HC 1652 Communities and Local Government CommitteeWritten submission from the Chartered Institute of Public Finance and Accountancy (CIPFA)

This submission has been prepared by Alison Scott and Lesley Lodge on behalf of the Chartered Institute of Public Finance and Accountancy.

CIPFA, the Chartered Institute of Public Finance and Accountancy, is the professional body for people in public finance. Our 14,000 members work throughout the public services, in national audit agencies, in major accountancy firms, and in other bodies where public money needs to be effectively and efficiently managed.

As the world’s only professional accountancy body to specialise exclusively in public services, CIPFA’s portfolio of qualifications are the foundation for a career in public finance. We also champion high performance in public services, translating our experience and insight into clear advice and practical services. They include information and guidance, courses and conferences, property and asset management solutions, consultancy and interim people for a range of public sector clients.

1. Summary

1.1 In CIPFA’s view, substantial investment in housing is urgently needed to sustain decent homes and to build new ones—this could relieve the pressure for affordable housing and contribute towards boosting the economy. This submission addresses two potential approaches that could support delivery of these aims:

1.Local authority guarantees (in particular mortgage guarantees).

2.Local authority borrowing for council housing.

1.2 Guarantees fall within two categories—financial instrument guarantees and other guarantees (ie any guarantee that is not a financial instrument guarantee, for example guaranteeing levels of service delivery). Financial instrument guarantees are those where the person or organisation giving the guarantee assumes responsibility for a debt if the original debtor is unable to make the due payments. In summary, guarantees other than financial instrument guarantees are treated as provisions, and therefore will be recognised as expenditure (and a liability) when it is more likely than not that the giver of the guarantee will be required to make a payment under the guarantee.

1.3 A cap on local authority borrowing for housing will be introduced with the implementation of the Self-Financing system on 1 April. In CIPFA’s view, the cap is both a potentially significant hindrance to the much-needed investment in council housing and unnecessary as borrowing by local authorities is already restricted to manageable levels by the Prudential Code.

2. Local Authority Guarantees (in Particular Mortgage Guarantees)

Accounting for Guarantees—general

2.1 Guarantees fall within two categories—financial instrument guarantees and other guarantees (ie any guarantee that is not a financial instrument guarantee, for example guaranteeing levels of service delivery). Financial instrument guarantees are those where the person or organisation giving the guarantee assumes responsibility for a debt if the original debtor is unable to make the due payments.

2.2 In summary, guarantees other than financial instrument guarantees are treated as provisions, and therefore will be recognised as expenditure (and a liability) when it is more likely than not that the giver of the guarantee will be required to make a payment under the guarantee. Although this type of guarantee is unlikely to be relevant to mortgage guarantees, it would be relevant if a third party (for example a charity or housing association) were building new homes and a local authority had provided a guarantee that the building would meet certain standards. Financial instrument guarantees, which would include mortgage guarantees, are accounted for under the financial instrument standards.

2.3 These are measured (valued) at fair value. Where the guarantees are given for a premium (fee), especially in an open market situation, fair value is initially the purchase price. A liability for the guarantee is recognised on the balance sheet, matched by the cash received for the premium. Profit or loss will be recognised subsequently in the income and expenditure account depending on whether the call on the guarantee is less than or more than the price.

2.4 Where no premium is paid, as is often the case when local authorities are giving guarantees for policy or service reasons (eg to enable a voluntary organisation to deliver a service), valuation techniques need to be used. The most common technique is to assess the probability of various levels of loss, and value the guarantee at the probability weighted average loss. If the other party could have obtained a guarantee elsewhere, the price they would have had to pay could also be used as the fair value. Again, a liability for the guarantee is recognised on the balance sheet. As no premium will have been received, this is treated as an immediate cost within the income and expenditure account, and subsequently adjusted as losses become more or less likely.

Mortgage Guarantees

2.5 CIPFA is not aware of authorities giving mortgage guarantees for HRA properties, as the authority is able to act as a mortgagor of last resort.

2.6 CIPFA understands that some authorities are considering involvement with a “Local Authority Mortgage Guarantee Scheme.” The Scheme involves the provision of financial assistance from a local authority to first-time home buyers who can afford to make mortgage repayments but cannot afford the larger deposits required to secure a maximum mortgage typically offered by most mortgage lenders of 75% loan to value. We also understand that it relates to the purchase of private sector housing and does not cover, for example, local authority Right to Buy, Self Build dwellings or new builds. Because the Scheme covers private sector housing rather than Right to Buy properties accounting entries will relate to an authority’s General Fund rather than its Housing Revenue Account.

