Carry on carrying…

Ok, so I know you treasury professionals out there may not be overly fond of commenting on articles that you have read (and perhaps even found interesting?) but I kick off this blog with a plea.  Please tell me, if you are an authority with both outstanding loans and a not insignificant level of investments, why are you holding investments?

I hope that with such an open and relatively straightforward question I will now be inundated with responses which I shall look forward to reading with great interest.

Why am I asking? Surely, having masqueraded as a treasury professional for the last 16 years, you may think I’d know the answer by now.  I think there was a time when I did indeed know the answer to this, but the problem is, the more I think about it, the less convinced I am of that reason.

If I asked myself this question 4 or more years ago, I probably would have replied that it’s as a result of having reserves, provisions and balances which are cash-backed.  Therefore, I needed to have the available cash to meet any payments due to be made from them – otherwise I may be forced out into the market to borrow.

I possibly would have elaborated further and talked about how my role was to manage both sides of the treasury coin: my debt portfolio and my investment portfolio.  My debt portfolio which, as it exists as a factor of the extent of past capital financing decisions, has a reasonably close relationship with my Capital Financing Requirement.  My investment portfolio therefore relates to the positive cash flow items on my balance sheet referred to above.

This approach was rarely questioned. The heady days of 2007 and 2008 in particular gifted LAs with returns on investments achieving rates well in excess of rates payable on borrowing. Happy days! What a great job was being done.  (Borrowing to on-lend? No way, I’m borrowing because my CFR says I “should” be)

So what has changed, why am I now doubting this rationale? What is making me question this apparent logic that seemed so obvious not that long ago?  A culmination of factors.

Firstly, credit events that highlighted the lack of immunity to credit events in the sector. There were real investment risks out there which had the ability to cause financial damage when they materialised.

Secondly, and very shortly after the first, the yield curve no longer justified the positions of having around £500m debt and around £250m of investments.  Long gone were the days of investments with a big figure 6, or 5 or even 2!  Within just a handful of MPC meetings, investments generating millions of pounds less interest receipts became a painful wake-up call, raising questions about why such large investment balances were held at all.  Crossing fingers and hoping for the return of a yield curve that suited became a much less convincing approach to treasury.

Thirdly, and perhaps most notably, I, like many others out there, started waking up to the true concepts of risk management.  Risk management was not something that was just said in the treasury code, the talk needed to be walked, it needed to come to life.

Tapping into expertise from other sectors, not previously available to local government meant I could actually see my treasury risks quantified.  This reinforced how little risk resided in my loans portfolio but demonstrated that investment risk was rife! I realised I wasn’t managing two separate portfolios, but in fact I was managing a position of net indebtedness.  I had the responsibility and the obligation to manage this net position in a low risk way and to keep my net interest costs as low as I could.

My CIPFA Treasury Management Advisory Group colleagues and I set about deriving the Risk Study to bring these concepts to the wider audience to help others acknowledge their own risk profiles.  The analysis clearly demonstrated that the biggest risk wasn’t arising from borrowing at unknown and possibly higher interest rates; as a sector we didn’t have enough conviction about the long term extent of our capital financing plans to suggest a huge financing need extending into the long term. The bigger risk to our net interest costs arose from investments. The higher the proportion of investments, the greater the risk.

Shouldn’t the level of external borrowing be more closely related to the net indebtedness, rather than being far in excess of this, resulting in the “excess” being lent out at dismal rates of return?  Just because we have always worked that way, does not mean it has to continue.  I don’t know when short term rates will rise again, but there is a huge risk that it won’t be for a very long time.  With budget restraints across the board, is the cost of carry an acceptable hit to the budget or can we do something different?  Let’s just really question the approach on whether we should carry on carrying…

Jackie Shute is the Co-founder of Public Sector Live