Council borrowing debt down - to £191 million

Figures for the end of the 2014/15 show the council benefitted from £81 million of debt maturing over the financial year.

By the end of the year, the total external borrowing  was £191 million, including long term liabilities.

That’s down from £195 million in April 2014.

The council subsequently took on £76 million of new borrowing - set against that £81 million of maturing debt.

Another near £20 million is owed to other authorities  in outstanding short term loans.

Over the year, the council continued using short-term borrowing from other local authorities to cover liquidity needs and capital spend, because of the large differential between short and longer-term interest rates.

Overall, the council paid £5.7 million in interest on its borrowing over the year, of which £600,000 was capitalised and added to the cost of associated fixed assets.

Capitalisation means more flexibility because the council can meet costs using existing borrowing powers or capital receipts, but it does add to borrowing costs over coming years. 

It is council strategy to maintain borrowing and investments below their underlying levels by using “internal borrowing” or borrowing by utilising usable reserves and keeping investment balances relatively low.

Interest rates from the Public Works Loan Board (PWLB) fell to historically low levels during the year enabling the council to replace some short-term loans with longer-term finance.

In 2014/15 the following longer term loans were taken out from the PWLB:

- December 16: £5 million over a 20 year period as an Equal Instalments of Principle (EIP) loan - repaid in equal instalments every six months – at an interest rate of 2.70 per cent.

- March 3: £5 million over 49 years, six months as a maturity or all principle repaid at the end of the loan period – at an interest rate of 2.87 per cent.

- March 31: £3 million over 35 years as an EIP at an interest rate of 2.73 per cent.

The premium charged by the PWLB for the early repayment of PWLB debt remained too expensive for existing loans in the council’s portfolio to be repaid and rescheduled.

No rescheduling activity was undertaken in 2014/15 but the council says this will continue to be “constantly considered”.

Principal of £4 million was repaid to the PWLB under existing annuity and EIP agreements.

Interest of £5.7 million was paid on council borrowing.

Short term borrowing totalled £19 million at the end of 2014/15 and long term borrowing £145.52 million – taking the initial overall total to £164.52 million – down from £168m at the end of 2013/14.

Of this sum, £12 million relates to two bank loans reclassified as long term borrowing on advice from Arlingclose, the council’s treasury management advisors.

Reclassification was an option with interest rates forecast to remain low.

With lenders unlikely to increase the interest rates charged, it would unlikely for the council to repay these loans over 2015/16.

The borrowing total tops £191.12 million with £26 million of other long-term liabilities added on.

These sums show the principal outstanding, figures in the council’s annual accounts will be higher as they include accrued interest and other required accounting adjustments.

The council’s underlying need to borrow - as measured by the Capital Financing Requirement (CFR) at the end of 2014/15 -  was £244.29 million.

An identified difference of £53.17 million between the CFR and total external borrowing represents internal borrowing from usable reserves and working capital.

The council says it chief objective when borrowing has been to “strike an appropriate balance” between using low cost short term finance, securing fixed low interest rates with cost certainty over the period for which funds will be required, and “retaining flexibility” to renegotiate loans should its long-term plans change.

In 2014/15 the weighted average interest rate paid on council borrowing was 3.43 per cent – down from 3.48 per cent in 2013/14.

The weighted average cost of long term borrowing was 4.07 per cent compared to 0.49% for short-term borrowing - being the gross cost including brokers’ commission of between 0.03 per cent and  0.10 per cent..

BACKGROUND – Council borrowing

Historically the council had always borrowed for longer periods at fixed interest rates.

While this achieved stability in the amount of its interest payments, the council currently has a large cost of carry when comparing its fixed interest debt to current (variable) investment rates.

On this basis, the council considers it “good practice” to have an element of variable rate borrowing that removes - or reduces – the cost of carry and, to the extent that the level of short-term debt does not exceed the level of the council’s investments, when interest rates rise increased investment income offers a hedge against increased borrowing costs.

However, the council can only borrow up to its Capital Financing Requirement - which represents the need to borrow for capital spend - and cannot borrow beyond this to finance the revenue budget.

Earlier this year, the Hereford Times reported fears that the council could take a borrowing debt as high as £215 million into its May election.

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

Projections have pitched the council as facing a future borrowing debt of £242 million just a year into office and a total topping £276 million beyond 2018.

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

Initial projections of additional borrowing identified 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 comprised both interest and debt repayment and were 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 has been estimated at 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.

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 Arlingclose, 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.

When the last council set its 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) had 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 feared the final debt figure would 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.

As reported by the Hereford Times, the council has already been warned of its exposure to “significant risk” over interest rate movements on both its borrowings and investments.