Salford City CouncilTreasury Management Presentation to Members

Richard Bason, Regional Director

Sector Treasury Services

December 2009

2

Sector Treasury Services Ltd

This presentation has been produced solely for the use of clients of Sector Treasury Services Ltd. The presentation itself, or any of the information contained therein, should not be disclosed to any third party without the prior written approval of Sector Treasury Services Ltd.  Strictly private and confidential.

Sector exists to provide its clients with advice on borrowing and investment. We are not legal experts and we have not obtained legal advice in giving our opinions and interpretations in this presentation. Clients are advised to seek expert legal advice before taking action as a result of any advice given in this paper. Whilst Sector makes every effort to ensure that all the information it provides is accurate and complete, it does not guarantee the correctness or the due receipt of such information and will not be held responsible for any errors therein or omissions arising there from. All information supplied by Sector should only be used as a factor to assist in the making of a business decision and should not be used as a sole basis for any decision. The Client should not regard the advice or information as a substitute for the exercise by the Client of its own judgement.

3

1. CIPFA Treasury Management Code

2. The Prudential Code

3. Integrated Treasury Management Strategy

4. Latest Treasury Management Issues to be Considered

Agenda

4

1. CIPFA Treasury Management Code

5

o Need to maintain high and consistent standards in looking after public funds and debt across 500 local authorities

o Total investments @ 31.3.2008 of £30bn+

o Total debt o/s @ 31.3.2008 £57bn+ (£51bn with PWLB at 31.3.09)

Local authorities are BIG players in the London financial markets

Why is a Code needed?

6

o To assist in the development and maintenance of firm foundations for T.M. activities and thereby add to public credibility

o To emphasise effective risk managemento To encourage the pursuit of best value through the use of performance

measuremento To enable CIPFA members to fulfill their professional and contractual

responsibilitieso To facilitate consistent TM policies and practices in the public sectoro To enable consistent auditing of TM matterso To further the confidence and understanding of organisations dealing with

public service organisationso To foster debate on the suitability of TM statutory/regulatory regimes

The 2001 Code’s “eight purposes”

7

1. Adopt the Code

2. Create and maintain: - • Treasury Management Policy Statement (TMPS)

• Treasury Management Practices (TMPs)

3. Receive specified annual reports (TMSS/MRP Policy/Stewardship Report)

4. Delegate responsibility for the treasury management function to specified parts of the organisation and officers

T.M. Code requires each council to:

8

This organisation defines its treasury management activities as:

“ The management of the authority’s cash flows, its banking, money market and capital market transactions; the effective control of the risks associated with those activities; and the pursuit of optimum performance consistent with those risks”.

Treasury Management Policy Statement

9

o TMP 1 Treasury risk managemento TMP 2 Best value and performance measuremento TMP 3 Decision - making and analysiso TMP 4 Approved instruments, methods and techniqueso TMP 5 Organisation, clarity and segregation of responsibilities &

dealing arrangementso TMP 6 Reporting requirements and management information

arrangementso TMP 7 Budgeting, accounting and audit arrangementso TMP 8 Cash and cash flow managemento TMP 9 Anti Money launderingo TMP 10 Staff training and qualificationso TMP 11 Use of external service providerso TMP 12 Corporate governance

12 Treasury Management Practices

10

o Treasury Management Strategy Statement (TMSS) – overall strategy for borrowing and investing for the year ahead (to be supplemented with a semi annual report)

o Annual MRP Statement (from 2008/09)

o Annual Investment Strategy – determination of which investment instruments to use (can be combined with TMSS)

o Annual Report – review of previous financial year (undertake by end of September 2009)

Members have a key role to play in approving all these treasury management reports and policies

Annual Council approval of the following:-

11

2. CIPFA Prudential Code

12

o New system to control capital expenditure started 1.4.04

o Allows LA’s, for the first time, to borrow additionally for capital projects without Government consent provided they can afford to service the debt without extra Government support

o What are the most cost effective and beneficial projects to spend capital resources on?

o What are the most cost effective ways of financing them?

