Re: NAO report on local authority investment and COVID-19

The Local Government Association (LGA) as the national voice of local government welcomes the opportunity to submit evidence to the Committee’s inquiry on local authority commercial investment and the National Audit Office (NAO) report. I also wanted outline the impact of the pandemic on local government finances and the Ministry of Housing, Communities and Local Government’s (MHCLG) response to COVID-19, as set out in the Committee’s terms of reference. I want to address the pandemic first and turn to investment in commercial property later in this letter.

COVID-19

The COVID-19 crisis is set to be the biggest challenge to the UK since the Second World War. It is more important than ever that we work jointly to support the most vulnerable members of our society while also providing certainty to residents that the public services they need are available when they need them.

Certainty over sufficiency of funding and liquidity is vital to ensure that councils can successfully deliver the best possible response to COVID-19. The two tranches of £1.6 billion funding, and the early payment of some grants and the deferral of business rates payments to central government to aid councils with their cash flow, were welcome and helped to provide some stability and certainty. We are pleased the Government continues to recognise the huge efforts councils are making.

It is vital that the Government continues to demonstrate a rock-solid commitment to meeting the extra costs, and the reductions in income local authorities are facing. Our members need to be confident that they will be given the financial means to see this challenge through. Without this councils may be forced to take extreme cost-cutting and rationing measures soon.

Council Finance Directors have a duty to ensure that councils are on track to balance their budgets and to issue a report to their council (known as a s114 report) if they think the council is at risk of spending beyond its means. It is important to note that a s114 report is not issued at the time when funding runs out. The legal duty of a Finance Director is to consider whether they are confident that financial pressures can be met in-year using resources that are available and issue a report as soon as that confidence is lost. We are aware that a number of Finance Directors are holding off issuing a s114 report on the basis of earlier promises by the Government about funding the impact of COVID-19.  If authorities lose this assurance, Finance Directors will have to take a different view of any additional spending in the light of their council’s overall budget position including loss of income. Councils should not be put in a position where a section 114 report will be needed as a result of the financial impact of, and response to, this crisis. The Ministry has been encouraging anyone thinking of a s114 report to contact it to discuss and so that it can capture information about pressures on local government.

In April, MHCLG undertook a voluntary survey of council’s finances which generated a very high rate of return. Councils were keen to inform the Ministry of the pressures that they face. Analysis of a sample of returns shared by councils with the LGA suggests the following emerging picture. The total projected financial pressure in the year 2020/21 arising from the impact of COVID-19, including cost pressures, lost income and savings opportunities, nationally amounts to 3 to 4 times the £3.2 billion that has been allocated by Government so far. This would amount to between £9.6 to £12.8 billion in total, meaning a further £6.4 to £9.6 billion is needed to bridge that gap. Of this, around two-thirds is due to projected losses in income, such as council tax, business rates, fees and charges. Councils fund anywhere between 5 and 70 per cent of their gross spending through sales fees and charges, and council tax alone is worth around half of all council spending power, so drastic losses of this income have a very significant impact. Even if councils used all their unallocated reserves, this would only cover up to half of the remaining shortfall.

This information is also backed up by case studies. For example, on the basis of a separate survey of finance directors of local authorities in the Yorkshire and Humberside region, depending on the distribution of the extra £1.6 billion announced on 18 April, this would still leave a financial shortfall of around £600 million in the region alone for 2020/21. Over 70 per cent of this challenge is due to predicted lost income.

The cost pressures facing councils go beyond just the immediate COVID-19 response. For example, increased demand for social care services, as well as the cost of provision, is unlikely to subside immediately once the crisis is over. Additionally, savings programmes for 2020/21 have been delayed as all efforts are rightly refocussed on helping our residents. The £500 million Hardship Fund may not be sufficient to meet the increased council tax support caseload as the fund was based on third quarter 2019 claimant counts, it also does not address the cost of additional local interventions where they are needed to help our most vulnerable residents. The net cost of recycling services is going up due to the collapse of the market.

Of course, it is not just cost pressures that councils are grappling with, as their income base is also collapsing. A very significant issue for many councils is a large and immediate reduction in income from fees and charges.  Services from which councils normally derive income have discontinued or been scaled back and councils have also rightly offered other services free of charge.  Local authorities are suffering severe income loss from a range of services from leisure, parking, bus operations, planning, and commercial waste. Many councils rely heavily on this income to fund their annual expenditure - on average, 10 per cent of total gross service costs are funded through fees and charges, this rises to up to an average of 25 per cent for shire districts, but with some funding up to 70 per cent of gross expenditure this way.

Many of these services also have high fixed costs which means it is not possible to balance the income loss with savings, particularly when the advice from central Government is not to furlough local government staff. Even if they did do this, there would still be significant fixed costs which could not be reduced. Therefore, it is not possible for councils to reduce their costs and activities to accommodate a loss of funding on this scale, particularly when facing other pressures. This loss of income represents a real reduction in the resources available to councils to fund services and will mean that, in the absence of any compensation, the balanced budgets set by councils will not be deliverable.

Local tax income is facing a sharp reduction as well. We have received evidence from a number of councils that already in April 10 to 20 per cent of council tax direct debits have been cancelled. This is a clear signal that income from council tax will be reduced sharply this year, with no guarantee that this can be recovered in future years. And while the Government’s package of business rates reliefs will be helpful to many businesses, councils still foresee issues with collecting business rates from other ratepayers which were not covered by the discounts – there is approximately £15 billion of business rates due this year.

At the same time as grappling with pressures on costs, income and local tax revenue, councils are being urged to continue to pay suppliers, in some cases up front before services have been provided. This is the right thing to do, but it can be a significant strain on council cash balances. Billing authorities, including shire district councils also have to pay council tax and business rates over to other local authorities in the area, and central government, ‘on plan’ rather than on the basis of actual collection, with any losses only shared in subsequent financial years. A drop in collected tax can cause significant cash flow strain as a result. The Government has announced a number of measures to aid councils’ cash flow, such as paying grants up front and the deferral of the payment of business rates to central government. These measures are welcome and provide additional certainty over the short term. An assessment of whether this will be sufficient in the longer term is now needed.

Cash flow issues should be kept under regular review. The minimum term for a Public Works Loan Board (PWLB) loan is 1 year and this is too long to help with cash flow. In the absence of a favourable short-term borrowing facility, councils facing cash flow problems will have to spend public resources on paying interest rates of what effectively amounts to ‘pay day loans’ which would be a highly inefficient but also unavoidable use of taxpayer funding.

The points I’ve outlined above are an overview of some of the financial challenges and views of our members at what has been an unprecedented and very rapidly evolving period. There are undoubtedly other pressures facing councils however, I hope this is helpful in your inquiry. We are happy to provide further details and evidence if needed.

NAO report on local authority investment

I will now turn to the other strand of the inquiry regarding the NAO report on local authority investment in commercial property and specifically any gaps in commercial skills in local government, and the extent to which the Department formally monitors commercial activity and long-term exposure to risk.

We welcome this report from the NAO. The report contains new and valuable analysis as well as reiterating some points which the LGA has been making for some time. The report emphasises the real terms decrease in all council spending power (central government funding plus council tax) of nearly 30 per cent between 2010/11 and 2019/20 and decreases in government funded spending power of nearly 60 per cent in the same period. In these circumstances, councils have faced a choice of either accepting funding reductions and cutting services – such as care for older and disabled people, protecting children, reducing homelessness, fixing roads and collecting bins – or seeking alternative sources of income, such as by making investments, to try and protect them.

The report contains a lot of detailed analysis. Some headlines from the report have been widely reported; for example, that local authorities have spent £6.6 billion on commercial property in the past three years, compared to £450 million in the preceding three years. Most of this (80 per cent) has been undertaken by a small number of councils (49 councils or 14 per cent).

The NAO’s definition of commercial property is ‘property for business use generally let to tenants for a commercial rent’. This means that it includes more than just properties bought in order to generate income. It includes properties bought for many different reasons but that will also generate a rental return. It is only a minority of councils that have invested in some property solely to make an income, in order to replace lost funding and support the council’s budget. Many more councils hold property for service reasons – for example, for place shaping or for economic regeneration such as plans to regenerate high streets by changing and influencing the mix of use of properties, and they also charge a commercial rental income on these, which may or may not cover their costs of holding the property. In many cases the distinction is not clear, and an individual property can be held for several different reasons. The NAO’s definition is broad and will include all types of property described here but it must be understood that it does not solely represent activity designed to generate a financial return. It is vital that councils retain the flexibility to make the right local decisions for their communities.

In October 2019 the Public Works Loans Board increased the interest rates charged to councils for new loans; some statements by Ministers linked the rise in rates to concerns over councils borrowing to purchase commercial properties. The rise has increased the revenue costs of any new borrowing for councils and thrown the viability of new capital programmes into doubt. While the provision in the Chancellor’s March 2020 Budget of specific discounted loans for social housing and some infrastructure is welcome, a return to the pre-October rates would enable councils to deliver more widely on key government priorities such as housing and regeneration.

As is recognised in the NAO report, councils have always owned and managed properties and many of these have had a rental element to them that can lead them to be seen as being “commercial”. As properties are held for a variety of reasons, there is no separate recording of “commercial property” in national local government finance statistics. A recent, if rough, estimate of the value of councils’ ‘commercial property estate’, using the NAO definition and including the £6.6 billion of purchases identified by the NAO, is that it is worth between £16 billion and £17 billion, most of which has been held for many years.

As outlined earlier, the current pandemic is having a significant impact on council income, particularly income from sales fees and charges. There is also an impact on commercial property rental income, but it is less clear. There is some anecdotal evidence that the areas of biggest income risks in the current pandemic are for those properties that are held primarily for purposes other than an income return; there is some anecdotal evidence that investments made primarily to generate income are holding up and that tenants there are less likely to defer rental payments.

With regard to the point on skills of councils in the inquiry terms of reference, as part of our annual Memorandum of Understanding with MHCLG, the LGA offers two commercial skills training courses for local authorities to ensure that councillors and officers are equipped with commercial skills to deliver successful, well managed commercial activities. The first course is “Commercial skills for officers”. This is a six-day course comprising commercialisation, governance, commercial strategy and finance modules. To date, 150 officers have attended the training. In 2019/20 93 per cent of attendees said they found the training useful.  The second course is “Commercial skills for councillors”, a one-day masterclass delivered by an LGA member peer and a commercial expert. This focusses on how other councillors have put their commercial skills into practice, including a case study from the member peer. To date, 145 councillors have attended the training. In 2019/20 89 per cent of attendees said they found the training useful.

As required by the prudential framework for local authority capital investment, all councils approve and publish Annual Strategies for Capital, Treasury Management, and Investments. As well as outlining local plans, these also make the appetite for risk clear. Many councils employ specialist investment and treasury management staff, recruiting people with the specialist skills. Many councils also appoint specialist external advisers when needed.

I hope the information outlined is helpful as councils continue to respond to the significant pressures and the challenges that they face, both in responding to the current pandemic and in generating income more long-term. We would welcome the opportunity to discuss council investment in commercial property in more detail in any further evidence sessions for this enquiry or at later date. If we can be of further assistance, please not hesitate to get in touch (iredia.oboh@local.gov.uk).   

May 2020