Annual Report on the Treasury Management Service 2002/03



HERTFORDSHIRE COUNTY COUNCIL | |

AUDIT COMMITTEE

THURSDAY 22 NOVEMBER 2012 AT 10.00AM

MID-YEAR REPORT ON THE TREASURY MANAGEMENT SERVICE

AND PRUDENTIAL INDICATORS 2012/13

Report of the Director Resources & Performance

Author: Patrick Towey, Head of Specialist Accounting

Tel: 01992 555148

Executive Member: David Lloyd, Resources & Economic Wellbeing

1. Purpose of Report

1. The CIPFA Prudential Code and CIPFA Code of Practice for Treasury Management in the Public Sector require the Council to set an annual Treasury Management Strategy and assess performance indicators and the treasury function throughout the year.

2. This mid–year report reviews the prudential indicators specified in the Integrated Plan, Part C approved by the County Council on 21 February 2012 and revised on 15 May 2012, in accordance with the requirements of the Prudential Code.

2. Summary

2.1 This report summarises the treasury activity of the Council for the first six months of this financial year up to 30 September 2012.

2.2 The Council currently has stringent minimum credit rating criteria for banks and building societies, both domestic and international. Consequently, with the poor ratings of UK banks, this has limited the range of investment instruments available. Therefore, the majority of deposits were placed in Money Market Funds (MMF).

2.3 The Council earned £0.376m of interest in the period April to September 2012. The Council’s deposits were placed primarily with UK counterparties that met the Lending Policy criteria which are MMFs and an HSBC 90 days notice account.

4. Fixed Term investments were primarily made in the government’s Debt Management Office and a £10m deposit was placed with the Nationwide Building Society.

2.5 Two Barclay’s loans totalling £27m were repaid on the 3 April 2012. No additional borrowing was undertaken during the period.

2.6 Ernst & Young, the administrators for Heritable Bank and Kaupthing,

Singer & Friedlander, Icelandic Banks under UK administration, made dividend distributions totalling £0.88m during the period April to September 2012.

2.7 The Icelandic bank Landsbanki, under Icelandic administration made a dividend distribution totalling £1.24m during the period April to September 2012. This distribution was made in a range of currencies. The Icelandic Krona element of the Glitnir and Landsbanki distributions is subject to currency restrictions by the Icelandic Central Bank and has been placed in Escrow accounts.

2.8 The Council has complied with the treasury management prudential indicators throughout the first half of this financial year to 30 September 2012.

3. Recommendations

3.1 The Committee are invited to note the Treasury Management mid–year report for 2012/13.

4. Background

1. The Council operates its treasury management function in accordance with the CIPFA Prudential Code and the CIPFA Code of Practice for Treasury Management in the Public Sector. The Codes require the Council to set prudential indicators for its capital expenditure and treasury management activities prior to the start of each financial year. The Council approved the 2012/13 Treasury Management Strategy as part of the Integrated Plan, Part C at its meeting on 21 February 2012. This was subsequently revised and agreed at the County Council Committee meeting on 15 May 2012.

4.2 The Codes also require that regular reports are provided reviewing performance and compliance at the end of each financial year and on a half-yearly basis. In addition to these reports, performance of the prudential indicators and treasury management activities are reported to Cabinet as part of the quarterly budget monitoring report.

5. Treasury Management Strategy

5.1 In setting the Treasury Management Strategy, the Council’s primary consideration is the security of the Council’s funds. The secondary consideration is liquidity, ensuring that sufficient funds are available to meet the council’s forecasted cashflow requirements. Only once both of these factors have been taken into account will the yield on investments be considered. Long term borrowing is only considered when it becomes necessary to avoid a prolonged short term overdraft position.

2. The Council approved the 2012/13 Treasury Management Strategy as part of the Integrated Plan, Part C at its meeting on 21 February 2012. This was subsequently revised and agreed at the County Council Committee meeting on 15 May 2012 to reflect the exclusion of the UK from the AAA minimum long term credit rating requirement and to include the use of Institutions in the Local Authority Mortgage Scheme (LAMS).

