchase of New Scotland Yard. Therefore the Treasurer has the potential to borrow up to £120m.

14. In deciding when it is prudent and favourable to negotiate new loans a long term view on interest rates needs to be taken. Interest rates have recently been at an historic low. The £30m of borrowing undertaken during May 2009 has attractive rates. The long term view is that rates are likely to rise.

15. The MPS is currently improving the alignment of the cash flow forecast into the funding requirements of the capital programme. A report on progress will be made to this committee later this year.

Performance

16. All investment and borrowing activity has been undertaken within the guidelines and objectives set out in current policy and strategy. Liquidity has been maintained to ensure that obligations have been discharged with borrowing undertaken to meet this objective. Additionally the timing of borrowing considered the historical movement in interest rates and was taken out at low fixed rates.

17. All investments were compliant with the requirements of the strategy and achieved a rate of return consistent with the limited opportunities available.

Credit Ratings

18. The Treasury Management Strategy is approved by the Finance and Resources Committee before the start of each year. The strategy requires that cash balances are invested in line with CIPFA's Code of Practice for Treasury Management in the Public Services which requires a prudent approach to the investment of temporarily surplus funds with priority given to security and liquidity. One of the conditions is that investments are made with institutions with a high credit rating (as determined by a credit rating agency).

The MPA uses two credit rating agencies and for an institution to have a high credit rating the strategy requires that the institution must satisfy the minimum of six criteria:

Currently, institutions under review and any changes to ratings are monitored to identify any weakening of an institution’s credit worthiness. The strategy requires the MPS to notify the MPA Treasurer when an institution’s ratings are either:

1. under review. The terminology for “under review” used by the two rating agencies differs slightly. Fitch use “Ratings Watch Negative” (RWN) and Moody’s use “Ratings Under Review” (RUR). Both indicate, in the current climate, that the rating agency could shortly revise the credit rating of the institution.
2. have a longer term negative outlook. The longer term negative outlook is used by both Fitch and Moody’s and does not indicate an imminent change to an institutions credit rating, but looks more at the longer term prospects of the institution within the current economic climate.

Current practice is that when an institution is placed under review the Treasurer is advised and no further investments are made with that institution. The institution is not removed from the counterparty list but is placed “on hold” pending the outcome of the review. Members are asked to decide whether institutions with ratings under review should be removed from the counterparty list.

The Treasurer is also advised when an institution is no longer being monitored or when an institution is to be added to the counterparty list, as approved by the Director of Finance. This provides added assurance about the security of investments on the counterparty list.

Members are asked to agree to the Treasurer undertaking a review of current the current investment strategy reporting back as part of the next quarterly update report.

Prudential Code Indicators

19. In monthly reports presented to the Treasurer during quarter 1 it was noted that the ratio of variable to fixed rate investments rose to 100% towards month end. This is above the agreed limit of 40%. This situation arose because at the end of each month, when cash balances are at their lowest, all funds are placed in the call account, which is a variable rate account, in order to provide liquidity for the management of short term cash requirements. Prior to the sale of NSY this did not occur as balances on fixed rate deposits were such that the set ratio was always maintained. This is no longer the case.

20. The limit is set to reduce exposure to adverse moves in interest rates associated with variable rate investments. However with interest rates currently low and unlikely to fall further, and because the call account is only variable because it tracks Bank of England base rate, there is minimal additional risk is raising the limit of this indicator. Members are therefore asked to approve raising the Prudential Code limit on variable rate investments to 100%.

Economic background

21. The Bank of England held Base Rate at 0.5% during quarter 1. One month LIBOR rate also held steady over the period at around 70 basis points. In May 2009 members of the Monetary Policy Committee decided in favour of a further £50 billion of asset purchases through the creation of central bank reserves, bringing the total of the asset purchase scheme to £125 billion, and this has since been increased to £175 billion.

C. Race and equality impact

Consideration is given to the requirements of equality legislation through the MPA/MPS Environmental Strategy and 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.

D. Financial implications

Budget for 2009/10 is £2.1 million. The estimated outturn was adjusted in May 2009 to £0.75 million

E. Legal implications

1. This is a financial monitoring report; therefore there are no direct legal implications.

2. The Treasurer’s responsibilities are set out in the Financial Regulations under Part E of the MPA standing orders. In accordance with the standing orders the Treasurer is required to report to the Authority, or a designated committee of the Authority, on treasury management operations on a quarterly basis.

3. The Resources sub-committee has authority in accordance with its terms of reference to receive and review the MPS Treasury Management report on a quarterly basis.

F. Background papers

• Appendix 1: Average portfolio balances and rate of return by sector 1st Quarter 2009/10
• Appendix 2: Investment income against budget 1st Quarter 2009/10
• Appendix 3: External debt maturity profile as % of total external debt at end 1st quarter 2009/10

G. Contact details

Report author: Paul James, Director of Finance.

For more information contact:

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

Abbreviations

DMO

Debt Management Office

PWLB

Public Works Loans Board

LIBOR

London Inter Bank Offered Rate

RUR

Ratings Under Review

RWN

Ratings Watch Negative

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