Luton Borough Council’s independent auditors, EY Ernst & Young, produced the following report, which had a verbal reading to LBC’s Audit and Governance Committee in March 2020, under the Statement of Accounts/External Audit Plan Update. The hard copy report will go to this Committee at their June meeting.
Normally we would comment on such reports, this one, however needs no comment
The purpose of this document is to provide a position statement on our external audit of the Council’s financial statements and conclusion on value for money arrangements. We do have outstanding matters to resolve before we are in a position to issue our audit opinion on the Council’s financial statements for the financial year ended 31st March 2019, and progress for the financial year ended 31st March 2020. However, the outstanding matters substantially relate to the provision of financial plans, modelling and decision making associated with the Council’s commercial arrangements and interest with London Luton Airport Limited (LLAL), where there has been a devastating impact of the Covid-19 pandemic on the airport and airline industry.
The National Audit Office has revised its audit code of practice for financial year ended 31st March 2021. This encourages us to report as soon as we become aware of risks of significant weaknesses in a Council’s Value for Money arrangements, irrespective of whether we have started the 2020-2021 audit or not. The Council’s statutory financial officer has shared the Council’s draft 2021-2022 revenue budget and medium term plans before these were considered by the budget executive on the 9th February 2021, and approved by full Council at its meeting on 17th February 2021. We provided a number of questions and comments on the draft 2021- 2022 budget directed to the financial sustainability risks and decision making associated with the Council’s plans to stabilise and support LLAL.
Medium to long term financial sustainability of the Council and exposure to the Airport
In February 2021, MHCLG agreed to the Council’s request for exceptional financial support as a result of Covid-19, awarding the Council a capitalisation direction. Up to £35million relates to the 2020-2021 financial year and is conditional on the Council agreeing to an MHCLG external review into its financial sustainability. The remaining £14million for 2021/2022 financial year comes with a condition that the Council reviews and presents a plan to reduce its risks of financial exposure with Luton Airport. In regularly discussing our questions and concerns prior to the end of March 2021, the Council’s Chief Executive and Chief Financial Officer have set out to us the following measures the Council has and is undertaking to address its financial exposure and risk to Luton Airport:
• Delivery of an emergency budget for the 2020-2021 financial year and setting a balanced budget for 2021-2022 financial year. Budgets have included financial commitments and priorities to address and improve the adequacy of the Council’s children’s social care services following a January 2021 improvement notice from Ofsted.
• The second phase of LLAL stabilisation and recovery plan has not yet been approved by the Council Executive. No financial commitment has been made by the Council to significant levels of additional borrowing to LLAL until a decision making and options paper has been reviewed by the Council’s Executive by the end of June 2021.
• The Council have commissioned an independent specialist review into options and alternatives to the Council’s ownership of Luton Airport.
• In mid-March 2021, we received LLALs stabilisation and recovery plans. We also received revised medium to long term assumptions and viability of the Airport expansion schemes following specialist reviews for LLAL by Arup. Jacobs are now undertaking an independent review of these plans for the Council and will form the basis of the Council’s decision making papers for its Executive by the end of June 2021.
Medium to long term financial sustainability of the Council and exposure to the Airport
Our questions and concerns are based on the following points we have made on the draft 2021-2022 revenue budget and medium term plan and other conditions we are aware of. We have briefed the Audit and Governance Committee on our audit progress at each scheduled meeting since the Covid-19 outbreak. We believe it is important that the Council’s decision making and options papers to Executive address these points to evidence how the Council is reducing its financial risks and exposure to LLAL:
• Our understanding is that the Council’s budget and medium term plans assumes a reasonable worst case scenario that the Council could be asked to support an additional £156million of borrowing for LLAL. We are expecting to receive the revised LLAL medium term financial plans that take account of the outcome of the special force majeure negotiations with LLAOL, the latest forecasts of the project costs for the Direct Air Rail Transport (DART) scheme and the Development Consent Order (DCO), alongside the actions the Council is taking to mitigate the impact on its budget and financial plans. This is important to determine whether there is a likelihood that the £156million borrowing could occur or if this may be more pessimistic and could increase to over £200million.
