PAPER B2

Purpose: For decision

Committee: EXECUTIVE

Date: 18 FEBRUARY 2002

Title: TREASURY STRATEGY 2002-2003

PORTFOLIO HOLDER – RESOURCES

1. SUMMARY

1.1 On 2 February 1993 the Council adopted the Code of Practice for Treasury Management and approved the Treasury Policy Statement. This report which is in pursuance of the Code of Practice seeks approval for the proposed Treasury Management Strategy for the financial year 2002-2003.

2. TREASURY MANAGEMENT

2.1. Treasury Management is the management of all money and capital market transactions in connection with the cash and funding resources of the local authority. All such transactions involve a degree of risk even if that risk is not immediately apparent or is of an opportunity lost rather than of actual or potential cost.

3. TREASURY MANAGEMENT TO DATE FOR YEAR 2001-2002

The Council’s principal source of long-term borrowing is the Public Works Loan Board (PWLB). The following PWLB loans have been raised in the period 1 April 2001 to 31^st January 2002:

PWLB Borrowing 2001/2002

Raised

Date of Loan Amount Interest Rate Term

£ Years

18.12.01 2,000,000 4⅞ 15

15.01.02 3,000,000 5% 25

In addition to the above a Money Market loan for £5 million was taken up on the 23^rd November 2001. This is a 40 year loan with interest initially fixed at 4.27% for the first four years. The lender has the option to increase this rate after four years, but should the rate move upwards, the Council has the option to repay.

In total £10 million of current year borrowing approvals have been taken to date at an average interest rate of 4.6%.

The total of Borrowing Approvals for the 2001/02 year is £11.0 million. Having regard to anticipated falls in interest rates, it was decided to delay taking new borrowing until later in the financial year. Bank base rate started the year at 5¾ and fell on six occasions reaching a level of 4% on the 8^th November 2001.

4. TREASURY STRATEGY 2002-2003

4.1. The proposed Treasury Strategy for 2002-2003 is set out in Appendix B to this report. It is necessarily in some detail and may be subject to review in the light of:

1. the final outcome of the Council’s budget deliberations,

2. changing market conditions, and

3. any future revision of forecast economic and market conditions.

Having maximised PWLB borrowing over the past two years as interest rates hit a thirty year low, there are currently sufficient investments of temporary funds to meet our borrowing requirements for the 2002-03 financial year. The extent of our need to utilise the realisation of these cash investments to meet new borrowing requirements needs to be balanced against the prevailing level of PWLB and market interest rates which remain very low in a historical context. Interest rates achievable on temporary investment are however now less than the interest rates applicable to PWLB loans, and therefore any new PWLB borrowing in advance of its related capital investment, will incur a marginal revenue cost.

4.2. For information the Treasury Policy Statement is reproduced at Appendix B.

5. RECOMMENDATIONS

It is recommended to Council that:

a) The Treasury Strategy for the financial year 2002-2003 set out in Appendix B of this report be approved.

b) The Strategic Director for Finance and Information and County Treasurer be authorized to vary the strategy according to prevailing conditions, provided

i) that any significant variations are reported to the next following Executive meeting, and

ii) it is in accordance with the provisions of Section 45 of the Local Government and Housing Act 1989.

FINANCIAL IMPLICATIONS

As detailed in Appendix B.

BACKGROUND PAPERS

Code of Practice and Guidelines for Chief Financial Officers on Treasury Management in Local Authorities.

Contact Point: Gareth Hughes (Tel. 823604)

J PULSFORD

Strategic Director

Finance and Information

and County Treasurer

R R BARRY

Portfolio Holder for Resources

APPENDIX A

TREASURY STRATEGY 2002-2003

1. TREASURY POLICY

1.1 This Strategy is pursuant to the Treasury Policy approved by the Council on 2 February 1993 and to the Code of Practice for Treasury Management in Local Authorities.

2. TREASURY MANAGEMENT

2.1. The Council’s Treasury Management activities may include the following activities:

1) Cash Flow (daily balances and longer term forecasting)

2) Investing surplus funds

3) Borrowing to finance day to day cash fluctuations

4) Funding of capital payments through borrowing, capital receipts, grants or leasing

5) Management of debt (including restructuring and monitoring an even maturity profile)

6) Interest rate exposure management

7) Dealing procedures with brokers, bank and Public Works Loan Board (PWLB).

3. OBJECTIVES

The major objectives to be followed in 2002-2003 are:

3.1. BORROWING

C To minimise the revenue costs of debt

C To manage the Council’s debt maturity profile, i.e. to leave no one future year with a high level of repayments that could cause problems in re-borrowing

C To affect funding in any one year at the cheapest cost commensurate with future risk

C To forecast average future interest rates and borrow accordingly (i.e. short term and/or variable when rates are “high”, long term and fixed when rates are “low”). Similarly maturity loans can be taken when rates are relatively low, to lock in the principal for the maximum period, and possibly annuity loans or equal installments of principal loans when rates are considered higher.

C To monitor and review the level of variable interest rate loans in order to take advantage of interest rate movements.

