Credit Rated  Banks and Building Societies (minimum rating AA/F1+)
Memorandum by Councillors David Boothroyd and
Paul Dimoldenberg, Westminster City Council (LAI 11)
SUMMARY
Westminster originally had a deliberately cautious
approach to investment. The council's in-house investment team
consistently outperformed external fund managers. However, the
investment policy suddenly changed over the winter of 2007-08,
to adopt deliberately more risky investment strategies in the
hope of increasing returns. The council's approach to checking
the risk of individual banks did not take account of outlook.
After the change in policy, despite warnings that Icelandic banks
were in trouble, the council invested £10 million in fixed
term deals.
1. Westminster City Council's approach to
investment prior to September 2007 was characterized by an
approach of "maximising income consistent with minimising
risk", as described in a report to the former Finance and
Support Services Overview and Scrutiny Committee on 11 September
2002.
2. The council traditionally divided the
funds available for investment into short term funds arising from
temporary cash surpluses through daily cash flow (receipts and
payments not aligning) and longer term cash arising from council
reserves and balances.
3. Short term funds were managed internally.
As of 2007, there were typically 160 individual deposits
at any one time, for varying durations.
4. Long term funds were divided into several
separately managed portfolios, most of which were given to outside
fund managers to invest on behalf of the council. One portfolio
was retained and managed internally as a "control fund"
against which other managers were assessed.
5. On 20 November 2002, the Finance
and Support Services Committee noted "internally managed
funds seemed to be performing better than externally managed ones",
and although the majority of the committee was reluctant to draw
the conclusion that it might benefit the council to retain a larger
proportion of funds in internal management.
6. The annual cost of the in-house Treasury
Management team was £150,000. They managed funds of over
£250 million.
Change in policy
7. For the meeting of the Resources and
Corporate Services Overview and Scrutiny Committee on 18 September
2007, a report was prepared by officers which proposed a new method
of investing cash balances.
8. The report noted, in paragraph 1.8, that
internal management had done better than external managers.
9. However the report considered that the
internal team was too "labour-intensive", and sought
support for externalizing the management of short-term funds.
It also considered that investing in AAA-rated money market funds
would be a lower risk than in the previous policy.
10. For longer-term funds, the report recommended
widening the range of investments, provided that they offered
100% capital protection. This guarantee was thought to be adequate
to justify the greater risk on the rate of return.
11. At the committee meeting, the representative
of Mercers (the City Council's advisers on its investment strategy)
described the investment strategy as "dull". Several
majority party members strongly supported a change in approach
in order to achieve greater returns, even if this led to increased
risk. One described this as an "imaginative" approach.
12. The minority party members advocated
a conventional, transparent and cautious approach should always
be taken when investing public money.
13. Subsequently a new investment strategy
was drawn up along the lines proposed, and approved by the Cabinet
on 25 February 2008, and by the full council on 5 March
2008.
Credit rating
14. Sector Treasury Services has been retained
by Westminster City Council as financial advisers for many years.
The council sees their role as being "to provide comparative
performance data for different cash managers to assist in the
monitoring process", rather than to provide credit ratings
for possible investments. This aligns with Sector's own views
of its role, as stated on its website: "it does not provide
recommendations in relation to the credit quality of financial
institutions, instead it supplies its clients with credit ratings
from rating agencies such as Fitch and others who do make this
financial assessment in order that clients can take an informed
view".
15. The effect of this is that the ratings
provided by Fitch and Moody's (including their assessment of the
outlook) are simply passed on to the council. An institution whose
rating does not come up to the required level cannot be invested
in. However it is up to the council to decide whether to risk
investing, for a term which may preclude early withdrawal of a
substantial sum, in an institution on negative outlook.
What was changed in the investment policy in March
2008?
16. The new proposal approved by the Cabinet
and pushed through by the Conservative majority on the council
added a new section to the "Investment Criteria" which
are in appendix 5 of the Treasury Management policy. Previously
the policy had allowed for long-term investment and day-to-day
cash balances, not recognizing any medium-term investments. The
new policy in March 2008 created new rules for handling medium
term funds.
17. The old and new policies are included
below. The changes were:
(1) The council allowed itself to invest freely
in AAA rated money market funds; previously this was only allowed
if declared appropriate.
(2) Deposits with UK main clearing banks and
other local authorities were limited to £75 million each.
(3) The limit of no more than 10% of total reserves
in a single institution in "specified investments" was
removed.
(4) Medium-term funds were allowed to be invested
as short-term funds had previously been.
(5) Collective Investment Schemes were permitted
for medium-term investments.
