Herefordshire Council could take a £215m borrowing debt into its May election

The extent of the council’s borrowing is emerging as one of the key issues on which that election will be fought.

Further projections suggest the new council may face a borrowing debt of £242 million just a year into office and a total topping £276 million beyond 2018.

A quarter of the council’s assets are now  financed by debt, with the repayment rate running at £10 million a year.

When full council met last week to set a 2015/16 budget, Independent group leader Cllr Bob Matthews publically committed to an “urgent review of unsustainable projects” should his group get a say in how the new authority was run.

Cllr Matthews spoke of  “concern on the doorstep” at the extent of council borrowing saying the burden of repayments threatened the future of a council with “nowhere to turn” given the extent of asset disposal so far.

It’s Our County (IOC) has already pledged to “re-rank or cancel” capital projects contributing to the borrowing debt, with group leader Cllr Anthony Powers saying it was priority to ensure the council lived within its increasingly limited means.

Lib-Dem leader Cllr Terry James fears a final debt figure will be far higher once accrued interest and other adjustments are added on, taking the total to around a quarter billion pounds.

That, says Cllr James, could “crush the council” if interest rates rise.

The council has already been warned of its exposure to “significant risk” over interest rate movements on both its borrowings and investments.

The Hereford Times has been tracking the rise of the council’s borrowing debt over the past five years.

As at October last year, the council held £168 million of loans - £134.5 million in long-term fixed rate loans and £33.5 million in short term variable rate loans.

A balance sheet forecast for the 2015/16 budget shows that the council’s borrowing estimated at  £215 million by March this year and to £242 million by March next year, assuming the timing and levels of capital spending are as budgeted.

The council’s current capital programme  lists nearly £147m worth  of projects.

These spends range from £40 million on the joint incinerator project with Worcestershire to £76,000 for closed landfill sites.

Some £27 million goes towards the Hereford link road and around £20 million to both the Fastershire Broadband scheme and roads.

Nearly £17 million is identified for “corporate accommodation”.

Projected additions to the programme are expected to total £57.5 million of which £48.6 million is funded by capital grants or revenue savings already identified.

A balance of nearly £9 million would be financed through borrowing added to borrowing levels within the council’s treasury management strategy.

Of that near £9 million, £4.5 million relates to Colwall School, and any contribution to the cost of a new school should it not be possible to rectify the ongoing damp problems affecting the current school.

Alternative grant funding has been  sought and, if successful, will reduce this borrowing.

Around £800,000 relates to borrowing for vehicles and equipment where the cost of  borrowing will be funded by the service areas concerned.

The remainder relates to property enhancements which are needed where structural deterioration threatens closure or litigation.

Additional investment has already been approved for the incinerator, leisure centre improvements, road investment and the Hereford link road – all of which are pitched as “self-financing” schemes.

The council currenlyt has a debt to asset percentage of 26 per cent, meaning a quarter of  its assets are financed by debt.

As identified, the additional borrowing will give rise to borrowing revenue costs of £35,000 in 2015-16, £210,000 in 2016-17 and £498,000 in 2017-18 to continue for a further 25 years.

These figures comprise both interest and debt repayment and are included in budget proposals to 2018 as new pressures.

Capital spending can be financed in a number of ways including the application of usable capital receipts, a direct charge to revenue, capital grant or by securing an “up front” contribution towards the cost of a project.

Capital spending not financed by one of the above methods will increase the council’s capital financing requirement (CFR), which reflects the council’s underlying need to finance capital spending by borrowing or by other long-term liability arrangements.

The council’s case is that the use of the term “borrowing” in this context does not necessarily imply external  debt because, with its integrated treasury management strategy, borrowing is not associated with specific capital spending.

As such, at any point in time, the council will have a number of cash flows both positive and negative and has options to  manage its position in terms of both borrowings and investments.

The movement in actual external debt and usable reserves - which have a direct bearing on when any internal borrowing may need to be externalised - combine to identify the council’s borrowing requirement and potential investment strategy in current and future years.

Increased borrowing increases both interest payable and the amount to be set aside each year for the repayment of loan principal or the Minimum Revenue Provision (MRP).

Annual MRP is estimated to be between £10 million and £12 million for the foreseeable future.

Therefore, the council case is that if the large capital schemes scheduled for the next few years are completed, then the new capital spend financed by  borrowing can be reduced to below the annual MRP, so the council’s total borrowing will fall.

The council maintains that its CFR is “no higher than average”  when compared with other unitary authorities in England.

But this claim is made on figures for 2013 with later values yet to be published.

The council’s main objective when borrowing money is to strike an appropriately low risk balance between securing low interest costs and achieving cost certainty over  the period for which funds are required.

Flexibility to renegotiate loans should long term plans change is a secondary objective.

Given the extent of on-going public spending cuts - and specifically local government funding – the council needs a borrowing strategy that addresses affordability without compromising the longer-term stability of the debt portfolio.

With short-term interest rates currently much lower than long-term rates, the council sees it as more cost effective in the short-term to use internal resources and borrow using short-term loans.

The council says this allows a reduction in both net borrowing costs and overall credit risk by tailoring the timing of borrowing to minimise balances held.

Benefits of internal are monitored against the potential for incurring additional costs by deferring borrowing into future years - when long-term borrowing rates are forecast to rise.

Analysis by Arlinghouse, the council's treasury advisor, will be a factor in determining whether the Authority borrows additional sums at long-term fixed rates in 2015/16 with a view to keeping future interest costs low, even if this causes additional cost in  the short-term.

There is provision in the council’s budget to take out additional long-term borrowing of £5 million each year.

But short-term loans do leave the council exposed to the risk of short-term interest rate rises and are subject to a limit on the net exposure to variable interest rates.

The council’s approved sources of long-term and short-term borrowing are:

• Public Works Loan Board (PWLB).

• UK local authorities.

• Any institution approved for investments.

• Any other bank or building society authorised to operate in the UK.

• UK public and private sector pension funds.

• Capital market bond investors.

• Local Capital Finance Company and other special purpose companies created to enable local authority bond issues..

Capital finance can also be raised by methods that are not borrowing but can be classed as other debt liabilities.

These are:

• Operating and finance leases.

• Hire purchase.

• Private Finance Initiative  (PFI).

• Sale and leaseback.

The council has two LOBO (Lender’s Option Borrower’s Option) loans of £6 million each on which the council pays interest at 4.5%.

Every six months, when interest charges are due, the lenders have the option to increase the interest rate being charged.

At which point the council can accept the revised terms or reject them and repay the loan.

LOBO loans are acknowledged by the council as a potential refinancing risk since the decision to amend the terms is entirely at the lender’s discretion.

The PWLB allows the repayment of  loans before maturity by either paying a premium or receiving a discount according to a set formula based on current interest rates.

Tough the council explored the possibility of doing this in 2014/15, low interest rates were said to limit opportunities for debt rescheduling.

However, this option  will be kept under review and the council may replace some loans with new loans where this could  lead to an overall saving or reduction in risk.