Local authority financial sustainability and the section 114 regime Contents

Annex: Croydon Council

A case study in local authority financial instability

1.We launched our inquiry into local government financial resilience following the issuing of a section 114 notice by Croydon Council, but the inquiry itself was not into the situation at Croydon itself. It is worth exploring what happened at Croydon, however, as it offers an example of how some of the factors discussed in our report played out in the real world. It also draws out another factor contributing to local government financial instability that our report does not touch on: financial mismanagement.

Timeline – Croydon Council

2.Mid-2020 – following a period of sustained financial instability, Croydon Councils approaches MHCLG informally for financial assistance. Over the next few weeks, several senior figures, including the Chief Executive and Council Leader announce their resignations.

3.23 October 2020 – Grant Thornton, the council’s external auditor, publishes a highly critical report on the council’s financial position and governance.175 In response, the Government commissions Chris Wood, former Chief Executive of Newham Council, to lead a non-statutory rapid review of the council’s governance, culture and risk management.

4.11 November 2020 – faced with a predicted budget shortfall of between £30 million and £67 million by the end of 2020–21, the council’s Chief Finance Officer issues a section 114 notice.

5.23 November 2020 – PwC produces a strategic review of the council’s commercial subsidiaries, principally Brick by Brick, the arm’s length property development company the council established in 2015 to support the delivery of high-quality affordable homes.176

6.1 December 2020 – the Chief Finance Officer issues a second section 114 notice.

7.Mid-December 2020 – the council formally requests a £150 million capitalisation direction from the Government. After discussions with CIPFA, it is agreed that no further section 114 notice will be necessary for the current financial year. At the same time, the council publishes a renewal improvement plan and financial recovery plan.

8.1 February 2021 – Chris Wood’s rapid review, produced in November, is made public.177 It is highly critical of the previous council leadership.

9.18 January 2021 – MHCLG appoints an improvement and assurance panel, led by Tony McArdle, as recommended by Chris Wood’s rapid review. The purpose of the panel is to provide external advice, challenge and expertise to the council in developing and implementing its improvement plan; and to provide assurance to the Secretary of State of the council’s progress in delivering this plan.

10.Mid-February 2021 – Katherine Kerswell, the interim CEO, suspends four executive directors following receipt of a still-unpublished report by independent inspector Richard Penn, produced with assistance from the Local Government Association, into senior management actions between April 2017 and September 2020. Two of the directors resign soon after.

11.Early March 2021 – the Government issues a capitalisation direction allowing the council to borrow £70 million in 2020–21 and £50 million in 2021–22 and to use the money to support its revenue budget position.178 The decision means the council can balance its budget and will not have to issue another section 114 notice.

12.25 March 2021 – Hamida Ali, the recently appointed Council Leader, Katherine Kerswell, the interim CEO, Chris Buss, the interim CFO, and Sarah Ironmonger, director of audit at Grant Thornton, appear before our Committee.

Causes of Croydon Council’s financial instability

13.There is little debate about the main causes of Croydon’s financial failure. All the witnesses, including the council’s representatives, as well as the rapid review and the report in the public interest attributed it to a combination of the council’s risky commercial strategy, its failure to make savings, its low reserves and, most importantly, its financial mismanagement and inability to stick to budgets. In addition, there is general agreement that one factor beyond the council’s control contributed to, though did not cause, its financial position: the large number of unaccompanied asylum-seeking children in the borough. The local authority in which an unaccompanied asylum-seeking child (UASC) first presents themselves is normally responsible for their care. Since an asylum intake unit is situated in Croydon, this places a particular financial burden on Croydon Council that is not fully covered by the additional money the Government makes available.179 According to Katherine Kerswell, the council receives £18 million a year from the Government, which is £7 million to £8 million short of what it needs.180 Richard Watts agreed the council faced “specific challenges” from having to care for a large population of UASCs and that this “did ramp up its costs”, as this extra responsibility was “not fully funded”.181

14.The Grant Thornton report in the public interest detailed Croydon’s deteriorating finances since 2017–18 and criticised the council for failing to implement its recommendations in previous reports. In particular, it criticised the council’s “unsustainably low level of reserves”, its significant overspends over the previous three years on children’s and adult social care, and its approach to borrowing and investment, which it said had “exposed the Council and future generations of taxpayers to significant financial risk”.182

15.In 2018, the council set up an asset investment fund (AIF) to fund non-residential property investment. Asset purchases accounted for under the AIF included the Croydon Park Hotel (£31.3 million) and the Colonnades leisure park (£53.5 million). The council originally forecast a return on its AIF assets of £2.4 million for financial year 2021–22. It is now forecasting a return of £82,000.183 Following the purchase of the Croydon Park Hotel, Simon Hall, the cabinet member for finance and resources, said:

This purchase will enable us to bring in additional income to the council, securing a new revenue stream to fund core services. At a time where government grant funding for local authorities continues to fall, we have to look at new and innovative ways to ensure we can provide services to residents. This purchase is one way to do it.184

The Croydon Park Hotel went into administration in June 2020.

