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Council exposed to 'significant risk' over interest rates
HEREFORDSHIRE Council is exposed to “significant risk” over interest rate movements on its borrowings and investments.
The warning comes in the council’s own 2012-13 statement of accounts.
Latest projections put the council on course for a £4m overspend on its 2013-14 budget which would have to be funded from reserves.
That 2013-14 budget puts the council’s general reserve at £6.6m after meeting the 2012-13 overspend. Another £13.9m is held in earmarked reserves.
By the end of the 2012-13 financial year the council’s total borrowing topped £157m - up from £144m at the end of the 2011-12 financial year - with another £34m in new loans estimated as needed to cover borrowing for the 2013-14 capital programme and a forecast fall in reserves.
As at the end of March this year £16m of short-term loans from other local authorities were outstanding.
By the end of July, however, eight short-term loans from other local authorities total £25m and ranged from 115 days to 283 days with interest rates varying from 0.36 per cent to 0.44 per cent including broker’s commission.
The council maintains that short-term borrowing from other authorities is “good practice” where interest rates are well below those available from other sources.
Another £12m relating to two potentially long-term bank loans is shown in the statement as repayable within one year. These loans are listed as current liabilities because every sixth months, when interest payments are due, the lenders have the option to increase the interest rates being charged.
The council did not take out any new long-term borrowing over 2012-13.
Principal of £3.9m was repaid to the Public Works Loans Board under existing annuity and EIP (Equal instalments of principal) agreements.
Short-term borrowing from other local authorities was taken out to cover liquidity requirements and capital spend. The statement says this strategy resulted in “significant saving” when compared to budgeted interest.
However, the statement warns of the “significant risk” the council now faces over its exposure to interest rates on its borrowings and £48m worth of investments - as at July this year - with impact made by changes in interest payable and receivable.
The effects of a rise in interest rates are listed as:
• Borrowings at variable rates - the interest expense charged to the surplus of deficit on the provision of services would increase.
• Borrowings at fixed rates - the fair value of borrowings would fall.
• Investments at variable rates - the interest received credited to the surplus or deficit on the provision of services would rise.
• Investments at fixed rates - the fair value of assets would fall.
The council’s loans are all fixed rate which means that when the Bank Base Rate is low, the interest rate paid on borrowing is relatively high compared to the rate received on investments.
Responsibility for assessing interest rate exposure lies with the council’s treasury management team to inform the setting of the annual budget and quarterly strategy meetings with the council’s treasury advisors.
The council also sets an annual treasury management strategy which includes analysing future interest rate forecasts.
If interest rates had been one per cent higher - with all other variables held constant - the financial impact on the council’s borrowings and investments would have seen a £284k increase in interest receivable on investment balances and a £52k increase in interest payable on new borrowing, benefiting the council in the short term as the interest received on investments tends to be at variable rates whereas all loans are currently at fixed rates.
Over the four months to July 31 this year, interest received on the council’s investments has exceeded budget with both the amounts invested and the average interest rates achieved being higher than the budgeted amounts.
Interest rates on the council’s £9m worth of instant access bank accounts, however, have fallen sharply, leaving the council to use notice accounts and term terms with an increased reliance on short term borrowing to provide liquidity.
This policy is possible because the interest rates payable on short-term borrowing are lower than the rates earned on the investments. The policy does see both short-term invest balances and short-term borrowing relatively high.
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