Appendix 5

Treasury management activities 2003/04

1 Introduction

1.1 The Treasury Management Policy Statement adopted by the County Council in February 2003 requires an annual report on the exercise of the treasury management function to be presented at the end of each year.

1.2 This report summarises the main aspects of the management of the Council's debt and lending in 2003/04 and in particular sets out:

· The Council's external borrowing requirement in 2003/04

· The economic background

· Types of borrowing used

· A comparison of the composition of the Capital Financing Requirement 31 March 2004 with that for the previous year.

2 External borrowing requirement in 2003/04

2.1 The Council's external net borrowing requirement depends on:

· The level of borrowing required

· Less the availability of internal balances.

2.2 The level of borrowing required for capital expenditure amounted to £53.2m in 2003/04 which was determined as follows:

2.3 As a result, bringing into account a decrease in internal funds of £9.8m and a reduction in the level of transferred debt of £2.9m (see table at paragraph 5.2), the level of external borrowing increased by £45.8m as the following table shows:

3 External borrowing

3.1 At its meeting in February 2003 the County Council set limits on total and temporary external debt of £360m and £240m respectively and borrowing levels remained within these limits during the year.

Long-term borrowing

3.2 The Cabinet approved a treasury management strategy for 2003/04 in February 2003. At that time, market commentators had been expecting base rates to rise marginally over the period to March 2004 as economic recovery strengthened. However, growing fears of world economic deflation led instead to cuts in base rates in February and July 2003 where they reached a low of 3.5%. Increased optimism about the economic outlook and continued strength in the housing market meant that this trend was then reversed and base rates returned to 4% in February 2004.

3.3 The Committee agreed the following strategy:

· Long-term and short-term rates to be closely monitored.

· Long-term fixed-rate borrowing to be considered if long-term rates stand at 5% or below.

· Long-term fixed-rate borrowing to be considered at rates higher than this if clear signs of a rising trend occur.

3.4 Long-term rates had been relatively stable over the year to February 2003. At the time of that meeting 25-year rates stood at 4.5%. Forecasters were predicting marginal increases in long-term rates in 2003/04 of between 0.25% and 0.5% as a result of new gilt issues needed to finance the Government's increased borrowing requirements. In the event, long-term gilt yields remained stable for the first three months of 2003/04 at around 4.5%, rising subsequently over the period from July to September to just below the 5% mark. They were stable at that level until the end of the financial year.

3.5 In February 2003, the Committee agreed a guideline figure for long-term borrowing in 2003/04 of £20m to maintain the balance between fixed and variable-rate debt. In practice, long-term loans were taken from the Public Works Loan Board (PWLB) matching that figure, in line with the agreed strategy. £14m worth of those loans were for periods of 10 years or more. The new loans taken are listed below:

3.6 The average rate payable on the long-term fixed-rate portfolio fell during the year from 6.8% to 6.5%. The current PWLB rate for over 20 years is 5.1%.

Lender's option/borrower's option loans

3.7 Recent treasury management strategy reports have mentioned that the commercial money market has become increasingly competitive in the last two years or so. In particular lender's option/borrower's option loans (LOBOs) were becoming more attractive, with rates matching or sometimes below PWLB rates.

3.8 A typical LOBO means taking a loan for a primary period at a relatively beneficial interest rate fixed for that period, followed by a higher rate for the remaining period which can be changed by the lender every six months. The Council, as borrower, would be able to opt to repay the loan at the end of the primary period and every six months thereafter, but only if the lender chooses to change the quoted rates.

3.9 As stated in previous reports, the main advantages of LOBOs are as follows:

· Very cheap initial rates can be obtained (sometimes below 1%), which cannot be matched either by long or short-term loans available elsewhere.

· Quoted rates for the remaining periods to maturity are also relatively attractive, being similar to those available from the PWLB, although the lender can change the rate every six months - at which point the Council can repay.

3.10 There are also disadvantages, which are:

· There is a lack of certainty - the lender can change the rate every six months at the end of the primary period.

· If the rate isn't changed the Council cannot repay.

· The minimum principal sum for a LOBO is £4m, higher than the normal £2m tranches being taken from the PWLB.

3.11 LOBOs do not provide the guaranteed long-term interest rate stability provided by the PWLB's fixed-rate loans, but they are an attractive option when they offer very low interest rates for the primary period, and competitive rates thereafter. The Cabinet agreed in February 2003 that a ratio of 2:1 between new long-term fixed-rate borrowing and LOBOs would be appropriate, which meant a target for LOBOs in 2003/04 of £10m. However, they would only be taken on two main conditions:

· That they would generate short-term savings over their primary periods compared with standard short and long-term interest rates.

· That their indicative rates for their remaining periods would be no higher than the trigger rate used for fixed-rate long-term borrowing.

3.12 Three LOBOs were taken in 2003/04 totalling £12m as follows:

Temporary borrowing

3.13 Temporary external debt includes borrowing from the Pension Fund and Hampshire Police Authority. Borrowing from these two sources reached peaks of £90.2m and £38.7m respectively. Temporary borrowing from other sources reached a peak of £11.1m in January 2004. Interest to the Pension Fund and Police Authority was paid based on the monthly average seven-day notice rate, which over the year averaged 3.58%. The average rate paid on borrowing from other organisations was 3.32%.

4 External lending

4.1 Surplus cash balances were lent out during the year to borrowers on the Council's approved list. The list is kept under continuous review to avoid the possibility of any capital loss. In 2003/04 it included the major clearing banks, one top building society, four highly rated European banks, and also four money market funds (MMFs), which were made available to local authorities from April 2002. MMFs are large pooled funds (most are over £1bn) that are able to invest in a whole range of money market instruments with maturities up to 13 months. Investors benefit when higher rates are available on longer-term deposits, but suffer no loss of liquidity. Funds can also be lent to other local authorities.

4.2 The weighted average rate achieved on funds lent out temporarily was 3.69%.

5 CLP debt outstanding

5.1 CLP debt outstanding represents the total indebtedness of the County Council on the acquisition and capitalised maintenance of assets not yet charged to the annual revenue accounts.

5.2 The following table sets out the balance of total indebtedness between long and short-term external borrowing and internal resources both at 1 April 2003 and 31 March 2004: