Liability Management Policy

1.0 Purpose

This policy outlines how the Council will manage its borrowings and other liabilities as at 1 July 2015.

2.0 Background

The Council must have a Liability Management Policy as required by section 102 (2) of the Local Government Act.

3.0 Key Definitions


Refer to Appendix 1.

4.0 Policy

1. General Policy

The Council borrows as it considers appropriate and exercises its flexible and diversified borrowing powers as outlined within the Local Government Act 2002. The Council approves borrowing by resolution arising from the Long Term Plan (LTP) and Annual Plan process. Projected debt levels are ascertained from cash flow forecasts prepared during these planning processes.

The Council acknowledges that there are various financial risks such as interest rate risk, liquidity risk and credit risk arising from its borrowing. Council is a risk averse entity and does not wish to incur additional risk from its treasury activities.

The Council’s finance function in relation to its treasury activities is a risk management function focused on protecting the Council’s budgeted interest costs and stabilising the Council’s cashflows. The Council does not normally undertake any treasury activity which is unrelated to its underlying cashflows or is purely speculative in nature unless with formal prior approval of Council.

The Council raises debt for the following primary purposes:

  • General debt to fund the Council’s balance sheet, including borrowing to fund Council Controlled Organisations (CCO’s) etc.
  • Specific debt associated with "special one-off" projects and capital expenditure
  • To fund assets with intergenerational qualities.

The Council is able to borrow through a variety of market mechanisms including:

  • Commercial Paper
  • Local Authority Bonds
  • Medium Term Notes
  • Floating Rate Notes
  • From the Local Government Funding Agency (“LGFA”)
  • Funding from internal sources.

Refer to Appendix 1 for definitions of these funding sources.

The Council incurs risks arising from its borrowing and associated interest rate risk activity. In evaluating any new or renewal of existing borrowings (in relation to source, term, size and pricing) the Council will take into account the following:

  • The size and the economic life of any specific project being funded
  • The impact of the new debt on overall borrowing limits.

Relevant margins under each borrowing source:

  • Overall debt maturity profile
  • Prevailing interest rates
  • Available term from bank and stock issuance
  • Legal documentation and financial covenants.

This policy document details how the Council will manage its borrowing with regard to key risks faced including:

  • Interest rate exposure
  • Liquidity and funding risk
  • Credit exposure
  • Specific borrowing limits
  • Provision of security.

2. Financial Covenants on Borrowings

In managing its borrowings, the Council will adhere to the following financial covenants:

  • Gross annual interest expense not to exceed 15% of total revenue
  • Net cashflow from operating activities to exceed gross annual interest expense by 2 times.
  • Net debt shall not exceed 150% of total revenue.

3. Interest Rate Exposure

Interest is incurred on any bank funding facility, issuance of local authority stock and other borrowing arrangements. This policy recognises that the longer the term of borrowing, the greater the interest rate risk. Longer term borrowings may be of benefit if the market interest rates rise, but equally may not allow the Council to take advantage of periods of low interest rates.

Interest rate risks may be managed by the use of derivative instruments, and by issuing fixed rate bonds or sourcing fixed rate bonds from the LGFA.

The table below outlines the minimum and maximum hedged or fixed rate exposure requirements within various time buckets. The actual hedging percentages in place, within these bands, will be determined, and reviewed on a regular basis.

 Fixed Rate Hedging Percentages

 Minimum Fixed RateMaximum Fixed Rate
Less than 2 years50%100%
2 years to 5 years25%80%
5 years to 10 years0%60%

Any hedging outside these parameters or for longer than 10 years must be approved by the full Council before being initiated.

When managing the interest rate risk of the Council the hedging percentages above relate to total core debt. Core debt cannot exceed borrowing projections as per the Annual Plan or LTP with the actual quantum used for policy parameters to be reviewed annually.

The hedging parameters are cumulative. For example if total debt was $25 million, $5 million of hedging entered into for a period of five years would increase the hedging profile for all time buckets up to five years, by 20%.

Fixed rate debt is defined as any debt that has an interest rate reset beyond 3 months.

The hedging parameters are dependent on the Reserve Bank of New Zealand continuing to implement monetary policy through adjustments to the Official Cash Rate (OCR).

The Council decides the interest rate risk management strategy by monitoring the interest rate markets on a regular basis, evaluating the outlook for short term rates in comparison to the rates payable on fixed rate borrowing.

The following interest rate risk management instruments may be used for interest rate risk management activity.

  • Forward rate agreements
  • Interest rate swaps
  • Swaptions
  • Interest rate collar type option strategies in a ratio not exceeding 1:1.

Selling interest rate options for the primary purpose of generating premium income is not permitted because of its speculative nature.

Interest rate risk management instruments may be used for interest rate risk management, with the formal prior approval of the Group Manager Corporate Services.

4. Benchmarking

The Council shall evaluate the performance of the interest rate management policy itself (i.e. the success and continued appropriateness of the risk control limits stipulated in the Liability Management Policy document) and their implementation at an operational level. This is achieved by measuring actual results (i.e. weighted average funding cost) against a market benchmark provided by an external source.

