Ever-increasing investments

I’ve been ploughing my way through local authority balance sheets recently, and it seems that despite the odds, and the cuts, investment balances are still on the rise. Latest ONS statistics show local government liquid assets at an all-time high of £39.4 billion at the end of June – no wonder Eric Pickles keeps harping on about it.

Part of the reason is that following the cessation of government supported borrowing in England, many authorities’ CFRs – their underlying need to borrow – is falling, but their debt isn’t. Setting aside MRP each year to repay debt, but not actually repaying the loans, leads to ever-rising investments.

Now, variable rate loans can be repaid without penalty, but with these generally costing only around 0.55% a year, it’s hardly worth doing except for the most risk-averse councils. Fixed rate loans, however are running at anything up to 15.25% – and so are much better candidates for repayment. There is usually a substantial penalty, which often puts authorities off, but this can be spread over the loan’s remaining life to soften the impact, and the annual premium cost will be less than the interest savings, at least in the early years.  And don’t forget that costs in later years will be less of a concern, due to the time value of money and the likelihood that rising investment rates will have lessened the burden on the treasury management budget.

The decision on whether debt repayment is beneficial over the long term depends principally on two unknowns – future short term investment rates and the authority’s future need to borrow. Uncertainty about the future can be used as a reason to delay repayment – after all, if short-term rates do rise soon, or if the loans need to be re-borrowed at higher rates, debt repayment might not have been a good idea after all. Waiting will bring the future nearer, and maybe reduce uncertainty, but you’ll lose out on the savings in the meantime.  I would encourage councils to do some scenario modelling to test under what circumstances debt repayment turns out to be a loser – you might be surprised at how unlikely they seem.

Where debt repayment doesn’t stack up – maybe because there’s a large capital scheme on the horizon – or because the authority is debt-free, we look at some medium-term investment opportunities, particularly those that come with the added security of being property-based.  Housing associations, now known as registered providers of social housing, are an interesting sector.  As highly regulated public sector bodies they receive substantial government support, as witnessed by the HCA-engineered rescue of Cosmopolitan Housing Group.  They might not be as creditworthy as local authorities – the 21 rated associations have an average rating of A+ – but they have simple easy to analyse business models and, unlike councils, registered providers can pledge their assets as security for money borrowed.  The investor can therefore get a fixed rate of return around 3.5% for 5 years, the comfort of knowing that their cash is being used for a socially beneficial purpose, and the security of knowing that if the borrower goes insolvent, they will recover substantial value from the pledged houses.  Compare that with lending to a bank at around 0.5% hoping that short-term rates will rise, with no idea what happens to your cash and worrying about the risk of being bailed-in if there’s a problem.  I know which I would prefer.

David Green is Client Director at Arlingclose Limited. This is the writer’s personal opinion and does not constitute investment advice.