(6) Real Estate Investment Trusts were allowed
for £10 million if approved by officers.
(7) Investment in property was allowed with cabinet
member approval, up to £50 million.
Westminster's investments in Iceland
18. The oldest of Westminster's investments
in Icelandic-owned banks which were frozen in October when the
Icelandic banking system collapsed, were placed in November and
December of 2006 for two year terms. These were £1.8
million in Landsbanki on 2 November 2006, £1 million
in Heritable Bank (owned by Landsbanki) on 6 December 2006,
£1.4 million with Landsbanki on 21 December 2006, and
£2.2 million in Heritable Bank on 5 February 2007.
19. Of more concern was some £9.85
million invested for varying terms in August 2008, which happened
after the change in policy. The timeline of these investments
is given at the end of this paper.
OLD POLICY—2007
APPENDIX 5—INVESTMENT CRITERIA
Specified Investments (unlimited by LG Act 2003)
Approved organisations for investment of day-to-day
cash balances.
Monies may be placed on deposit (term deposit or
certificate of deposit) with credit-rated financial institutions,
public bodies, and other local authorities, subject to the following
limits:
No limit
| Main UK Clearing Banks with minimum credit rating of A/F1 UK Local Authorities
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£25 Million limit- |
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£15 Million limit- | Selected A/F1 Credit Rated Banks Credit rated Building Societies with assets in excess of £4,000 million
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£5 Million limit | Other Credit Rated Banks (A/F1)
Credit Rated Building Societies with assets in excess of £500million.
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This lending list will be reviewed by the Director of Finance & Resources at least each quarter and updated taking into account credit rating information published either by Fitch or Moody's. It was last reviewed in February 2007 when some newly credit-rated banks were added to the list, and some individual lending limits were changed.
Notes:
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| Subject to the overall constraint that not more than 10% of outstanding investments to be placed with a single institution.
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| F1+ and F1 are the highest ratings in the range of short-term credit ratings and AAA, AA, A and BBB are the investment grade long-term credit ratings awarded to banking institutions by the Fitch credit rating agency. The equivalent investment grade ratings awarded by Moody's are P-1 and P-2 (short-term), and Aaa, A1, A2 and Baa1 (long-term).
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If appropriate for cash-flow and liquidity requirements, monies may also be placed on deposit with the Government-backed Debt Management Agency Deposit Facility (DMADF) and invested in AAA rated money market funds.
Non-specified Investments (set by WCC, limited by LG Act 2003)
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Holdings in UK gilts, sovereign bond issues and bonds issued by
multilateral development banks
— included in externally managed investment portfolios,
subject to guidelines agreed with managers and an overall maximum
limit of 30% of investment portfolios.
Term deposits over 12 months
with Credit Rated Banks
and Building Societies (minimum rating AA/F1+) may be included
in in-house portfolio at the Director of Finance & Resources's
discretion to preserve income if interest rates are expected to
fall.
(Subject to a maximum limit of £10 million with
any one counter-party and a maximum period of five years).
Deposits with non-investment grade credit ratings or non-credit-rated
banks and building societies are only permitted if a credit-rating
is reduced or withdrawn after the deposit has been made.
In total, non-specified investments should not exceed
40% of the Council's investments.
Investments which are not permitted (as per LG Act
2003)
Corporate bonds (issued by bodies other than sovereign
bodies) and Floating Rate Notes are not permitted, as under current
investment rules such investments would count as capital expenditure.
NEW POLICY—2008
APPENDIX 5—INVESTMENT CRITERIA
APPROVED INVESTMENTS FOR DAY-TO-DAY CASH BALANCES
Specified Investments (unlimited by LG Act 2003)
AAA rated money market funds—Maximum £50 million
per Fund
Deposits
Monies may be placed on deposit (term deposit or certificate of
deposit) with credit-rated financial institutions, public bodies,
and other local authorities, subject to the following limits:
| £75 Million limit | Main UK Clearing Banks with minimum credit rating of A/F1
UK Local Authorities
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£25 Million limit | Credit Rated Banks and Building Societies (minimum rating AA/F1+)
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£15 Million limit | Selected A/F1 Credit Rated Banks
Credit—rated Building Societies with assets in excess of £4,000 million
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£5 Million limit | Other Credit Rated Banks (A/F1)
Credit Rated Building Societies with assets in excess of £500 million.
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This lending list will be reviewed by the Director of Finance
& Resources at least each quarter and updated taking into
account credit rating information published either by Fitch or
Moody's. It was last reviewed in February 2008 when no new credit-rated
banks were added to the list, but some individual lending limits
were changed (reduced) due to falling credit-ratings.
