How councils can better value their investments in council companies

By Tim Hampton, Principal Consultant, 31ten

With year end approaching do you know enough about the performance of your council’s companies and joint ventures to stand behind their value on your balance sheet?

In this blog, Tim Hampton, Principal Consultant at 31ten, takes a look at some of the key challenges of having a clear picture, and how they can be overcome so that councils can realise real benefits from their council companies.

Whilst you must assess at each year end whether your investments in subsidiaries need impairing, treating this solely as a compliance exercise misses a critical opportunity for a health check of companies’ financial performance – and one that should be embedded into your organisation governance.

Under tight deadlines it can be tempting to roll forward last year’s carrying values and only impair where a specific problem has surfaced in year. However, loans require an expected credit loss assessment, a forward-looking judgement about whether the council will be repaid in full, and where impairments arise can have significant minimum revenue provision implications.

The challenges of reviewing council company performance

It’s true that company financial performance can be hard to read. Taking housing companies as an example, development vehicles forward load costs relying on uncertain market conditions to remain profitable. Where properties are retained for letting, it can take decades for investments to be repaid, relying on continued, strong operational performance to maintain net incomes, compounded by a rolling programme of new schemes which can obscure how existing ones are performing.

The housing market across the UK is facing headwinds from build cost inflation, greater regulatory burdens, rising borrowing costs and a subdued sales market. As a result, the assumptions underpinning a project’s full business case may no longer hold true.

The opportunity to be gained from a ‘health check’

By taking a health check approach, you can look at a selection of leading indicators to be confident of current performance and provide early warning of any areas of concern.

At 31ten, our council company health check starts with a few fundamental questions, including:

1. Are any loans in default, including technical default? Have there been any late payments, underpayments or covenant breaches.
2. Have repayment profiles slipped? Is interest being rolled up rather than paid, principal deferred, or recharges from the council not being recovered?
3. Are business plans up to date and grounded in current market data? A plan that is late, unapproved, or repeatedly rebased to push returns further out is a warning sign in itself. Are figures reasonable, recent and supported by independent future forecasts?
4. Is new lending or investment supported by a business case? Each new drawdown should be justified on its own merits, not used to sustain the existing portfolio.
5. Does the financial performance rely on a continued pipeline of projects? While you should anticipate some initial investment before returns can be generated, if the financial sustainability continues to be reliant on continued investment of land, resources and business by the council, is this sustainable and does it represent value for money to the council?
6. Is financial and operational performance reported regularly and are these accurate, consistent and timely? The absence of regular, consistent reporting of performance, either through board, shareholder panel or management accounts is a significant area of concern.
7. Are the terms between the council and company market facing? Is the company’s financial health based on sub-market rates and has this been recognised as soft loans and the necessarily subsidy control processes followed?

Enabling evidence-based decisions of council company strategy

Approached properly, the year-end impairment review will give you an annual, evidence-based view of your companies’ health. This provides you with an opportunity to act while options remain open, whether by recapitalising, restructuring, reshaping the business plan or, where necessary, planning an appropriate exit.

Working with councils across the UK on company strategy, our experience has shown that being required to recognise the financial impact of impairments can be the catalyst for change, making a clear statement that the current business is not working. Unfortunately sometimes this can come too late to take decisive action and leaves the council with fewer options to mitigate revenue and capital implications.

Support from 31ten

At 31ten, we’ve developed a light-touch company review, built on our previous experience and sector benchmarking. It provides you with an independent insight into your company financial performance, which helps you to assess whether your balance sheets are robust. Where issues are identified, our health check process ensures you have sufficient time to take action to mitigate their impact.

Tim Hampton leads on our company health checks. Get in touch with Tim using the contact details below, or book a short chat with Tim using this calendar booking link.