Agenda item

The Authority currently held £5.5m of debt.  Borrowing was at fixed rates, ranging between 4.10% and 4.88% and as a result of this the Authority incurred annual interest charges of £0.25m.

As part of the 2017/18 Treasury Management Strategy, presented to Members in February, a review of debt restructuring opportunities was undertaken which identified that the cost of repaying the loans in the year would be in the region of £1.6m. This would result in lower interest payments over the period of the loans of £2.7m, a net gain over the period of the loans of £1.1m. However, paying the loans early would result in a loss of investment income, and allowing for future interest rate forecasts, once this was taken into consideration then it was estimated that the repayment of the loans would cost rather than save the Authority money. Hence it was recommended that debt restructuring was not undertaken at that time, but that the situation would be reviewed again as part of the mid-year update.

Mid-Year Update

It was noted that a loan for £330k matured on 31 December 2017, and as such was excluded from the review as this would be repaid at that time.

The level of penalty applicable on early repayment of loans had been reviewed again and this now stood at £1.7m.  (As previously reported the level of penalty was dependent upon two factors, the difference between the interest chargeable on the loan and current interest rates, the greater this difference the greater the penalty, and the length to maturity, the greater the remaining time of the loan the greater the penalty. Hence as interest rates increase or as loans got closer to maturity, the level of penalty would reduce.) This compared with the outstanding interest payable between now and maturity of £2.6m; giving a gross saving of £0.9m.  However as highlighted as part of the strategy, and referred to above, any early repayment meant that cash balances available for investment would be reduced and hence interest receivable would also be reduced. The extent of which was dependent upon future interest rates.

Comparison Utilising Base Rate 0.25%

As a starting point a forecast was provided based on interest rates remaining at their current level of 0.25%.  Based on this the anticipated reduction in interest receivable, as a result of the early repayment of loans, was £0.2m.  Hence the net saving by repaying loans early was £0.7m.  The overall position was broken down into a loan by loan analysis in the report as now presented.  This showed at current interest rates it would be financially advantageous to pay off all loans. However, using 0.25% as an interest rate forecast throughout the duration of the loan period seemed unrealistic, as forecasts suggested that interest rates would increase in future years.

Comparison Utilising Forecast Increase in Base Rate to 0.50%

The latest indications from the Bank of England were that base rates were likely to rise to 0.50% earlier than previously anticipated; hence the calculations had been re-run utilising that. Based on this the anticipated reduction in interest receivable, as a result of the early repayment of loans, increased to £0.4m, hence the net saving by repaying loans early fell to £0.5m.  The overall position was broken down into a loan by loan analysis in the report.  This showed that at a revised base rate of 0.50% it would be beneficial to pay off the longer term loans, but not those that mature in the next 6 years. However, even using an updated base rate of 0.50% as an interest rate forecast throughout the duration of the loan period seemed unrealistic, as all forecasts suggested that interest rates would increase further in future years.

Comparison Utilising Current Gilt Rates

As such the net impact based on current investment returns on Gilts, available mid-September had been re-calculated. The overall position was summarised in the report which showed that the anticipated reduction in interest receivable was far more significant, £1.2m, resulting in a net cost of £0.3m if all the loans were repaid.  The position on loans maturing within the next 10 years was fairly cost neutral, a net loss of £40k, it was the longer term loans where the majority of losses would be incurred. 

Comparison Utilising Inter-Authority Fixed Term Investments

Whilst Gilts represented the safest investment, as they were backed by the Government, inter-authority fixed term investments offered a greater return, albeit they were marginally more risky, which would result in a greater net cost in early repayment, £0.7m.

Comparison Demonstrating Breakeven Position

As a final comparator a breakeven position had been calculated in terms of the average interest rate that would be required over the remaining life of each loan in order for early repayment costs to be fully offset.  If average interest rates throughout the remaining life of each loan were lower than the breakeven interest rates shown then it was financially advantageous to pay off the loan, if they were greater then it would cost more to pay off the loan than the net saving on interest.

It was noted that other than during the current financial crisis interest rates had never been at such a low rate as were required to achieve the breakeven position shown. If, as seemed likely, interest rates proved to be higher than this then the early repayment of debt resulted in a worse overall financial position.

Ultimately any decision re: early repayment of debt relied on future interest rates which could not be known with any degree of certainty; hence there was always a risk that any decision would be incorrect. Paying off the debt early gave certainty; it enabled all the costs to be met in the current year and eliminated the interest payable budget in future years, reducing the pressure on the revenue budget. The Authority had sufficient cash balances to meet any repayments costs, having set aside an earmarked reserve of £1.0m to offset a proportion of any penalty costs associated with this, with any balance being met in year.

As an alternative a series of fixed term investments could be established to mirror our debt portfolio with investment returns offsetting interest payments. Utilising Gilts in this way would generate £1.0m of interest receivable over the life of the loans, compared with interest payable of £2.5m, a shortfall of £1.5m. This was still less than the penalty being charged on early repayment, £1.7m, and was considered a risk free strategy as it was based on Government investment. An earmarked reserve could be established to offset any in year shortfall over the life of the debt, i.e. £1.5m over the next 20 years. Given we had already established a reserve of £1.0m to meet potential penalty costs associated with early repayment, we would need to transfer a further £0.5m into this reserve in order to completely offset future net interest payments. Whilst this is a viable option, the level of returns on Gilts still appeared to be extremely low and hence it was still not considered an ideal solution at the present time, albeit it was still more attractive than repayment of all debt and the associated penalty.

Members debated the options.  In response to a question raised by CC Wilkins the Director of Corporate Services confirmed that there may be a need to borrow in the future dependent upon future capital requirements, but that the existing 5-year programme did not include any such requirement at the present time.

A summary position was tabled setting out the position based on paying off all loans that matured in the next 10 years, taking account of investment returns in line with current gilt rates. 

The penalty charged and the loss of interest receivable still exceeded the savings on interest payable by £41k, however the loss of interest receivable was very much dependent upon the assumed interest rate, and whilst this option showed a loss based on the gilt rates, it would show a profit utilising the existing base rate, 0.25% or a revised base rate of 0.50%.  Paying off these loans gave the Authority certainty in terms of current cost, removing the variable associated with future interest rates.

Paying off these loans would leave 3 loans that would mature after the 10 year period.

RESOLVED: - That the Committee agreed to pay off all loans that matured in the next 10 years.