Crystal balls required

It’s time to get the crystal balls out.  English local authorities with housing responsibilities have a one-off opportunity to plan the shape of their long-term debt portfolios, either because they have significant sums to borrow or because they are dividing up existing loans into General Fund and HRA pools.

The CLG valuation model provides a 30 year business plan, which authorities will be adapting to include their latest forecasts for income and expenditure.  So it’s no use consulting short-term forecasters like the Institute for Fiscal Studies or even the Met Office.  Treasury managers really need the foresight of Nostradamus or Cassandra of Troy to build a perfect plan for the long-term.

In the absence of such certainty over the future, debt portfolios should be designed with risk management very much in mind.  Where future cash flows are relatively certain, treasury risks can be minimised by having loans that mature when cash is available to repay them.  Too little cash will leave the authority exposed to the risks of liquidity shortages and rising interest rates, while too much cash can leave it exposed to the risks of low interest rates and credit defaults.  And don’t forget that credit loss impairments can only be charged to the General Fund, not the HRA.

As you look further into the future, and uncertainty increases, treasury risks can be lowered by building in some flexibility to the portfolio.  For example, PWLB variable rate loans can be repaid without penalty on any reset date, a big advantage over fixed rate loans.  Alternatively, bank revolving credit facilities, which operate like call accounts in reverse, provide another way to keep borrowing aligned with funding needs.

A degree of modelling and scenario testing is therefore required, noting that the uncertainty around many of the variables is not symmetrical.  For example, there is a greater risk that future revenue and capital expenditure will be higher than in the business plan, than it being lower.  This could be due to building materials inflation, staff pension costs, new properties being built, the impact of benefit localisation or future governments raiding surpluses, etc.  And there is clearly much more scope for future interest rates to be higher than the current market consensus.

But risk management needn’t be the only concern.  Sometimes when you see a bargain it should be grabbed with both hands.  The ability to borrow 50 year loans at 3.25% is an opportunity we are unlikely to see ever again, and if the authority can demonstrate that it will have a borrowing need for the very long term, either HRA or General Fund, a longer-dated debt maturity profile should be seriously considered.  Scenario testing will demonstrate whether the risks of such an approach are offset by the long-term cost savings it presents.

David Green is the Head of Sterling Consultancy Services, a provider of treasury management advice to local authorities and other not for profit organisations.  This is the writer’s personal opinion and does not constitute investment advice.  It should not be relied upon when making investment decisions.