Dan Bates from LG Improve outlines that borrowing debt being used as an indicator of councils’ financial health can be ‘misleading’, as there isn’t just one factor that accesses whether an authority is ‘good or bad’.
Debt should not be used alone as an indicator of a council’s financial health, although it is an important factor. We must understand debt in a context that’s often complex, rarely intuitive and certainly much harder to communicate than well-worn tropes that play out in a narrative shaped by failures at Thurrock and Woking.
The risk is that all indebted councils are derided regardless of the purpose and structure of their loans, perhaps to the extent that they’re forced to sell good assets. At the same time, the flow of capital into local initiatives could dry up as councils become too risk-averse.
Borrowing has been an important way for councils to build resilience as well as fund capital investment in housing and infrastructure that generates income and other social and economic benefits.
Smart councils will have stress-tested the long-term affordability of loans at far higher interest rates than we have today. Others may have secured enviable fixed-rate deals. It wasn’t that long ago that loans fixed at 1% for fifty years were available. Those who secured these terms will be laughing now; at least they would be, were the prevailing anti-debt narrative not quite so one-sided.
HRA councils under the spotlight
The government has consulted on four risk mitigation measures one of which looks at borrowing as a proportion of spending power, much like a measure used by the Office for Local Government. Immediately, that puts a lot of Housing Revenue Account (HRA) councils, which provide council housing, under the spotlight.
These councils will usually have borrowed to fund new builds or to improve existing stock. They will also have 30 years of rental income to pay down the debt, which is why the debt ratio is decreasing for HRA authorities in general. The measure isn’t intrinsically wrong, but it can be misleading and damaging without the context, which I believe is too often overlooked.
Clearly, borrowing isn’t always bad. I think that also extends to borrowing with the pure aim of generating financial returns as much as it does to investment in community assets. Councils bore the brunt of austerity and now face booming service demands. We all knew this was coming and no number of mergers or efficiency drives will plug the gap.
Councils that have exercised due diligence and built sustainable investment portfolios to fund better services should be supported in my view. As with HRA councils, the returns on those investments are used to pay down the debt over a long period of time. There are success stories but there just doesn’t seem to be room for them in today’s climate and that stems from debt being associated as a measure of failure. The government encouraged councils to find new income streams and might well claim a policy success if we could have a more nuanced debate.
Of course, it’s easy for me to say. I spend much of my time analysing balance sheets to unravel the full picture. I review multiple indicators and see them in context. I do understand that others need a simplified view. Often, I highlight reserve levels which offer a more consistent indicator of financial health than debt, although it can be misunderstood too. For instance, reserves were generally growing at the start of this decade, not because councils were suddenly booming, but because they were preparing for tough times ahead.
Reserve levels
Reserves are now firmly in decline. Based on two-thirds of councils that have now published audited 2022/23 accounts, likely (but not definitively) the healthier portion of councils, reserves have decreased on average by 13%. Some report much faster rates of depletion, which does indicate financial stress.
By looking at reserves across local government, patterns emerge that might not be apparent to councils themselves. Take the ten authorities with the most rapid depletion of reserves. Most are small unitary councils, two being metropolitan boroughs. This cluster appears to be independent of political leadership and geography, suggesting a systemic bias against the council type. There will be other factors, some councils that fit this profile are doing fine, but it shows a level of complexity that’s not immediately apparent.
I hope that the examples I’ve shared show that council finances are neither intuitive nor fairly summed up by any single measure. There isn’t one factor that tells you if a council is good or bad, let alone why things are as they are. I think it’s important that we support one another as a finance profession to get this message heard and to prevent the response to failures from turning into a witch hunt.
Dan Bates is the financial resilience director at consultancy LG Improve. He will be exploring these points more in an open Microsoft Teams webinar on 10 October.
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