NAO: revenue budgets face ‘fundamental problem’ caused by servicing debt

The “pressure” placed on local revenue budgets by capital programmes is a “fundamental problem”, according to the National Audit Office.

Parliament’s spending watchdog made the comments in a report on council finances which concluded that the servicing of debt taken on to fund capital projects was a threat to revenue spending.

The NAO noted that many local authorities have used internal borrowing to reduce the cost of debt, but if interest rates are set to rise they may look for external debt in a bid to lock in preferable rates before they go up.

Research also found that changes to loan terms by the Public Works Loan Board means early repayment of debt has become unattractive.

Debt costs

The NAO’s report said debt servicing costs accounted for 7.8% of revenue spend in 2014-15. For a quarter of single tier and county councils the proportion is as high as 9.9%.

At the same time, according to the NAO, revenue spending power has fallen 25.2% since 2010-11. Capital grants went through a minor rise of 0.2%.

The NAO said: “If authorities cannot reduce their debt servicing costs, this will place further pressure on revenue spending.”

It added that minimising the revenue cost of capital programmes is the “the primary challenge facing authorities”.

It noted that local authorities have adopted a number of “prudent” treasury approaches to tackle the issue including “minimising” external borrowing and recalculating the minimum revenue provision to be set aside. Council’s also focused on “internal borrowing” from temporary surplus cash.

Housing

But the NAO also noted that housing revenue accounts have been increasingly targeted for funds to support capital spending. 2014-15 saw a 58% increase in funds drawn from HRA from £1.4bn to £2.2bn.

Contributions from capital receipts have increased year-on-year from £1.4bn to £1.7bn while developer contributions to capital programme also rose by £100m to £700m.

Out of total capital spend of £12.3bn in 2014-15 the largest proportion was on fixed assets (new construction, conversion and renovation) and amounted to £9.2bn. However, spending on loans and grants rose 21% to £220m.

Interest rates

Councils indicated the internal borrowing model could change if interest rates looked set to rise.

The NAO noted that figures showed the stock of borrowing looked as if it was shifting. 2014-15 saw the stock of external debt grow by £872m while the stock of internal debt fell by £49m. The previous year, 2013-14, saw the sum of external debt fall by £925m while the internal debt pool rocketed by £1.47bn.

“Authorities have used internal borrowing to delay external borrowing and keep the costs of debt servicing repayments down,” said the NAO.

“However, case study authorities told us that if interest rates looked likely to rise this may encourage them to switch to external borrowing to avoid the risk that, when they do return to the market, interest rates will have risen … even if authorities do return to external borrowing before rates rise, any switch to external borrowing will increase the cost of debt servicing relative to internal borrowing.”

Invest

A shortage of funds have persuaded many authorities to turn to “invest to save” strategies. But this has shifted spending on “existing assets” lower down the list of priorities.

“Capital strategies have begun to move from focusing on managing assets, to generating revenue savings and commercial income.

“Total spending has remained stable, but increasingly capital activities are focused on invest to save and growth schemes that cover their costs or have potential to deliver a revenue return.

“However, many areas of authorities’ asset management programmes do not meet these criteria and are now seen as a lower priority.

“In particular, authorities told us they are delaying long-term investment in capital works on existing assets. This raises concerns about the possible degradation of authorities’ assets and pushes the costs of the maintenance backlog into the future.”

PWLB

Meanwhile with £25.4bn in investments in 2014-15, alongside £58.7bn of gross external debt, the NAO concludes that local authorities in general are less likely to repay debt early.

This is partly due to lower interests rates which have increased the premium on early repayment. But councils also told the NAO that changes made by the PWLB were also responsible.

“…authorities we spoke to said that changes to PWLB’s early repayment terms in 2007-08 (to protect the National Loans Fund) and to new loan terms in 2010-11 mean early repayment was now no longer value for money.”

Recommendations

The NAO made a number of recommendations including a review of how minimal revenue provisions are calculated.

The Treasury is also called on to investigate the causes of “systemic risks” resulting from a build-up of investment cash held on deposit by local authorities.

The NAO also wants a review to see whether the current capital framework produces decision making geared toward the long term.

This issue should also be considered by CIPFA, says the NAO, in its review of the Prudential Code.

A statement issued by the Local Government Association said: “Revenue funding reductions over a number of years mean councils have been forced to concentrate on investing money in capital schemes to save ongoing costs and prevent cutbacks to local services as much as possible. This inevitably has left less money for them to invest in existing assets.

“Councils have been working hard to try and minimise the cost of paying interest on outstanding debts.

“However, the cost to local authorities of paying off debts early has increased after rule changes by the Government’s Public Works Loans Board and this has made it harder for them to benefit from low interest rates.”

CIPFA said: “The NAO report provides valuable insight into the current state of capital spending, particularly during this time of austerity. It demonstrates the real need for affordable, prudent and sustainable medium term financial planning.

“CIPFA has been working closely with the NAO on this topic and will certainly be considering its recommendations during our planned review of the Prudential Code.”

/ends