The benchmark standard shall consist of the following:

  • 20% Average 90 day bank bill rate for the reporting month;
  • 10% Average 1 year swap rate for the reporting month;
  • 10% Average 1 year swap rate for the reporting month, 1 year ago;
  • 10% Average 3 year swap rate for the reporting month;
  • 10% Average 3 year swap rate for the reporting month, 3 years ago;
  • 10% Average 5 year swap rate for the reporting month;
  • 10% Average 5 year swap rate for the reporting month, 5 years ago.
  • 10% Average 7 year swap rate for the reporting month;
  • 10% Average 7 year swap rate for the reporting month, 7 years ago.

The above percentages are predicated off the midpoints of the risk control bands contained in the ‘Fixed Rate Hedging Percentages’ table.

The Council’s actual average credit margin over market benchmarks would be deducted off actual funding costs for benchmark calculation purposes.

For reporting of interest rate comparisons, rates rather than dollar values should be used.

Benchmarking is not required if total external borrowings are less than $10 million.

5. Liquidity and Funding Risk Management

The Council’s ability to readily attract cost effective borrowing is largely driven by its ability to rate, maintain a strong balance sheet as well as its ability to manage its relationship with its banker(s) and the capital markets.

To minimise the risk of large concentrations of debt maturing or being reissued in periods where credit margins are high for reasons within or beyond the Council’s control, the Council ensures material debt maturities are spread over a number of years. The Council manages this by aiming where practical to have no more than 40% of its outstanding borrowings subject to refinancing in any rolling twelve month period.

The Council’s treasury operation must also ensure that there are sufficient resources or “liquidity” to provide the funds to meet its immediate obligations such as creditors and current debt maturities.

Appropriate cash flow reporting mechanisms will be maintained to monitor the Council’s estimated liquidity position over the next 12 months. In any case funding facilities must be in place to give headroom of at least 110% over and above the maximum net debt requirement as estimated in the Annual Plan or LTP.

6. Credit Exposures (Treasury)

In general the Council borrows funds from a variety of registered banks, institutional investors and the LGFA. It is considered that the range and size of Council’s individual borrowings together with the relative strength of these lenders offsets any institutional credit risk.

7. Provision of Security

For its general borrowing programme the Council offers security under its debenture trust deed, for which security is a charge over all rates.

In unusual circumstances, with the prior consent of the Council, security may be offered by providing a charge over one or more of the Council’s assets.

8. Repayment

The Council repays borrowings from general or targeted rates, general funds or renewal loans.

9. New Zealand Local Government Funding Agency Limited Investment

Despite anything earlier in this Liability Management Policy, the Council may borrow from the New Zealand Local Government Funding Agency Limited (LGFA) and, in connection with that borrowing, may enter into the following related transactions to the extent it considers necessary or desirable:

a) contribute a portion of its borrowing back to the LGFA as an equity contribution to the LGFA;

b) provide guarantees of the indebtedness of other local authorities to the LGFA and of the indebtedness of the LGFA itself;

c) commit to contributing additional equity (or subordinated debt) to the LGFA if required;

d) subscribe for shares and uncalled capital in the LGFA; and

e) secure its borrowing from the LGFA, and the performance of other obligations to the LGFA or its creditors with a charge over the Council’s rates and rates revenue.

10. Management and Reporting Procedure

The Council’s Policy and Development Committee (P&DC) oversees and monitors the risks arising from its treasury activities to ensure consistency with the Council’s Long Term Plan and to evaluate the finance function’s effectiveness in achieving its objectives. The P&DC is responsible for approving strategy and for monitoring compliance and performance of the Council’s treasury activities.

The Group Manager Corporate Services has financial management responsibility over the Council’s borrowing and investments. The Council is able to appoint an independent advisor to assist in the management of the financial market exposures that the council is subjected to. The scope of the appointment and the parameters within which the advisor operates, will be determined by the Group Manager Corporate Services and at all times will operate within the parameters of this policy document. The Council’s borrowing and cash management activities are managed centrally through its finance function.

The Management of the Council’s borrowing portfolio is carried out under delegated authority to the Group Manager Corporate Services (who has delegated the day to day operation to the Council’s Finance Manager and Management Accountant). Reports on the Council’s borrowings are prepared on a quarterly basis for the Council.

Appendix I

Borrowing Instruments Definitions

1 Bank Sourced Borrowing

1.1 Bank Bill Facilities

Commercial Bills cover all types of bills of exchange which are defined under the Bills of Exchange Act 1908 as:

“An unconditional order in writing, addressed by one person to another signed by the person giving it, requiring the person to whom it is addressed to pay on demand, or at fixed or determinable future time, a sum certain in money to, or to the order of a specified person, or to bearer.”

Bank bill facilities are normally for a term of up to three years but may be for as long as five years. Bank bills are bills of exchange, drawn or issued usually by the original borrower and accepted or endorsed by a bank.

For a Bank Accepted Bill, the bank makes the payment of the face value of the bill on maturity. Most bank bills traded in the New Zealand market are Bank Accepted Bills.