16.The PwC report accepted that the failure of these investments was partly down to the covid-19 pandemic, although the report by Grant Thornton concluded that they “were not grounded in a sufficient understanding of the retail and leisure market and have again illustrated that the Council’s strategy to invest its way out of financial challenge rather than pay attention to controlling expenditure on core services was inherently flawed.”185 The same report also states: “The Council’s governance and oversight of the companies shows insufficient rigor and control. Despite heavy investment from the Council, the Council has not yet received any significant return.”186

17.In 2015, the council established an arm’s length commercial subsidiary, Brick by Brick, with the stated aim of supporting the delivery of high-quality affordable housing. The council borrowed money from the PWLB and then lent it to the company. The initial business case envisaged that the company would build and sell properties and generate income for the council through the payment of dividends. The Grant Thornton report found that, as of October, the company had borrowed £200 million from the council, which had borrowed it from the PWLB, but repaid nothing.187 The company attributes its poor performance to the covid-19 pandemic and other issues that have delayed development, although the PwC report, which found that the company had “significantly underperformed”, dismissed the pandemic as an excuse, since the 2019–20 reporting year ended on 31 March. In perhaps its harshest criticism on this point, the report found:

As of October 2020, the delays in bringing new homes to the market has put the Council at serious financial risk and resulted in only a handful of new homes being available. As a consequence, savings have not been made. The severity of this situation has not been exposed until late in 2020, as the formal controls that should have been in place were absent.188

18.On the council’s overall commercial investment strategy, the Grant Thornton report found:

The Council has increased the level of borrowing significantly in recent years (£545 million in three years) and used the borrowing to invest in companies it established and to purchase investment properties. The strategy for investing in properties was approved at Full Council using guillotine procedures meaning there was insufficient time to discuss and challenge the strategy and the first purchase was made two months prior to approving the strategy. The Council’s approach to borrowing and investments has exposed the Council and future generations of taxpayers to significant financial risk. There has not been appropriate governance over the significant capital spending and the strategy to finance that spending.189

19.We heard in our inquiry how the council’s low reserves, its failure to make savings and its risky commercial strategy were connected. According to Rob Whiteman from CIPFA Croydon had a strategy for years “to invest in town centre regeneration in order to increase its tax yield”. Although this meant running down its reserves, the council thought “it would get more council tax and more business rates income from a regenerated town centre”, but “events caught up with that” and “the extra tax yield did not come through quickly enough”. As a result of this strategy, the council also neglected to do “other things that were needed in order to balance the books”, such as reducing the cost of services, which were “quite expensive”. He thought the council had “scope to make savings” but probably felt it did not need to because it “had a strategy of regeneration that would mean they could avoid cuts.” He concluded: “Croydon bet the bank on regeneration.”190 Richard Watts agreed with Whiteman’s interpretation.191 In turn, Hamida Ali, the council leader, agreed with their “collective analysis”.192

20.The problem went deeper than the council’s commercial strategy. According to Rob Whiteman, its investments did not breach the prudential code; the issue was with the execution.193 This points to the most profound failure at the council: financial mismanagement. Richard Watts said the council’s “core problem” was that there “was not a culture of compliance with budgets”.194 The report in the public interest described the council’s oversight of its wholly and partly owned subsidiaries as lacking rigour and control and said the council’s repeated failure to deal with the budget gap showed “a failure of governance” and “a lack of understanding of the urgency of the financial position”.195 It accused the council of “collective corporate blindness to both the seriousness of the financial position and the urgency with which actions needed to be taken.”196 The rapid review came to the same conclusion, finding that the council “had significant failings in leadership and management (particularly in the sphere of financial management) and its governance and assurance mechanisms have failed in identifying, escalating and addressing risk.”197

21.Hamida Ali and Katherine Kerswell accepted the findings of the report in the public interest. Ali agreed that the council’s financial oversight had been inadequate and that the leadership had failed to take the auditor’s concerns seriously.198 She also said the failure had been “corporate” and permeated “all parts of the organisation”.199 As a full cabinet member through the period in question, she also told us: “I fully accept my responsibility as a cabinet member at the time”.200 She acknowledged that lack of financial resilience and poor governance were the reasons for Croydon’s financial failure. She also accepted that the council had a track record of not sticking to budgets and that this had been “partly cultural”.201 She neatly summed up the whole of Croydon’s failure:

We thought we could absorb the impact of the reduction in local government funding that we had experienced and protect residents from that impact, so we did not make the savings we should have done, which we are looking to make now. When you combine that with the failure by us to keep within our budgets, particularly around adult social care and children’s social care, and the absence of a culture of rigorous financial compliance, those had a compounded effect on our financial resilience. When the impact of covid came and some of our strategies did not deliver, we just were not able to withstand the shock of that.202

178 MHCLG, Croydon capitalisation direction, (March 2020)

186 Ibid, p. 3

187 Ibid, p. 12

196 Ibid, p. 3

197 Chris Wood, Non-statutory review: London Borough of Croydon, (November 2020), para 2.1

Published: 19 July 2021 Site information    Accessibility statement