3. The Chief Financial Officer is pleased to report that all treasury management activity undertaken during the period complied with the approved strategy, the CIPFA Code of Practice for Treasury Management and the relevant legislative provisions.

4. During the period April to September there has been a limited range of counterparties available for investment that meet the current Treasury Management Strategy. A £10m fixed term investment for 364 days has been made with Nationwide, £15m has been invested in an HSBC 90 day notice account and the remaining average balance of £83m has been held, predominantly, in MMFs.

5. At the beginning of the financial year there was a need to invest excess cash into the government’s Debt Management Account Deposit Facility. (DMADF) which has a current interest rate of 0.25% compared to MMF interest rates for the same period of between 0.40% and 0.80%. The investments in the DMADF were necessary since all available investment options during the period had reached their operational limit.

6. In the latter part of the period the rate of return for MMFs has significantly decreased from an average rate of return of 0.63% at the 1 April, to an average of 0.48% on the 30 September. The fall in rates resulted from the introduction of the Funding for Lending Scheme following the HM Treasury and the Bank of England announcement in June 2012. This scheme has reduced the costs of borrowing for banks with a consequent reduction in yields earned in MMFs.

6. Economic Review

6.1 The first half of the financial year has seen continued uncertainty in the global economy, amidst low global economic growth and continued concern about sovereign creditworthiness. Many western developed nations, including the UK, have remained in recession. In June, HM Treasury and Bank of England announced two schemes to reduce bank funding costs and increase the availability of cheaper finance for businesses in an attempt to pull the UK economy out of recession.

6.2 The Eurozone sovereign debt crisis has had the most influence on financial markets with investors concerned about the consequences of a European sovereign default on the global financial system. The Eurozone crisis has been brought back into focus with the two Greek elections, failure of the Spanish bank Bankia and speculation of a Spanish bail out. Eurozone leaders made some progress towards a solution prompted by the realisation that the link between sovereign and bank needed to be broken. Leaders, at the EU summit in June, agreed that the yet to be initiated bailout fund, the European Stability Mechanism (ESM), would have more flexibility allowing it to cut the debt of struggling countries or directly recapitalise banks. The ECB, at its meeting in September, announced proposals for unlimited purchases of short term sovereign debt of countries that applied for financial assistance to the Eurozone bailout funds. The ECB’s pledge eased fears of a short term collapse of the Eurozone, and saw a significant reduction in Italian and Spanish Government yields.

3. Outside the Eurozone, the US economy continues to stutter with slow employment growth placing further pressure on the Federal Reserve to engage in additional monetary stimulus. There were also concerns about a slow down in Chinese growth with weaker domestic demand and a softer export outlook; this prompted the People’s Bank of China to introduce a number of interest rate cuts in an attempt to prop up economic outlook. The deteriorating outlook for global growth had a significant impact on commodity prices with the oil price falling 30% over May and June.

4. In the UK the recession continued into quarter two. The UK was not immune from the uncertainty emanating from the Eurozone and data suggested that underlying business conditions had weakened. Goods exports to the Eurozone were declining and a weak housing market and a declining construction sector also had an impact on the economy.

5. The banking sector and credit bottleneck were perceived to be an important factor holding back UK economic growth, prompting HM Treasury and the Bank of England to announce two schemes in June to reduce bank funding costs and increase the availability of cheaper finance for businesses, The MPC also increased the asset purchase facility by £50bn to £375bn to further stimulate the economy.

7. Interest Rate Prospects

1. The August Inflation Report showed that the Bank of England expects little economic growth this year and a gradual recovery in 2013. The weakness in demand is projected to place downward pressure on inflation, maintaining it around target for the next few years. The recent downward trend in CPI inflation rate allied with the apparent synchronised global downturn led by the Eurozone has pushed markets expectations for a rise in interest rates out to at least 2014. Market sentiment is also indicating that there is a marginal possibility of a cut in the base rate to 0.25%. However, it is also expected that the Bank of England will opt for more Quantitative Easing to stimulate the economy.