Bank Endorsed Bills have been endorsed by a bank with another party as acceptor. In the event of default of the original acceptor, payment can be sought through the chain of endorsers to the bill.

An investor in bank bills can sell the bills prior to maturity date and receive the cash. Bank bills are a longer term borrowing instrument than cash loans. Bills are normally drawn for terms of 30, 60 or 90 days with a few being drawn for 180 days. The 90 day bank bill is the underlying traded benchmark instrument for the short end of the market.

Costs:

The principal costs to the borrower are the discounting bank’s yield at which it discounts the bill at the time of drawdown, an arrangement fee, an acceptance fee and a line fee (expressed in basis points or percentage per annum) and margin. Acceptance fees, arranger fees, line fees and margins in aggregate normally range between 20 - 300 basis points (i.e. 0.20% - 3.00%), depending on the credit worthiness of the borrower.

1.2 Revolving Credit Facilities (Variable Amount Term Loans)

Revolving credit facilities are similar from a borrower’s perspective except interest is paid in arrears rather than upfront as in the case of bank bills. Revolving credit facilities are usually for a term of up to three years but may be for as long as five years and like bank bills drawings under the facility are priced off the bank bill buy rate. Most facilities allow for the borrowers to draw up to the facility amount in various tranches of debt and for various terms out to a maximum term of the maturity date of the facility. Like bank bills most borrowers use these facilities to borrow on a 90-day basis.

Costs:

The principal costs are the same as with bank bills. The lending bank’s yield sets the base rate at the time of lending, an arrangement fee, an acceptance fee and a line fee (expressed in basis points or percentage per annum) and the margin. Acceptance fees, arranger fees, line fees and margins in aggregate normally range between 20-300 basis points (i.e. 0.20% - 3.00%), depending on the credit worthiness of the borrower.

1.3 Short Term Money Market Lines

Short term money market loans or cash loans can be Committed or Uncommitted. A customer pays for a guarantee of the availability of the funds in a Committed Loan. In an Uncommitted Loan, funds are provided on a best endeavours basis and no line/commitment fee is payable. In addition to a line fee, a margin may be charged on any line usage.

The minimum amount for a cash loan is $1,000,000. Smaller loans can be arranged, although the interest rate quoted will be a reflection of the size of the loan.

The main usage of cash loans is to cover day-to-day shortfalls in funds. The interest rate is governed by the term of the borrowing and the implied or implicit credit rating of the borrower. Cash loans are short term only and are normally drawn for a term of one (overnight) to seven days. Interest collection can be daily.

2 Capital Markets Programmes

Commercial Paper (CP.) programmes normally provide for issuance with tenors of between 7 and 364 days. The majority of CP. issued in the New Zealand market is for terms of 30, 60, or 90 days.

Corporate Bonds commonly in existence in the New Zealand market have essentially the same characteristics as Government Stock. These are a source of longer term fixed or variable rate finance which can be sold either in bearer or registered form (normally registered). Bonds are normally issued with coupon interest paid in arrears on a six monthly basis for fixed rate instruments, and three monthly for floating rate instruments. Local Authority Bonds are issued by a variety of local governments by tender or private placement. The Bonds are registered securities. They are repayable on a fixed date, and are generally issued for terms ranging from one to fifteen years.

Local Authority Bonds are priced on a semi annual basis and issued at a discount to face value. A fixed coupon payment is made semi annually to the holder of the security. The pricing formula is the same as Government Bonds.

The term bond is usually reserved for securities with terms longer than five years, to clearly distinguish between short term (CP.), medium term (MTNs) and long term (Bonds) debt instruments. Given that the term “bond” can also be used generically to denote any coupon bearing instrument irrespective of tenor this term will be used for this paper and will include the MTN security. Fixed term, floating rate instruments are becoming increasingly common. The name usually given to these instruments is “Floating Rate Notes” (FRNs), and these are also covered under the generic heading “Bond”. FRNs are typically for terms of 2-5 years.

CP. and Bonds usually constitute unconditional, unsecured and unsubordinated obligations of the issuer, except indebtedness given by preference by operation law.

3 Structured and Project Finance

Project and structured financing matches up debt to suit the quantifiable income stream from the project. This type of financing is appropriate for the funding of stand alone assets which are able to be ring-fenced and over which security can be taken. The sort of assets to which this usually applies are assets which are transferable, and for which an international equity market exists, e.g. infrastructural assets. The owner of the asset usually retains an equity interest in the asset.

4 Local Government Funding Agency

The Local Government Funding Agency was enabled under the Local Government Borrowing Act 2011 and was incorporated on 1 December 2011. The LGFA is owned by a group of shareholding councils and the Crown. It is a Council Controlled Organisation (CCO) operating under the Local Government Act 2002. The LGFA’s primary purpose is to provide more efficient funding costs and diversified funding sources (including foreign currency) for NZ local authorities. It provides investors with a source of securities either in floating rate or fixed rate form and with a range of maturity dates. It is rated at AA+ (domestic long term) by international credit ratings agencies Standard and Poor's and Fitch Ratings. These ratings are the same as the NZ Government.


 Adopted by Policy and Development Committee 14 October 2014