In a deep recession and with Iceland in mind, councils are playing it safe with their cash. But are they doing enough?
As the full impact of the recession on local authorities remains to be seen, most councils are concentrating on reducing their risk exposure and making sure their finances are in the best shape to cope with a prolonged downturn. However, many might not be reducing risk by as much as they think or are not being adequately rewarded for the risk they are taking. There is much they can do to ensure their investments and debt portfolios perform better.
A slew of rapid cuts in interest rates by the Bank of England has made decent returns harder to achieve, at least for the medium term. Many authorities had built sizeable investment returns into their financial plans that are now unachievable. Ways to reduce this problem do not need to be complex, but should be designed around the management of risk.
Credit rating agencies continue to be the cornerstone of lending policies, despite controversies over their methodology, accuracy, transparency and effectiveness. The lesson from the Icelandic banks issue must surely be that credit ratings cannot be a substitute for specialised expertise. Simply following credit ratings would not have avoided an exposure to Iceland’s banks or their subsidiaries. The key to good treasury management is consistent application and to consider other sources of information and interpretation.
The central question for local authorities is whether there are any safe counterparties? Councils had become used to moving their cash assets around to benefit from the highest interest rates – but now there are few options. With interest rates historically low, more analysis is required to pick out investments where the potential return truly outweighs the inherent risk.
To reduce risk, many authorities have invested in the Debt Management Account Deposit Facility, run by the Treasury’s Debt Management Office. The funds placed in this cash deposit facility for councils are guaranteed by the government. However, the rate of interest paid is comparatively low. Arguably, UK institutions that have access to the government’s Credit Guarantee Scheme and are viewed as systemically vital offer a better risk/reward trade-off.
In terms of the rates paid on debt, there are also various areas of flexibility. As councils pay their bills on time and do not go bust, lenders might be willing to renegotiate terms. Authorities can also improve their debt position by exploiting the steep yield curve through a combination of debt restructuring and sensible borrowing strategies.
While longer-term interest rate levels have increased in response to the deteriorating macroeconomic position, they remain relatively low. The economic outlook is also influenced by potential developments in the Public Works Loan Board’s lending policy, following criticism by the Commons communities and local government select committee and the Audit Commission’s inquiries into local authority investments.
One of the lasting legacies of the past 12 months will be treasury managers’ increased reluctance to borrow money they are not convinced will be spent. Gone are the days when borrowing to support capital plans was a win-win option because temporary investment returns exceeded the underlying cost of borrowing.
Now there is a greater emphasis on the way capital programmes are devised, funded, monitored and delivered in relation to borrowing. Local authorities are renowned for ‘slippage’ or delays in capital plans – not just for days or weeks but for months and years. This used to make councils money, now it costs them.
Challenging times are ahead and, with taxpayers’ money at stake, local authorities have to make sound and informed decisions to improve their situation and financial outlook.
By adopting a flexible, realistic and well informed approach, and ensuring they have access to the best training and advice, treasury managers can maximise financial performance, reduce risk and ensure their debt and investments work in the most effective way. The world has changed but has the treasury management outlook?
Mark Horsfield is a director of Arlingclose