2.7 Our understanding is that the Scheme requires a local authority to provide an indemnity to a participating mortgage lender, on behalf of a mortgagee, of up to 20% of the value of the property. This will require a smaller deposit to be made by the home buyer (to a level of 5%). This would enable the mortgagee to obtain, using the example of 5%, a 95% mortgage on similar terms to a 75% mortgage.

2.8 CIPFA has not had sight of the legal agreements under which the Scheme operates. However, our understanding is that there are two models that can be followed:

Unfunded model

2.9 The unfunded model operates as a financial instrument guarantee, as described above. A premium may be charged for the award of the guarantee. Authorities will need to determine whether this amounts to the fair value of the guarantee, in which case the accounting treatment is as set out above, or whether they are providing a guarantee at below market rates. If the latter is the case, valuation techniques (as described above) would be used to determine the fair value of the guarantee, and the difference between this value and the premium received would be treated as an immediate cost in the income and expenditure account.

Cash Backed Model

2.10 Under this model, the Local Authority invests with the participating lender for the full value of the indemnity being offered (up to 20% of the property cost). Interest is received on this investment.

2.11 The accounting treatment for this model appears to be covered by Regulation 25(1) (b) of the Local Authorities (Capital Finance and Accounting) (England) Regulations 2003 (SI 2003 No 3146) (as amended), although CIPFA has not taken legal advice on this issue. This regulation requires that “a loan; grant or other financial assistance to any person, whether for use by that person or by a third party, towards expenditure which would, if incurred by the authority…” is treated as capital expenditure.

2.12 The payment to the lender would be included in the balance sheet, and would be treated as capital expenditure. Unless this was funded from capital receipts or grants, this would increase an authority’s Capital Financing Requirement, and consideration would need to be given to meeting the requirement for prudent Minimum Revenue Provision charges in accordance with the statutory guidance. Interest received would be treated as income in the income and expenditure account. When the principal amount of the investment was repaid, this would be treated as a capital receipt, and CIPFA would expect authorities to use this to reduce the Capital Financing Requirement, although there would be no legal obligation to do so. Where calls on the deposit were made, the amount returned to the council would be reduced, and this might leave the authority with a balance to be funded.

2.13 If it subsequently emerges that the Scheme is not covered by the regulation, the investment with the participating lender would be accounted for as a financial asset.

3. Local Authority Borrowing for Housing

3.1 The implementation of Self-Financing, the new system of financing for council housing, will introduce a cap on local authority borrowing for housing from 1 April. However, substantial investment in council housing is urgently needed to sustain decent homes and to build new ones. This could also relieve the pressure for affordable housing and contribute towards boosting the economy. It is estimated that, with social housing grant, councils could build an extra 100,000 homes in the next five years, if released from the restriction of the cap and that even without grant, they could build some 50,000 new homes.

3.2 CIPFA has long considered that such a cap is totally unnecessary because the introduction of Prudential Code has clearly proved that Local Authorities can be trusted to act prudently with regard to borrowing. Under prudential borrowing, a local authority must only borrow when and if the debt repayments and interest are affordable. Affordability is crucial and therefore aggregate borrowing should never reach unaffordable levels. The cost and availability of loans in itself provides the commercial discipline, obviating any need for regulation.

3.3 The building of new homes would also generate additional rental income that could be used to meet the increased costs of borrowing.

3.4 When it was introduced in 2004, prudential borrowing marked a major shift in how local authority capital spending was controlled. The previous prescriptive central controls were swept away and instead councils were given responsibility to make their own decisions and manage their own affairs. We believe that local authorities rose to that challenge. Borrowing since 2004 has been both prudent and modest, and focused on financing spending that delivers savings or service improvements. Capital spending has been better linked to business objectives and better value for money has been realised with the ending of the perverse incentives in the earlier system—for example to take on leases when purchase was clearly more economic.

3.5 Currently, local authority borrowing for council housing is around £7,000 per unit—less than half that of housing associations—and will be restricted under the cap to the level that applies in each authority at the time of implementation. However councils could borrow more than this and still stay within the agreed borrowing rules under the prudential borrowing framework. In CIPFA’s view, such necessary local authority borrowing can be properly and prudently financed and used to meet urgent housing needs.

3.6 Throughout the period since 2004, the Treasury has never had to use its reserve powers to intervene in these borrowing arrangements—and the costs of central oversight and control have been reduced. There are broader lessons too. Councils can be trusted to manage complex finances on behalf of their local communities. Localism is a good model for ensuring joined-up decision making, efficient outcomes and economic growth.

3.7 CIPFA believes the prudential borrowing framework has worked very well. We would urge the Government to retain the full flexibilities of these arrangements and not to press ahead with the introduction of a cap on housing borrowing.

4. CIPFA would be happy to provide further information on any aspects of this response.

February 2012

Prepared 1st May 2012