2. The latest interest rate forecast from the Council’s treasury management advisers, Sterling, is shown in Table 1.

Table 1: Interest rate forecast

| |Bank Rate |3 month LIBOR |12 month LIBOR |25 year PWLB 2 |

|Current |0.50 |0.65 |0.89 |4.03 |

|Q3 2012 |0.50 |0.65 |1.40 |4.10 |

|Q4 2012 |0.50 |0.65 |1.20 |4.15 |

|Q1 2013 |0.50 |0.65 |1.30 |4.20 |

|Q2 2013 |0.50 |0.70 |1.40 |4.25 |

|Q3 2013 |0.50 |0.80 |1.45 |4.35 |

|Q4 2013 |0.75 |0.95 |1.50 |4.50 |

|H1 2014 |1.00 |1.20 |1.80 |4.85 |

|H2 2014 |1.50 |1.70 |2.30 |5.10 |

|H1 2015 |2.00 |2.20 |2.80 |5.25 |

|H2 2015 |2.50 |2.75 |3.30 |5.50 |

[?] London Inter-bank Offer Rate

2 The government’s Public Works and Loan Board

8. Summary of Transactions

1. During the first half of the financial year to September 2012, funds were invested as fixed term investments with the Debt Management Account Deposit Facility (DMADF), HSBC and Nationwide and in instant access MMFs with BlackRock, Ignis, Scottish Widows, Insight, JP Morgan, Deutsche and Goldman Sach.

2. Table 2 shows a summary of the treasury activity in the period April to September 2012.

Table 2: 2012/13 Treasury Activity - 1 April to 30 September 2012

|Measure |April to September 2012|

|Average size of portfolio (excluding Iceland investments) |£108m |

|Number of MMF transactions |158 |

|Number of fixed term deals |44 |

|Weighted average term (fixed term only) |12 days |

|Number of counterparties used |10 |

|Average rate earned |0.86% |

|Interest earned |£0.376m |

8.3 Table 3 shows the investments outstanding on 30 September 2012.

Table 3: Investments at 30 September 2012

|Counterparty |Start Date |Maturity Date |Amount |Interest Rate |

| | | |£m |% |

|Blackrock MMF |Call |- | 15.0 |0.49% |

|Ignis MMF |Call |- | 15.0 |0.67% |

|Insight MMF |Call |- | 15.0 |0.68% |

|Goldman Sachs MMF |Call |- | 15.0 |0.50% |

|Deutsche |Call |- | 14.6 |0.47% |

|Nationwide |10/05/12 |09/05/13 | 10.0 |1.82% |

|HSBC Notice Account |Call |- | 15.0 |0.78% |

|Icelandic Banks |Various |Various | 9.9 |n/a |

|TOTAL | | | 109.5M | |

Table 3 demonstrates that the majority of funds are being invested in MMFs providing a high level of liquidity, low security risk, as funds can be withdrawn without notice and a reasonable return in the current market.

9. Icelandic deposits

9.1 Following the Icelandic Supreme Court’s decision to recognise the Local Authority creditors’ claims as priority claims, the winding up boards (WUPs) for both Glitnir and Landsbanki have made distributions to creditors. Details of the amounts recovered to date are shown in table 4. The distributions are made in a range of currencies including Icelandic Krona. The Icelandic Krona element is subject to currency restrictions imposed by the Icelandic Central Bank and is currently held in an escrow account earning interest.

9.2 Heritable and Kaupthing, Singer & Friedlander are under UK administration and at 30 September 2012, the Council had received £0.88m dividend distributions from the UK administrators Ernst & Young.

9.3 The Icelandic bank Landsbanki, under Icelandic administration has made a dividend distribution totalling £1.24m during the period April to September 2012.

9.4 Table 4 provides details of dividends received to 30 September 2012 together with the anticipated value and percentage recovery for Icelandic investments. Estimated recovery is based on information available at 1 June 2012.

