Making investment decisions: capital structure and debt portfolio management

28 Oct 20

It is vital that treasury strategies consider the long- and short-term risks of borrowing decisions, and that these decisions are carefully documented. As a treasury manager you should ensure all borrowing undertaken is affordable, prudent and sustainable.

Key takeaways

  • Appreciate the importance of having a robust borrowing strategy
  • Acknowledge the implications of borrowing for capital on your revenue budget
  • Assess and manage your debt structure
  • Understand the various sources of finance and what suits your organisation’s needs


What should you consider in a corporate borrowing strategy?

A robust borrowing strategy is a crucial component of a high-performing treasury management function; it underpins your capital and investment strategy where external resources need to be considered for making an investment.

Having an overarching objective in your strategy is essential – whether this is to strike a balance between low interest and certainty of costs, or you want flexibility to refinance in the event your organisation’s plans change. This objective needs to be managed alongside the risks of various strategies and approved by key stakeholders.

Exposures of various types of debt finance should also be acknowledged in your strategy – how exposed to short- or long-term finance is your organisation? Is the organisation over exposed to variable loans? Consider these factors to ensure you are taking on an appropriate level of risk.

You must also identify your options. Sources can become unavailable in some circumstances, such as a recession. You therefore need to plan the raising of new funds ahead of when you need them in order to diversify the organisation’s sources of funding. Availability of funding cannot always be relied upon. For example, banks’ risk appetites vary depending on market conditions and this will impact the availability of loan debt.


How do you make decisions on funding?

Borrowing can be undertaken using different products, from a variety of sources, for a range of periods and increasingly, using a number of different structures. Reducing overreliance on any one type of funding gives a greater pool of potential future support for financing.

When assessing funding sources, you should first consider the size of the debt issue. For example, a public bond would require around a £200–£250m issue size minimum for effective execution. Therefore, if you are looking for a smaller sum a bank loan would be more appropriate.

You should also consider the maturity period you are looking to achieve; various sources will have different time horizons. The administration and complexity of the debt instruments should also be factored in, if they require a credit check or other processes of due diligence, for example. This will all impact the time horizon between when you are considering borrowing and when your organisation receives the cash.


In which ways can affordability of options be assessed?

The assessment of affordability can be made in a variety of ways. You should assess budgetary projections for future years to determine how much headroom there might be to absorb the additional costs that might arise, which may need to be financed from borrowing. This headroom would then be factored up to give an overall increase in the capital programme that would be supportable should more finance need to be accessed. A similar exercise should be undertaken if the finance is linked to the market and has variable factors such as the interest rate. Stress test these factors to ensure they are affordable in a range of scenarios.

Then assess your individual schemes; analyse the implications for revenue of a particular capital investment proposal, and then compare these to the headroom that might be available against future forecasts in your organisation’s revenue budget. Always ensure there is a strong link between capital schemes that are financed from debt and your long-term borrowing strategy.


How do you manage your debt portfolio?

Debt needs to be continually reviewed to ensure that opportunities are sought to generate revenue savings in interest payable or enhance the balance of your portfolio.

Authorities must maintain an ongoing review of the debt portfolio to seek these opportunities, by identifying scope to refinance loans to achieve savings, for example. However, in many cases the terms and conditions of loan agreements may preclude earlier repayment. While rescheduling can result in savings, there are also a number of risks such as refinancing risk and interest rate risk that need to be assessed in order to ensure that short-term financial gain is not at the expense of long-term financial loss.


Questions for you

  • Do you understand what borrowing options are available to your organisation?
  • Does your strategy consider affordability of borrowing in various scenarios?
  • Does your borrowing strategy consider exposures of key risks such as refinancing and interest rate risk?
  • Do you have a process for consistent review of your debt portfolio?


Sources of further information

CIPFA Treasury Management Network – join for the latest advice, guidance and updates on treasury management.

TISonline Treasury Management Stream – a comprehensive guide to the investment of local authority funds, debt management and treasury management practices.

CIPFA Qualifications in International Public Sector Accounting Standards – courses to provide trainees with a comprehensive knowledge of the published standards and guidance.

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