Notes:
F1+ and F1 are
the highest ratings in the range of short-term credit ratings
and AAA, AA, A and BBB are the investment grade
long-term credit ratings awarded to banking institutions by the
Fitch credit rating agency. The equivalent investment grade ratings
awarded by Moody's are P-1 and P-2 (short-term), and
Aaa, A1, A2 and Baa1 (long-term).
If appropriate for cash-flow and liquidity requirements, monies
may also be placed on deposit with the Government-backed Debt
Management Agency Deposit Facility (DMADF).
APPROVED INVESTMENTS FOR MEDIUM TERM FUNDS
Specified Investments (unlimited by LG Act 2003)
As shown above.
Non-specified Investments (set by WCC, limited by LG Act 2003)
Term deposits with maturities greater than 12 months
Monies may be placed on deposit (term deposit or certificate of
deposit) with credit-rated financial institutions, public bodies,
and other local authorities, in line with the limits set out for
short term deposits above, provided that the combined amount on
deposit for both the short term (specified) investment and the
longer term (non-specified) investment does not exceed the overall
credit limit for the institution concerned.
No single deposit should exceed £50 million. The amount
of deposits with an underlying equity component should not exceed
£100 million. The amount of deposits with an underlying
fixed interest component should not exceed £100 million.
The maximum term of a deposit will be five years.
Holdings in UK gilts, sovereign bond issues and bonds issued by
multilateral development banks
Included in externally managed investment portfolios, subject
to guidelines agreed with managers and an overall maximum limit
of 30% of investment portfolios.
Deposits with non-investment grade credit ratings or non-credit-rated
banks and building societies are only permitted if a credit-rating
is reduced or withdrawn after the deposit has been made.
Collective Investment Schemes structured as Open-Ended Investment
Companies (OEICS).
Investing in Money Market Funds, Enhanced Cash Funds, Bond Funds
and Gilt Funds
Real Estate Investment Trusts (REITS) after appraisal by Director
of Finance and subject to a maximum investment of £10 million.
Property—investment in property is permitted, subject to
specific Member approval and an overall limit of £50 million.
(note that investment in property counts as capital expenditure).
In total, non-specified investments should not exceed £300 million.
Investments which are not permitted (as per LG Act 2003)
Corporate bonds (issued by bodies other than sovereign bodies)
and Floating Rate Notes are not permitted, as under current investment
rules such investments would count as capital expenditure.
Timeline after the Change in Policy
March 2008 | Standard & Poors write of their concern that the Icelandic Government might have to rescue all three major banks, Kaupthing, Glitnir and Landsbanki. Iceland interest rates hit 15%.
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20 March 2008 | Surrey County Council removes Landsbanki and Glitnir from its list of approved investments.
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31 March 2008 | Perth and Kinross Council removes all three Icelandic banks from its list of approved investments, citing "diminishing confidence in the Icelandic banking sector and economy".
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1 April 2008 | Fitch put Landsbanki on watch for being downgraded. North Tyneside Council decides not to make any further investments with them.
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26 April 2008 | The Economist writes of Icelandic banks in 2007 that "the market signal was clear enough: the banks were in trouble, and there was a question-mark over the central bank's ability to stand behind them."
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16 May 2008 | The central banks of Norway, Denmark and Sweden agree to loan Iceland €500 million each in case of emergency, to try to stabilize its banking system.
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21 July 2008 | The cost of insuring against the loss of deposits in Icelandic banks hits 1,000 base points; according to the Financial Times this level "usually indicate[s] traders think a company is very likely to default on its debt".
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22 July 2008 | Conservative MP Michael Fallon asks searching questions in Parliament about the ability of the Icelandic compensation scheme to guarantee the savings of Britons in Icelandic banks.
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4 August 2008 | Westminster deposits £3.3 million in Heritable Bank, maturing on 20 October 2008.
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15 August 2008 | Westminster deposits £1 million in Heritable Bank, maturing on 14 August 2009.
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22 August 2008 | Westminster deposits £1.85 million in Landsbanki, maturing on 22 December 2008.
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27 August 2008 | Westminster deposits £2.35 million in Heritable Bank, maturing on 22 December 2008.
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29 August 2008 | Westminster deposits £1.35 million in Landsbanki, maturing on 22 December 2008.
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29 September 2008 | The Icelandic government nationalizes Glitnir bank to try to save it from bankruptcy.
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7 October 2008 | Landsbanki goes into receivership. Heritable Bank stops savers making withdrawals and freezes all funds.
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