• MHCLG have committed to a capitalisation direction of up to £49million covering two financial years. The 2021/2022 budget and medium term plan assumes the Council may be required to finance £156million additional borrowing to LLAL. We will seek to understand how the Council will ensure that it complies with the requirements of the changes CIPFA are proposing to the prudential code for capital financing in Local Authorities. This puts greater emphasis on the external debt to revenue budget ratios, which we expect will be significantly over 100% for the Council with any further financial commitment to LLAL.
• We will need to corroborate whether additional levels of borrowing is both to stabilise LLAL and does include all of the expected impact of a special force majeure claim from the Airport operator. We have also asked whether the plans take in to account the expected costs to complete the DART scheme, originally estimated to be £225million; any further commitment to Airport expansion schemes, including DCO and Century Park Access Road (CPAR).
• As part of the Council’s review of LLALs revised medium term financial plan, we would expect to see an impairment assessment of LLALs ability to repay debenture loans. In light of the stabilisation assumptions to date, our question is whether LLAL is entirely reliant in the short to medium term on the Council to provide the financing to enable it to do so. Testing the recoverability of debenture loans is important to determine whether the Council can rely on the annual LLAL net interest receipts of £22million.
• Both the Council and LLAL are carrying the cost of DCO and CPAR as assets, with current costs now in excess £50million. The Council has to demonstrate and address our questions on the circumstances in which these costs can be capitalised as any transfer of economic benefits for a larger scale expansion of the Airport (32mppa) and CPAR are uncertain and at best a long term prospect. These schemes are heavily dependant on a commitment to investment and the conditions being appropriate to approve the expansion of the Airport post Covid-19. It is reasonable to expect that if the viability of the DCO works cannot be demonstrated beyond an initial phase of adaptations to the current terminal building, an impairment assessment is made of the costs incurred to date.
• To inform the review of ownership options, we understand the Council has requested up-to-date information on the current market valuation of the Airport. This is vital to enable decision makers to make an informed choice
Next steps
We recommend that the Council’s decision making papers to its Executive by the end of June 2021 includes all relevant and appropriate financial and non-financial information to enable an informed decision and choice to be made on the Council’s future financial commitment to LLAL. We believe this decision cannot be made until the Council has completed and considered a comprehensive assessment on the options and alternatives to its ownership of the Airport. We also recommend that the decision making report evidences the actions taken to address the questions and concerns we have set out on page three of this report.
Now that we have recently been provided with further information on LLAL stabilisation and recovery plans from the Council’s officers, we can progress with the remaining parts of our audit procedures and reporting for the 2018-2019 and 2019-2020 accounts. We are currently drawing on specialist corporate finance support to review the LLAL stabilisation and recovery plans. To enable us to make further progress with our historic audits, we will also require:
• LLAL external auditors to have completed their 2019-2020 audit procedures and associated audit reporting on LLALs disclosures and judgements on going concern, capitalisation of Airport expansion scheme costs and valuation of the Airport.
• Council officers to then provide for the group accounts their documented assessment and disclosures associated with going concern (of itself and LLAL), capitalisation of Airport expansion schemes and valuation of the Airport.
The Council have committed to provide this information as soon as practicable. This will allow us sufficient time to perform our audit procedures; which will include drawing on specialist corporate finance and real estate support, quality assurance and professional practice consultations. We recognise the importance of closing historic audits as soon as practicable. We will report the results of our historic audits to the Audit and Governance Committee at each stage these have concluded.
All of this information, including evidence of governance measures the Council is undertaking to take further decisions on its commitment to LLAL, will also inform the nature, timing and extent of any further reporting we may wish to do from this point and as we undertake the 2020-2021 audit under the Local Audit and Accountability Act 2014.
Given the significance of the Council’s decisions associated with its interest in LLAL, we believe we have a duty to consider at any stage our reporting options under our statutory audit powers. These may include issuing a statutory recommendation and/or a public interest report. Any decision to exercise our statutory audit powers is not taken lightly, and will take account of the Council’s response to our questions, concerns and recommendation in this report, its own public reporting, disclosures, financial and decision making arrangements as well as our professional practice consultations.