C To restructure debt in order to take advantage of potential savings as interest rates change.

3.2. INVESTMENT

C To invest such monies as are temporarily surplus to requirements

C To maintain capital security

C To achieve a level of return equal to or greater than would be secured by internal investment

C To maintain policy flexibility.

The Council is estimated to have investments of £20 million as at 31^st March 2002. This represents the investment of reserves, temporary surpluses on cash flow, and any advance drawdown of loans to finance the capital programme.

4. FORECAST OF INTEREST RATES FOR 2002-2003

Bank base rate commenced the current financial year at 5.75% and fell to a level of 4% by November. Forecasters are predicting that apparent improvement in the U.S. economy and higher than expected GDP for the UK are seen to be sufficient to forecast no further reduction in base rates. Base rate is now expected to be on hold for a few months before ending the year at 4.5%.

5. STRATEGY

5.1. CAPITAL FINANCE

To maximise the use of Basic and Supplementary Credit Approvals, to maximise the use of capital grants and to utilise available capital receipts and leasing to finance a capital programme consistent with the Council’s revenue budget.

5.2. BORROWING

The strategy will in general be:

i to borrow long term when interest rates are relatively low and to borrow short term when interest rates are judged to be high.

ii to keep a reasonable balance between short term and long term loans so that

S there is not an unreasonable exposure to short term loans with corresponding risk of increased interest charges; or

S over reliance on long term loans which could restrict flexibility in renewing debt at advantageous interest rates.

iii to aim generally to be in a net day to day borrowing position so that the need for investment of temporary excess funds is avoided as far as possible.

This will be subject to variation in order to take advantage where appropriate of prevailing market conditions.

For 2002-2003 the strategy will be to continue to borrow medium to long term at fixed interest rates, having regard to the low interest rates that are currently available.

5.3. TEMPORARY INVESTMENTS

To invest funds temporarily surplus so as to produce the maximum return.

5.4. DEBT RESTRUCTURING

To use available PWLB quota to take advantage of opportunities to redeem PWLB debt or convert from fixed to variable rates or vice versa and replace debt so as to smooth the pattern of debt repayment and/or minimise overall long term capital financing costs. Consideration will be given to the availability and attractiveness of loans other than PWLB for debt restructuring purposes.

6. RAISING CAPITAL FINANCE

6.1. The following list specifies which borrowing instruments, on and off-balance sheet, can be adopted. Only those marked a are currently used by the Council.

Fixed Variable

$ PWLB a a

$ Market Long-term a a

· Market Temporary a a

· Local Bonds a a

· Overdraft a

· Negotiable Bonds a a

· Stock Issues a a

· Internal (capital receipts and revenue balances) a a

· Commercial Paper a

· Medium Term Notes a

· Leasing a a

· Bills a

7. SOURCES OF FINANCING

The following list specifies which borrowing instruments the Council may adopt.

7.1. PUBLIC WORKS LOAN BOARD (PWLB)

1) The main source of longer term borrowing for the Council for many years has been from the Government through the Public Works Loan Board.

2) It is still likely that the PWLB will remain the major source of the Council’s long term borrowing requirements. The 2002-2003 quota for the Council is estimated to be £13.2 million.

3) Forecasts are that interest rates on long-term loans (including long term PWLB loans) will be stable in the near future, and the timing of borrowing will therefore take account of this forecast.

7.2. MONEY MARKET LOANS - LONG TERM

The availability of PWLB loans has become easier and their rates of interest are expected to remain competitive. Loans available through the London money market do not generally match the lowest interest rates that become available from the PWLB. Debt rescheduling may, however, require borrowing from this source during the year if the overall benefits of any transaction outweighs any additional cost.

7.3. MONEY MARKET LOANS -TEMPORARY (LOANS UP TO 364 DAYS)

Short term loans are used to avoid any unforeseen overdrawn position with the bank.

7.4. OVERDRAFT

An overdraft limit of £3m is available with the Council’s bankers. This facility will be used on occasions when temporary borrowing is difficult, or for amounts of under £100,000 wherever the transaction costs outweigh any benefits from using the money market.

7.5. INTERNAL

Internal funds include “reserved” or “set-aside” capital receipts which are to be used to repay debt as a substitute for new borrowing. There is no provision in legislation to compel authorities to use such receipts in the year they are received, and those funds are normally used internally thereby reducing the need for external borrowing but they could be externalised and new borrowing taken up if conditions merit such an approach.

7.6. LEASING

Operating Leases fall outside capital expenditure controls, and therefore this form of finance will be used where appropriate and economically viable (eg for the purchase of equipment and vehicles), and where the transaction costs are within available resources and show no material cost over that of borrowing.

8. BORROWING

8.1. The Council will have an estimated borrowing requirements in 2002-2003 of £13.2 million, in order to finance new capital expenditure covered by Credit Approvals.

