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SubscribeArlingclose director David Green discusses some of the latest local government treasury trends as he anticipates potential government actions and offers advice on investment strategies.
David Green, director at Arlingclose, thinks there could be some “tweaks” in tomorrow’s Budget (30 October) or in the near future, even if it is “only extending the Housing Revenue Account (HRA) rate”, which is set to expire in June 2025.
He tells Room151: “If they can convince themselves that that makes money for central government, whether it’s up or down, you can see them doing that. But they can’t raise it too high, because it’s better to keep that margin within the public sector rather than risk the private sector take the margin.”
However, he sees the PWLB rate of gilts plus 80 as “more or less the natural level”. There is something of a chicken and egg argument here, though. “Do private sector lenders never lend far below PWLB rates because they don’t need to, because local authorities will take them at anything that’s slightly below?” he asks. “Is it not a proper market out there? But equally, there’s not much out there that undercuts gilts plus 80, and I think nothing that undercuts gilts plus 40, which is the HRA rate and also the UK Infrastructure Bank rate.”
He notes that with environmental or town centre regeneration projects potentially using the lower UKIB rate, and with the HRA rate for council housing, “we’re getting to a reasonably small subset of things that you have to borrow at gilts plus 80 for – schools and leisure centres and not a lot else”.
So why are these being effectively “penalised”, Green wonders? “It’s almost as if we’ve made the reduction so wide that people aren’t doing schemes without reduced rates. It makes sense to cut everything to PWLB plus 40 and stop penalising people who want to build leisure centres.”
But given that this will be “scored as a cost to central government”, he does not necessarily see this as likely.
Many respondents to Room151’s 2024 treasury management survey agree with Green that adjusting PWLB margins could be an important ‘quick win’ for government. If more favourable rates were widened beyond specific housing areas, respondents felt that would support local authorities in delivering the place objectives that they have.
Investment in a falling rate environment
Moving on to investment and borrowing, and with there potentially being between four and eight interest rate cuts next calendar year, and “probably” one this year in early November, councils may need to take a different approach to treasury management.
He says long-term investments represent good value in the falling interest rate environment, while long-term borrowing should be delayed in favour of a short-term approach.
“For investors, there’s an opportunity to lock in now at long-term rates that are a bit lower than today’s short-term rate. This will give you any higher income now, and less next year, as you smooth that transition across,” he says.
“The longer you lend for, the more certain you’ve got to be with the credit risk, because there’s more time for things to go wrong. If you take that view for three years a covered bond, for example, has very low credit risk. You get paid a premium for locking money out as well, because borrowers prefer long-term certainty, so they pay up for those type of loans.”
For borrowers, it could be the opposite situation. “It could be about putting off long-term borrowing, because short-term borrowing is going to be so much cheaper next year,” Green adds.
Asked what and whether there could be an impact from many local authorities taking the same actions at the same time, Green notes that because the local to local market is “essentially the whole short-term market”, if the number of borrowers doubles but the number of investors stays the same, then the “price goes up, and there aren’t enough other non-local authority lenders in the market to balance it out in the short term”.
But there will be little impact in long-term borrowing, as the amount of gilt supply in local government is “very small” compared to the total and what central government is borrowing.
Action on capital flexibilities?
It will also be interesting to see what the new government does with capital flexibilities, after the previous government invited views on a set of options. The consultation centred around whether to use capital receipts for even more revenue activities, or whether to borrow for certain revenue activities, Green says. Making it easier to move money between two different pots is an “absolutely sensible thing” to do, he thinks.
“The public finds it difficult to see why a council has large amounts of cash, but very tight revenue reserves and a very tight revenue budget, because all the money is in capital receipts, and that it can’t spend because it’s in the wrong pot; it’s in the capital pot, not the revenue pot,” he explains.
“There’s a limit to how much we can use one off income to fund recurring expenditure, but not all revenue expenditure is recurring.”
He offers the example of redundancy costs. Capital receipts can currently only be used for statutory redundancy costs, and not for voluntary redundancy or for amounts above the statutory minimum. “That’s an obvious one-off cost that they could extend capital flexibilities for,” Green comments.
With commercial investments coming under increased scrutiny in recent years, the government could also give more capital flexibilities to the sale of investment properties and other sales as a “soft encouragement to sell them without making it a legal requirement to sell”.
However, this could be seen as rewarding people who bought the properties and “who took the risks”, “almost to the expense of the people who didn’t”. A note of caution must therefore be struck.
Although Green “gets the feeling” the new government is committed to localism, he does not see them mandating sales of such properties. “But absolutely there could be something that nudges it, through some more flexibility on that side,” he adds.
Liability benchmark will prove its worth
Green has been a “big proponent” of the liability benchmark; the effectiveness of which split opinion in Room151’s 2024 treasury management survey. While most said it was ‘somewhat effective’, there were only slightly fewer who said it was ‘not effective’.
It is still “early days” though, says Green, for the benchmark which Arlingclose describes as “effectively the net borrowing requirement of a local authority plus a liquidity allowance” and for which it has been preparing clients for over ten years.
“It’s great to see that CIPFA finally brought it in,” he comments. “How do you make a 50-year borrowing decision without a 50-year forecast of how much cash you need? Yes, it’s never going to be a perfect forecast, but there are some things you do know. You know your CFR is going to come down with MRP. You don’t know how much it’s going to go up by with new capital expenditure, but really you shouldn’t be borrowing today for capital expenditure that you might incur in ten or twenty years’ time anyway.”
He notes that some officers try to explain the liability benchmark to elected members by detailing how they’ve built it up, “which is quite complicated”, whereas “they need to be explaining it by what it actually means”.
Broadly, he says, “you’ve got your actual debt, the known item in it, the debt you’ve already borrowed and how quickly it matures off. And then you’ve got a couple of lines for, essentially, the maximum you’re able to borrow under the Prudential Code, and a minimum line showing how much to borrow to no cash, the technical minimum. Your liability benchmark should be the sweet spot between the two.”
At the maximum end, there is lots of borrowing and investments, and cash generation, but there is a risk of borrowing at one rate and reinvesting at a lower rate. At the bottom, there is a minimum amount of borrowing and no cash, so there is a liquidity risk.
“There’s risks at both extremities and the liability benchmark is meant to be this sweet spot between the two where we can’t cancel all the risk, but we can take a more moderate position. Comparing this ideal borrowing position to the actual [means that risks are taken] with our eyes wide open, and it can be [more easily] explained why [a council] is doing something different to the ideal position.”
The rainy day has come
Green also points out that officers should use the next five months to have a “good look” at their minimum revenue provision (MRP) policy, with new requirements coming in at the end of March 2025.
“One of the things is that you can’t change your MRP policy just to make savings. So if you want to do that, you’ve got to get it in in the next five months,” he points out.
“I think there’s still places where people are charging too much through MRP or not capitalising interest, and some people still charge capital directly to revenue in the year. The sector as a whole is crying out for cash. Let’s stop making charges that don’t benefit anyone in what’s just an accounting move.”
While finance directors “always like to keep something in reserve for a rainy day”, Green wonders what other storm they could possibly be waiting for to make potential one-off savings, given “the inflation spike, costs increasing massively, and government grants and council tax not increasing at the same rate”.
Green adds: “Is this as bad as it gets? Or is central government funding so tight that things are only going to get worse? I think that’s a question lots of finance officers are wrestling with. Do we release these one-off savings now, because this is the bottom, or are we going to keep going down the mountain? Do we need to keep these for later years?”
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