The 2004 Prudential Code system

13

TO ENSURE THAT:-

o Capital expenditure plans are affordable (implications for council tax)

o External borrowing and other long term liabilities are within prudent and sustainable levels (cost of interest etc)

o Treasury management decisions are taken in accordance with good practice

Objectives of the Prudential Code

14

Operational Boundaryo Total external debt – the most likely level – NOT worst case

Authorised Limito Total external debt – the maximum permitted level i.e. “sufficient to allow

for unusual cash movements”

Capital Financing Requirement – the “Acid Test”o The underlying need to borrow i.e. the amount of capital expenditure which

has not yet been charged to ratepayers or financed from grant etc

Key controls under the Prudential Code

15

o Every local authority must set Prudential Indicators (affordability and prudence)

o For 3 years forward (minimum)

o Taking into account:-₋ Capital receipts, grants, revenue contributions etc₋ Revenue impact of capital expenditure – short & long term₋ Interest payable on borrowing and receivable on investments₋ Alternative means of financing capital expenditure or acquiring the

use of capital assets

Setting of Prudential Indicators

16

o There is virtually no limit on how much an authority can spend on capital expenditure if by so doing it can generate financial savings on its current level of revenue expenditure which pay for the additional financing costs.

o A LA now has the freedom to choose the most cost effective method of financing the acquisition / use of capital assets.

o It can now focus on whole life costs of capital assets rather than short term capital restrictions

o Asset management and best value are now key policies

It is for MEMBERS to approve the parameters within which treasury management is to take place

Prudential Code summary

17

3. Integrated Treasury Management Strategy

18

Investing

19

o All investments split into two categories ‘Specified’ and ‘Non-Specified’o SLY - three key principles:-

Security: the top priority: specified investments will include bodies or investment schemes with a ‘high credit rating’ (not defined)

Liquidity also key to prudent investment

Yield: optimum return - still need to “seek the highest rate of return consistent with proper levels of risk”

Key principles for investing under investment guidance

20

o High security and high liquidity - under 1 year to maturityo Institutions or investment schemes with a high credit rating

o Do not score as capital expenditure (or capital receipts when mature / sold)

o Require minimal procedural formalities (para 20)o Justification of use of each class of instrument NOT required in the

Annual Investment Strategy

Specified Investments - principles

21

Term deposits with: -

o Highly credit rated banks and building societies

o Local authorities

o UK government - Debt Management Agency Deposit Facility (DMADF)

o Money market funds

Specified Investments (example)

22

o Investments in excess of 1 year to maturityo Investments with non credit rated institutions will be ‘non-specified’ e.g.

most building societies

o Use of each class of non specified investment will need to be justified in the Annual Investment Strategy

o No Government intention to discourage local authorities from using non-specified investments

o Some investment classes score as capital expenditure

Non-Specified Investments - principles

23

o Deposits with unrated deposit takers e.g. most building societies

BUYING PAPER INSTRUMENTS: -o Bonds issued by Multi Lateral Development Banks (MLDBs) (- Euro

Sterling)o Corporate Bonds

Non-Specified Investments - instruments

24

o To be approved by the full council (or nearest equivalent if that does not exist)

o Before the start of the financial yearo It is to set out HOW the authority will manage its investmentso And how it will give priority to securityo And to liquidity – setting maturity limitso How ‘high credit rating’ is to be definedo Which investment instruments are specified investments i.e. may be

used with little formalityo Whether / which non specified investments may be prudently usedo How interest rate risk is to be managed - expectations for movements

in interest rates and the authority’s strategy for investments

Annual Investment Strategy

25

o They are opinions issued by professional organisations of an entity’s ability to punctually service and repay debt obligations

o Ratings provide international capital markets with a globally consistent framework for comparing the credit quality of institutions

What are credit ratings?

26

o Long-term rating – ability to promptly pay all obligations for periods in excess of 13 months. Range from AAA to D (default)

o Short-term rating - ability to promptly pay all obligations for periods less than 13 months. Range F1+ to D (default)

o Individual rating – assessment of the strength of a bank to withstand difficulties without any support. Range from A to F (failed).

o Support rating – ability and propensity of a parent or state to provide support should a bank get into difficulty. Range from 1 to 5.

Fitch rating agency ratings

27

21

Sector’s Colour Matrices

Individual

1 2 3 4A

A/BB

B/CC

C/DD

Support Individual

1 2 3 4A

A/BB

B/CC

C/DD

Support

Individual

1 2 3 4A

A/BB

B/CC

C/DD

between 1 and 2 years

Support Individual

1 2 3 4A

A/BB

B/CC

C/DD

between 1 and 5 yrs

Support

Short Term: F1+; Long-Term Rating: AAA, AA+, AA, AA- Short Term: F1; Long-Term Rating: A+, A

Short Term: F1+; Long-Term Rating: AA- Short Term: F1+; Long-Term Rating: AAA, AA+, AA

Up to 3 months Up to 1 month

Up to 6 months Up to 1 year

Sector’s 2009 credit rating matrix

28

Diversification – Use Sovereign Credit Ratings – 15 AAA Rated countries…for now (UK on negative watch with S&P)

U.S.A.SpainLuxembourgFinland

U.K.SingaporeDenmark

SwitzerlandNorwayGermanyCanada

SwedenNetherlandsFranceAustria

U.S.A.SpainLuxembourgFinland

Denmark

SwitzerlandGermanyCanada

SwedenNetherlandsFranceAustria

Investment options in the current economic environment - risk aversion

29

0

50

100

150

200

250

300

350

400

450

Date

Sp

rea

d (

bp

s)

UK Germany France Italy Portugal Spain Austria

Finland Belgium Netherlands Ireland Denmark Norway Sweden

Investment options in the current economic environment – is risk aversion just using the UK?

30

o Top down approach to credit quality

o Move away from sole reliance on credit ratings for individual banks

o Addition of AAA rated sovereign ratings filter is an aid in placement of

investments

o Monitoring of Credit Default Swaps spreads helps identify countries or

banks which may be at risk of significant credit rating downgrades

o If in doubt, do the safest option…use DMADF etc

Investment conclusions – risk aversion

31

Borrowing

32

o Authorised Limit

- 2010 £744m

o Operational Boundary

- 2010 £644m

o Capital Financing Requirement (underlying need to borrow for capital purposes)

- 2010 £445m total, of which £87m is HRA

o Total borrowing

- £458m at 2.97% (average 36 years)

- The current borrowing position reflects the strong balance sheet

of the Council

- The Council is able to minimise net interest payments and reduce credit

risk near-term by continuing to temporarily use its cash surpluses

(reserves, provisions, positive cash flow etc)

Salford City Council borrowing position

33

Salford City Council - current borrowing position

CURRENT MATURITY PROFILE

£0

£20,000,000

£40,000,000

£60,000,000

£80,000,000

£100,000,000

£120,000,0002009/1

0

2011/1

2

2013/1

4

2015/1

6

2017/1

8

2019/2

0

2021/2

2

2023/2

4

2025/2

6

2027/2

8

2029/3

0

2031/3

2

2033/3

4

2035/3

6

2037/3

8

2039/4

0

2041/4

2

2043/4

4

2045/4

6

2047/4

8

2049/5

0

2051/5

2

2053/5

4

2055/5

6

2057/5

8

2059/6

0

2061/6

2

2063/6

4

2065/6

6

2067/6

8

2069/7

0

2071/7

2

2073/7

4

2075/7

6

2077/7

8

2079/8

0

2081/8

2

FINANCIAL YEAR

VALU

E O

F P

RIN

CIP

AL

MARKET DEBT

PWLB VARIABLE

PWLB MATURITY

PWLB ANNUITY

PWLB EIP

34

o £298m of the Council’s borrowing is in the shape of market loans

o These were/are generally a cheaper borrowing option than the PWLB alternative but are less flexible

o The majority of the Council’s market loans are LOBOs

o For the lower rate paid, they provide the lender with the option of having the loan repaid prematurely on certain dates (call dates). There is no penalty for this early redemption

o The Council has a debt maturity strategy that ensures that over time a greater proportion of the portfolio will become PWLB loans – providing more certainty albeit probably at a marginally higher cost (still low overall)