The estimated requirements of £3.2m may be met as follows: £M

Total Requirement 13.2

Less: movement in amounts set aside 2.1

Minimum External Borrowing Requirement 11.1

9. APPROVED ORGANISATIONS FOR INVESTMENT

9.1. The current policy is that the investment of surplus funds is limited to:

Major British Clearing Banks and Subsidiaries

Larger Merchant Banks

Top Building Societies

Other Local Authorities

9.2. There may be exceptions to this approved list from time to time depending on individual circumstances. The list of above organisations is reviewed monthly having regard to their credit ratings.

Apart from the Council=s own bank not more than £6 million may be loaned to any single institution on one date. Not more than £2 million may be loaned to any subsidiary of one of the clearing banks and no such loan may exceed 1 month. A maximum advance of £6 million may be loaned to Building Societies with appropriate credit ratings for a period of up to three months.

9.3. Approved organisations will be reviewed at least quarterly taking into account credit rating and other relevant information and amended by the Strategic Director for Finance and Information and County Treasurer as appropriate.

10. SECTION 45 OF THE LOCAL GOVERNMENT AND HOUSING ACT 1989

10.1. POLICY ON INTEREST RATE EXPOSURE

1) Section 45 of this Act requires the Council to fix each year the maximum proportion of interest on borrowing which is subject to variable rate interest.

2) In order to take advantage where appropriate of low short-term interest rates it is proposed that for the financial year 2002-2003.

the limit on the proportion of interest payable by the Council which is at a rate or rates which can be varied by the person to whom it is payable or by reference to any external factors be 40%.

10.2. OVERALL BORROWING LIMIT

Taking account of existing debt and the requirements for 2002/03 and the borrowing powers available:

the maximum amount which the authority may have outstanding by way of borrowing be £115 million.

10.3. SHORT TERM BORROWING LIMIT

Taking account of the need for flexibility in borrowing and in order to take advantage of low short term interest rates as appropriate:

the maximum amount which the authority may have outstanding by way of short term borrowing (being part of the overall borrowing limit) be £35 million.

11. POLICY ON EXTERNAL MANAGERS

11.1. Treasury Advisers have been employed by the Council to:

S forecast movements in long term and short term interest rates

S advise on long term borrowing and debt maturity profiles

S advise on leasing and capital finance legislation

S restructuring of PWLB debt

S advise on future interest rate movements (including PWLB) and other market developments

The Strategic Director for Finance and Information and County Treasurer has responsibility for the review of future provision of such advice, and to amend the conditions or appoint different advisers as appropriate.

12. BUDGET FOR BORROWING COSTS 2002-2003

12.1. The estimated average cost of borrowing for the Council in 2002-2003 is 5.8%, and the estimated cost of interest payable on long term borrowing is £5.9 million. Interest receipts from temporary investments are anticipated to be £900,000, resulting in net interest expenditure of £5.0 million in respect of loans and investments. The latest CIPFA statistics on local authority Capital Expenditure and Treasury Management indicate that the Isle of Wight Council average interest rate on external borrowing remains in the lowest ten of sixty-eight Unitary Authorities in England and Wales. These statistics show a Council average of 7.06% compared with an average for all Unitary Authorities of 7.91%. On the Council’s current loan portfolio of £97 million this would represent approximately £800,000 less in annual interest payments compared to the average authority with a similar size portfolio (equivalent to a 2% increase on Council Tax).

APPENDIX B

TREASURY POLICY STATEMENT

BACKGROUND

The statement set out below proposes arrangements for the delegation of responsibility for Treasury Management by the Council.

Two major characteristics of Treasury Management need to be borne in mind when determining appropriate decision-making, monitoring and reporting processes.

First, Treasury Management involves risk. A simple decision to borrow a sum of money for a given period at an agreed rate of interest runs a series of risks on which judgments can be made with the benefit of hindsight. It is therefore important that this risk is managed, and that Treasury Management staff have clear guidelines and parameters within which they can operate.

Second, Treasury Management requires quick decisions on transactions. This speed of response precludes individual decisions being taken by a committee, and it is therefore necessary to delegate them. However, as a corollary it is vital to ensure good communications and understanding of roles, to have mechanisms for monitoring compliance with systems, and to put reporting procedures in place to ensure that performance is being properly assessed.

The statement of responsibilities below therefore provides for a considerable degree of delegation to the Strategic Director for Finance and Information and County Treasurer, who is in the best position to assess risk and determine the parameters within which his staff can operate. The responsibilities are in line with those currently operated, but provide for a more formal reporting process to the Executive Committee.

TREASURY POLICY STATEMENT

The responsible committee for Treasury Management matters will be the Executive. It will consider all reports submitted by the Strategic Director for Finance and Information and County Treasurer and will have specific responsibility for:

C approving an annual Treasury Management strategy at its annual budget meeting, this strategy will cover the raising of capital finance, the management of the Council=s long term debt portfolio and the investment of its surplus funds,

C consideration of the annual report by the Director of Finance & Information on the exercise of Treasury Management powers delegated to him,

C the recommendation of borrowing limits as in Section 45 of the Local Government and Housing Act 1989 (being limits on total external borrowing, temporary borrowing, and the proportion of interest paid at variable rates) to the Council at its annual budget meeting.

C the policy on the appointment of external advisers for the management of the Treasury function.