Table 4: Icelandic bank deposits at 30 September 2012

|Bank |Value of original |Recovered as at |Total expected |

| |deposits |30/09/12 |distribution |

| |£m |£m |£m |% |

|Heritable Bank |7.00 | 5.24 |6.16 |88.00 |

|Kaupthing, Singer & Friedlander |4.00 | 2.99 |3.34 |83.50 |

|Glitnir |7.00 | 5.99 |7.00 |100.00 |

|Landsbanki |10.00 | 4.19 |10.00 |100.00 |

|TOTAL |28.00 | 18.41 |26.50 |94.64 |

10. Borrowing

1. Long Term Borrowing

Table 5 shows total long term borrowing outstanding at 30 September 2012, the future maturity profile of borrowing and an analysis of sources of borrowing shown as a percentage of total borrowing.

Table 5: Borrowing maturity profile at 30 September 2012

| |Total | |Sources of Borrowing |

| | | |PWLB 1 |LOBO 2 |

| |

|Security |Weighted average credit rating | 2.72 |

|Liquidity |Weighted average maturity of investments | 33 days |

|Yield |Investment return | 0.86% |

|Yield |7 day LIBID rate | 0.42% |

1. The weighted average credit rating indicator in Table 6 compares the ratings of the counterparties used by the Authority against a scale from 1 to 10. A rating of 1 is equivalent to AAA rating derived from one of the credit rating agencies such as Fitch, Standard & Poors or Moodys; this rating would represent the most secure form of deposit. A rating of AA would represent a score of 4; banks such as HSBC have this rating. The lowest rating is BBB and non-rated institutions, and this is equivalent to a score of 10. The lower the credit rating score on the scale indicates a counterparty that is financially more stable and secure than counterparty with a higher score.

2. Table 7 shows the operational indicators for the period April to September 2012. There were no breaches in the application of the Lending Policy during the period to 30 September.

Table 7: Operational indicators to 30 September 2012

|Operational Indicators |

|Breaches in lending policy |None |

|Number of MMF transactions |158 |

|Number of fixed term transactions |44 |

|Number of counterparties used |10 |

13. Treasury Management Prudential Indicators

1. Interest rate exposure

This indicator is set to control the Council’s exposure to interest rate risk. The exposure to fixed and variable rate interest rates is expressed as an amount of net principal borrowed and shown in Table 8.

Table 8: Interest rate exposure

| |Limit |Met |

|Upper limit on fixed rate exposures |£355.0m |( |

|Upper limit on variable rate exposures |£106.5m |( |

2. Maturity structure of borrowing

This indicator is set to control the Council’s exposure to refinancing risk. Table 9 shows the maturity structure of fixed rate borrowing.

Table 9: Maturity structure of borrowing

| |Upper limit |Lower limit |Met |

|Under 12 months |25% |0% |( |

|12 months and within 24 months |40% |0% |( |

|24 months and within 5 years |60% |0% |( |

|5 years and within 10 years |80% |1% |( |

|10 years and above |100% |99% |( |

3. Principal sums invested for periods longer than 364 days

The purpose of this indicator is to control the Council’s exposure to the risk of incurring losses by seeking early repayment of its investments. This relates to principal sums invested with a maturity date greater than 364 days as at the 30 September 2012. No investments meeting these criteria were outstanding at 30 September 2012.

13. Hertfordshire Police Authority – Treasury Management

1. The Police Authority contracts with Hertfordshire County Council to deliver its Treasury Management services.

2. A separate treasury management strategy is maintained for the Police Authority. Police Authority officers provide data concerning the Police Authority’s cashflow to Council Officers and any surplus cashflow is invested in accordance with the investment criteria outlined in the treasury management strategy. Cashflow and investment portfolio is maintained separately from the Council’s funds.

14.3 The reporting arrangements for the Police Authority are similar to the Council. The Police Authority receives an annual treasury management strategy before the start of each financial year. The Police Authority also receives an annual report on the previous financial years’ treasury management activity as well a mid-year report on treasury management activity for the current financial year. Quarterly reports are sent to the Police Authority’s Resources Committee when required; this Committee has the prime responsibility for scrutinising the treasury management strategy, performance and activities.

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