Many local authorities are under borrowed against their capital financing requirement, and this could present an unexpected risk, according to panellists at Room151’s Monthly Online Treasury Briefing (MOTB).
Innes Edwards, principal treasury & banking manager for the City of Edinburgh Council, warned that should “something go wrong politically” – with interest rates then rising rather than falling as expected – the sector’s current investment strategies put it at “huge risk”.
Local authorities have either been taking short local authority loans “in lieu of long-term borrowing”, or at the end of March dipped into the PWLB where they have for the most part been going short, he said at this morning’s (28 June) MOTB, although some one year or “sensible” 13-month loans have been taken.
“We’ve got a borrowing environment in the next five years of about £1.5bn, and it seriously worries me that with the level of gilt issuance that’s coming along, that if something goes wrong politically, if somebody takes the wrong decision and we’re heading towards ‘Truss land’ [referencing the consequences seen as a result of Liz Truss’ so-called ‘mini-budget’ in September 2022], the strategies that we’re all running have huge risk attached to them,” he said.
Joining Edwards on the Finance Panel at the MOTB was Khadija Saeed, head of corporate finance at Lancashire County Council, who said the under borrowing position was largely “tactical” and the result of “a level of brinkmanship going on”.
She noted that because the cost of making the borrowing decision is “quite significant”, and given the interest rate environment, most local authorities were focused on satisfying their cash flow needs and were “resisting borrowing”, but are “using up their stocks of cash that they previously got borrowed”.
Saeed also noted the impact of the age profile of treasury managers. “People are not borrowing if they don’t absolutely need to borrow, because the rates given haven’t been seen by many of the staff that are currently working in these local authorities, given their age profile, and they will see it as very expensive,” she said.
“They will think this is extremely unusual to be committing to borrowing at these levels, especially when a lot of the press globally is talking about rates coming down. So it will be very hard to convince someone to commit to long term borrowing. And in a local authority, any member of the council chief executive would ask why a high level was being committed to when the rates are expected to come down.”
Despite his expressed concerns, Edwards said his central forecast was for gilts to still come down, with the UK bank rate also coming down. He expects this to lead to a position where “we can borrow decent amounts”.
Investment strategies
During the MOTB Finance Panel, Saeed noted that Lancashire’s investment strategy had changed very little in recent times, as the authority has “always passed quite a wide view of things”.
However, Lancashire has “tended towards financial assets rather than property”, meaning it has been less exposed to some of the “volatility around valuations and perhaps requests around that”.
That has proved somewhat significant as Saeed noted that Moody’s, which provides a credit rating for the authority, was particularly keen to assess Lancashire’s exposure to commercial properties. Saeed said the press coverage of this issue had potentially given the impression that “local authorities are the only people who invest in properties”.
Edwards noted that Edinburgh did not borrow from the PWLB between 2012 and 2019 and created interest rate risk, which over the following three years, was locked out by borrowing nearly £500m. This put the authority “right up to our capital financing requirement”, giving it significant cash balances. In recent years Edinburgh, as rates went up, has not been borrowing, putting it well under the capital financing requirement.
Edinburgh is, though, one of the top ten local authority lenders in the UK. “Our strategy has changed a bit. I think for the good of the local authority sector, we’ve actually increased the loans we have to local authorities to the extent that around December, we had 75% of our cash fund lent to other locals,” he said.
“There was a lack of liquidity in the local authority market at the end of 2023 24 but as a lender, this was really good for us. For the first time in quite a while, not only do we have a positive, real return from cash, but we were well ahead of our benchmark over that period, after more than a year with 14 consecutive interest rate rises where it was virtually impossible to perform any sensible benchmark.”
Edwards said that Edinburgh has been “quite picky” about local authorities it lends to. Having railed against borrowing from the PWLB and investing it in commercial property in the past, “we took the view in Edinburgh that if I was saying that in treasury management panels, we shouldn’t, therefore, be lending to authorities with large commercial property portfolios funded by borrowing”.
This month’s MOTB also featured an insightful macro and property market update from CCLA’s Richard Sankey, in which the ‘Magnificent Seven’ technology companies’ strong earnings growth was considered, along with the potential impact of the UK and US elections.
Subscribers of Room151’s Monthly Online Treasury Briefings, which take place on the last Friday of every month, can view recordings of the sessions at a later date of their convenience along with presentation materials. Please click here to register for the MOTB.
June’s MOTB was sponsored by CCLA.
—————
FREE bi-weekly newsletters
Subscribe to Room151 Newsletters
Follow us on LinkedIn
Follow us here
Monthly Online Treasury Briefing
Sign up here with a .gov.uk email address
Room151 Webinars
Visit the Room151 channel
