Richard Paver on cuts, borrowing and derivatives

Richard Paver has been City Treasurer of Manchester City Council since 1999 and became the first Treasurer of the Greater Manchester Combined Authority in 2001. In these roles he has been responsible for negotiating, as part of the HRA reform, the repayment of a substantial sum of market LOBO loans and, as part of the Combined Authority’s Metrolink funding, a £450m facility with the European Investment Bank.

 

Room151: There are moves afoot to create a bond agency for local authorities – how attractive do you think that will be as an alternative source of lending? Does it depend entirely on the rate?

Richard Paver: I think it’s of some interest. Clearly we’re waiting to see the shape of the PWLB proposals for reduced margins and I think a lot of it will come down to the rate that’s on offer and the flexibility of the product, not least in the certainty of pricing as you run up to a bond issuance. With the PWLB, at the time you deal you know what you’re getting and you make a decision about whether you go for it or not. It’s always going to be a slight worry to me that in a volatile market you set yourself off on a route with bonds but actually you don’t know what the outcome is going to be until the deal’s struck. It’s a bit like PFI where you’re in the lap of the gods for a few days. But if PWLB comes down 20 bps and people are still paying PWLB-like rates for bonds, I can’t see why you’d go down the bond route. If they can undercut PWLB sizeably then of course people will look at it.

Room151: What do you think PWLB will ask of you in return for the additional reduction in borrowing costs, on top of the 20 bps?

RP: I honestly don’t know. Presumably you’ll define a strategy in terms of capital expenditure and get some sort of sign off from your auditors who look at capital strategies. Where you’ve got prudential borrowing you’ve got a business cases behind it and maybe that’s the sort of thing they’ll be looking at. I imagine there’ll be a certain degree of self-certification though because they’re not going to want to trawl through 400 different authorities’ capital programmes and capital strategies.

Where they go beyond that for lower rates – or the bit that would interest me as treasurer of the combined authority as well as city treasurer – would be lower rates for projects that generate economic value. That’s certainly something we would want to see on the agenda. We (the combined authority) are ploughing a billion pounds of borrowing into Metrolink and other highways and transport schemes. That’s the sort of project you’d think Government would want to encourage.

At the minute they’re taxing our growth – so we’re spending money on growth and they’re making money out of us – which seems slightly perverse.

Room151: How would they quantify that economic growth from the outset to make a call on the interest rate reduction in the borrowing?

RP: I think they’ve got through the City Deal negotiations with mechanisms for having those discussions. As you know we’re using the ‘earn-back’ model where we try to quantify the economic growth from the investment we’re already making. So those conversations are starting to happen – there’s a long way to go  – but if the principle of the ‘earn-back’ model is agreed we’d hope to see that feed through into PWLB rates.

Room151: Does Manchester lend to or borrow from other councils? If so is it something you’re doing more than you used to? 

RP: We lend shorter term to other councils. The strategy of both authorities we manage is to minimise the cash that we’ve got by delaying draw-down of long-term funds – because of the cost of carry. However, both of the authorities are cash rich at the moment – although that will reverse as the year goes on – so we are lending quite extensively to other authorities but only up to a month or two, we won’t go further than that.

We went more to the banks and building societies in the good old days but if you look at our lending list now I’ve got £8m with Birmingham, £10m with Glasgow, £10m with Leeds. I’ve got money out with Dumfries & Galloway, Dundee, Glasgow, GLA and then I’ve got the Nationwide and the DMO. So yes, we are lending more to other authorities. Both of our authorities have a lending limit of £5m to commercial institutions so if you have substantial cash balances, you soon run out of places to put it apart from other authorities and debt management office. I’ve got £47m with the DMO – once you’ve exhausted counterparties who are prepared to pay a bit more, then what do you do with it? Our strategy has been safety first.

Room151: Would you like to be able to manage your treasury risks with derivatives? 