Salford City Council – issues to consider regarding market loans

35

o How much needs to be borrowed?

o Over what period of time?

o Which type of loan is most appropriate (PWLB/market/short-term)?

o Which maturity duration is most attractive?

o What is your view of short/medium/long-term interest rates?

o What are the risks to your forecast?

o Set a target rate for the loan duration you settle on?

o Fixed or variable rate borrowing?

o 3 year timeframe but no borrowing in advance of need without explicit member

agreement

Basics to be considered in respect of external borrowing

36

o Deepening of pessimism over affordability of gilt issuance by UK

Government causes major sell off of gilts. Long gilt yields rise

o Post recession inflation causes major sell off of gilts, yields rise

Conversely:

o Double dip recession causes a ‘flight to quality’ from equities to gilts; long

gilt yields < 4%

o Government / BoE embarks on additional quantitative easing to drive

bond and gilt prices up, yields down. Short term interest rates remain low

for longer

Key treasury management risks at the present time

37

o Undertake selective new borrowing – favour short to medium dated or

temporary borrowing

o Consider borrowing LOBOs out of forward dates. This would provide

the Council with the flexibility to lock in a proportion of its borrowing

requirement at current low levels

o Forward deal structures include loans that run at close to Bank Rate

for the next two to three years if the Council wishes to manage its interest

rate risk

Summary of options in respect of an integrated TM strategy

38

o Debt rescheduling is the premature repayment of a loan and its replacement

with another loan of a different duration

o The decision to restructure is driven by the objectives of actively managing a

loans portfolio to generate interest savings whilst maintaining a prudent debt

maturity profile

o The driver for the implementation of the strategy is the shape of the yield

curve

o When a loan is restructured there are two core elements to consider:

- The interest rate differential between repaid and replacement loan

- The discount rate that applies to the residual term of a repaid loan

Basics of debt rescheduling

39

Discounts

o If a 25 year loan is running at, say, 4.5% and the repayment discount rate for the residual term is 5% (this rate will be specified daily), a discount (a credit) of, say, £1m will be achieved

o Discounts are written down over 10 years as a maximum for General Fund purposes – so the £1m discount in our example is written down at £100,000 per annum for 10 years

Premiums

o If, however, a 25 year loan is running at, say, 5.5% and the repayment discount rate for the residual term is 5%, a premium (a penalty) of, say, £1m is payable

o Premiums are written down over either the life of the repaid or replacement loan (the choice is the Council’s). So assuming we write the premium down over 25 years the charge to revenue is £40,000 per annum for 25 years

Other considerations

o There are also some rather complex apportionments of interest and discount/premia that need to be made between the General Fund and the Housing Revenue Account and cashflow funding of premiums etc…but we won’t worry about that today!

Basics of debt rescheduling – premiums and discounts

40

And Finally…

4. Latest Treasury Management Issues to be Considered

41

o Inappropriate to restrict LA investment optionso CIPFA reviewing TM Code of Practice

To confirm the need for an Audit Committee with specific responsibility for Treasury Management functions

To confirm the ability to appoint non elected experts to serve/chair the Audit Committee

To confirm the limitations of credit ratings, and their use within the wider context of financial and economic information and advice

o Member training on Treasury Management matters to be a priorityo CLG to provide clarification in respect of the appropriate use of credit ratingso In respect of Treasury Management, the Audit Commission, CIPFA and FSA to

clarify their roles as regulatory and advisory bodieso Government to carry out an urgent review of the arrangements for early

repayment of debt to the PWLB

CLG Committee report on Local Authority investments(November 2009) – key conclusions and recommendations

42

Questions?