More councils set to issue section 114 notices, credit ratings firm warns

A leading risk assessment firm has said it expects more local authorities to issue section 114 notices in the near term as falling commercial property prices, high inflation, and service demand widen budget gaps.

In its 'sector in-depth' report on local government finances, Moody's also observed that an audit backlog is likely to reveal more failures given that just 12% of fiscal audits in 2022 were completed by the statutory deadline.

The report, published on 7 September, just two days after Birmingham City Council issued its section 114 notice, noted that council borrowing for commercial investment increased significantly over the past decade.

"The Public Accounts Committee estimates that LAs have spent £7.6 billion on commercial investments since fiscal 2016. Of that, 49 LAs, or 14% of the sector, accounted for 80% of this spending."

According to Moody's, this practice has been facilitated by "significant" borrowing flexibility introduced by central government in 2003 and 2011 and was fuelled by a need to offset a decline in Government funding.

Borrowing rules have tightened since 2020, effectively ending councils' property investments strictly for revenue gains, but "the consequences of past borrowing and investment are still materialising," the auditor said.

Falling commercial property prices, which Moody's forecasts to be between 5% and 15% over the next 18 months, are also set to be problematic, according to the report.

It noted that: "If legacy assets are revalued below historical cost and revaluation reserves are depleted, a number of LAs will face budget deficits. Overall, credit quality in the LA sector is likely to weaken."

Of the five councils that have issued section 114 notices since 2021, three of them (Thurrock, Woking and Croydon) have been impacted by falling property prices and commercial property investments.

Commenting on the three councils, Moody's said the trio "based their investments on overly optimistic projections, with no or little provision for reserve buffers; and there was a lack of internal and external scrutiny of these transactions".

Another aspect of the issues facing local government finance is the lack of scrutiny and transparency of commercial investments in the sector, the report stated.

According to the report, there is a "substantial lack of capacity for local government audit".

"This limits transparency and disclosure, and has resulted in a huge auditing backlog in the sector, leaving many LAs without audited accounts for multiple years."

The resulting delays also mean that "major accounting misstatements can be undetected for a number of years, leaving LAs with limited options for coping with often highly material adjustments," the report added.

This mirrors Birmingham's section 114 notice, which was issued after a refreshed look at the council's accounts revealed the local authority had to pay £760m to settle equal pay disputes.

Adam Carey