RP: I think there’s considerable merit in being able to do it and the caveat is skills and expertise etc. What we’ve done with our European Investment Bank loan is to fix future draw-down up to, I think, 2015 so we’ve effectively hedged interest rate movement through a loan facility rather than a derivative and for a big programme that really is heavily exposed to interest rate risk, that’s a huge bonus. Without that we’d be funding almost on a pay-as-you-go basis and if rates stay low you’re fine but if rates suddenly go up you’d be hugely exposed. So having the facility to use derivatives to do that sort of hedging of interest rate risk  must make sense, providing you’ve got the skills, risk management and governance in place which perhaps people haven’t had in the past.

We were one of the two or three authorities who were repaying market debt for the HRA reforms – we had £90m of market debt and £200m through the PWLB – and during the run up to that we were quite heavily exposed to interest rate risk and a mismatch between the way the CLG was calculating the premium and the loan that we held: they were effectively pricing 20-year PWLB and we got 40 to 50 year LOBOs. The danger that they would move out of sync – sometimes they move together and sometimes they don’t and we were exposed to them moving in opposite directions and had no way of hedging that.

Room151: What measures have you taken to manage central government cuts?

RP:  We had roughly £170m to save over two years – we were one of the worst hit by the settlement along with Liverpool and one or two others so redundancies had their place in that; about 40% of savings came from staffing and 60% from non-staffing.

Procurement’s been part of that for the last four or five years. We have a very well advanced and well regarded procurement function. We’ve got very much into contract management – not just the initial vetting of the contract but the whole contract management procedure –  and have gone into the non-traditional areas like social care, children’s care, children’s educational placements, the elderly, learning disabilities, areas like that. Most councils don’t touch those areas in procurement terms and we’ve achieved quite considerable savings there.

We’ve been looking at the way you provide leisure and library facilities – designed not to close down the services but to deliver them in different ways. Financially that’s pretty much at the margin though.

We’ve paid a lot of attention to waste – waste recycling, waste disposal etc, and made savings there. We’ve also looked at our early years, Sure Start provision, which was very much a universal service, now moving more to a commissioner of targeted services for those in need which will see us move out of the delivery of early years services.

Now we’re into Community Budgets and we’re doing some soft market testing for Social Impact Bonds. Greater Manchester is one of the four pilots for Community Budgets.

Room151: So with more cuts on the horizon is there much more you can do?

RP: One of the big questions is how much are the reductions going to be but there’s a huge degree of uncertainty of both the totality of local authority spend and then the distribution of that through the funding mechanisms. Looking two years hence we’ve got figures in mind of between £55m and £80m. Community Budgets in the wider sense have got to be a part of delivering savings and the thorny subject of the localisation of council tax benefit is an area we’re addressing with a view to making savings next year.

We’re not expecting cuts to be as severe as the last two years though. We’ve modeled what we think the current CSR process means for us, come up with a figure and added half again to give us a range of scenarios to work with. We’re very much focusing though on trying to make savings without reducing frontline services and that’s where we think Community Budgets comes in.

Room151: LGPS have been courted recently to invest in infrastructure. What do you think is the most likely source of investment for infrastructure projects?

RP: We’re doing some work with the Greater Manchester Pension Fund on a housing investment but it’s a commercial model – homes for rent or for sale – in some sites that the Council and the Homes and Communities Agency own: a kind of ‘joint venture’ approach. That fits with the risk profile of the pension fund and the kind of return the fund wants and it fits because it’s not a council service – it’s not infrastructure in the sense of roads and schools.

I do struggle to see, if a council wanted to build roads or develop schools, why we would look to pension funds to provide what we can borrow from the PWLB. The housing scheme is very different. It’s a project with risk – our investment is our land value – and the pension fund puts in capital which the market will pay a return on.

I think the notion that we’ll go and raise bonds through pension funds just to do what we can do already is way off the mark.

We’ve had developers coming along and say they can fund projects and they require a certain rate of return and they’ll need the Council to guarantee that, and we say: why would we do that when we can borrow more cheaply and flexibly than you can provide?

So I think there’s a place for pension funds for projects that are commercial in nature but their rate of return requirements are way above what the cost of capital is to us at the moment.

———————————————————————————————————————————————–
The Local Authority Treasurers’ Investment Forum September 25th, 2012, London Stock Exchange
———————————————————————————————————————————————–