A £400m forward borrowing deal undertaken by Westminster City Council in 2019 has now concluded at massive discounts to the current interest rates – saving the authority around £8m a year for 50 years. Here, Matt Hopson and Phil Triggs, who worked on these private deals, detail how they did it.
“Luck is where opportunity meets preparation.” So declared Seneca, the ancient Roman philosopher. He was expressing the idea that luck is not a matter of chance, but a result of being ready and willing to seize opportunities that arise. In other words, preparation and then timing are everything.
Phil Triggs alluded to this in his Room151 article from 2014. “There will be a time when interest rates are at their absolute lowest and that future day will come and go, and no one will ring a bell during that particular morning. Hindsight is indeed 20/20 vision,” he wrote.
That particular day came seven years later: it was 9 December 2021 when the PWLB certainty rate for 49.5 to 50yr and 50yr + rate was 1.25%.
This day came far later than any of us could have predicted, with seemingly one crisis after another since the Great Financial Crash of 2008. We went through Brexit, Theresa May’s hung parliament, European deflation, and then Covid-19 struck. There was seemingly always a reason for interest rates to stay lower for longer, to the point where some major economists and advisors felt that the mechanism allowing inflation to feed through the financial system was permanently broken.
Taking on Seneca’s advice for being prepared, Westminster City Council came close to the sweet spot in terms of timing and prudence in its borrowing and treasury management strategy. During 2019/20, the council secured forward borrowing loans totalling £400m at an average rate of 2.58%.
With the comparable general fund rates on offer standing at an eye watering 5.43% today [as at 1 December 2023], this amounts to a staggering £11.3m a year difference in interest payments. However, the journey was not without its complications and a fair share of drama.
A crucial decision
In 2014, 50-year gilt rates at 4.4% looked a bargain. However, in 2019 when the same loans could be booked at 1.9%, the 2014 scenario looked astronomically expensive. Treasury managers were often left second guessing the best course of action. The two major providers of treasury advice, Link and Arlingclose, had directly contradictory advice: Link to take the loans on offer, Arlingclose to borrow only when cash levels had been exhausted.
Westminster City Council confronted this dilemma head on back in 2017. Faced with an extremely ambitious future ten-year capital programme set to cost around £1bn net, but with no immediate cash flow problems forecast until the early 2020s at least, officers devised a list of various options for borrowing over the long term. These were:
- Continue to internally borrow and take no further action.
- Borrow now to lock in low rates (at circa 2.5%).
- Lock in the rates now but commit to receiving the money three to four years in the future.
- A combination of the above.
Like many other councils, Westminster favoured internal borrowing as the preferred course of action, minimising the cost of carry (the difference between loan interest cost and the rate of return on cash investments) and waiting for when expenditure was needed. However, the risk of a huge cliff edge in terms of refinancing and the interest rate risk cocktail was one that could no longer be tolerated. Each percentage rise in the cost of borrowing would increase Westminster’s capital programme cost by £10m per annum.
“Our successors at Westminster may curse us in ten years’ time for not filling our boots at these rates now,” is a quote from the discussions at the time and demonstrates the tensions that were present in decision making.
There was much deliberation on the best course of action and many reiterations of a borrowing strategy but, eventually, the decision was made to take a balanced view of the options above and lock in £400m of general fund borrowing forward in 2019, with a view to receiving the funds in 2022 and 2023. The objective of the strategy was simply to make sure that the worst-case scenario risks were managed.
The £400m was just under half of the assumed medium term capital financing requirement, with the amount deemed a win-win scenario for the authority:
- If the interest rates went up by 2022, the council has secured a significant amount of required funds already at a rate it knew was affordable.
- If rates went down, further funds could be borrowed at even cheaper rates than what was known to be already affordable.
Scaling new heights
Of course, deciding what to do was only the first part of the struggle. It was also vital to ensure that everyone (officers, senior management and cabinet members) understood and supported the strategy, which involved legal advice, Link’s treasury advice, economists giving their opinion on how, why and when markets might move, and even looking to investment managers for their predictions on bond markets.
This type of forward transaction on such a large scale had never before been attempted by a local authority. Previously, the largest agreed forward borrowing transaction for a local authority had been for only £50m. Other authorities had also embarked on large market loans, but these had been through bond issuance.
Officers opened discussions with Link, negotiating the advisory fee for the transactions, before they went to market on the council’s behalf, drawing up a shortlist of private lenders interested in investing with Westminster.
Once interested parties were shortlisted, the next step was the Dragon’s Den style grilling from the lenders themselves. The task was selling the Westminster narrative and its financial strength relative to its credit risk – a task much easier in 2019 than in 2023, it has to be said. These discussions helped to set the spread to gilts that Westminster would ultimately have to pay for the loan.
The next stage was taking on the unenviable task of explaining UK local government accounting practices to large American insurance companies. Attempting to clarify to meticulous Americans the complexities of the Movement in Reserves Statement (MiRS), prudential indicators and the local authority collection fund is a challenging experience.
Perhaps the biggest challenge of all was the myriad of legal documentation. There were disagreements over whose legal opinion the investors would accept in terms of whether Westminster actually had the legal power to make the deal, thinking back to the House of Lords Hammersmith and Fulham interest rate swap case of 1992. The legal complexity was such that for one of our lenders, the deal was almost not transacted.
Then there were disagreements on certain covenants. Examples include trying to second guess and future proof against primary legislation for any central government changes to local government or, if failing to deliver a set of unqualified audited accounts by 30 September, whether that would result in a loan default (it definitely does).
Getting the paperwork over the line took months of negotiations with the lenders, but they were finally all agreed at the end of August 2019.
Perfect… and not so perfect… timing
Initially, Westminster’s officers couldn’t believe how lucky the timing was. Within a few weeks, in the face of many cases of reckless borrowing by local authorities in a vast spending spree on UK commercial property, the UK government raised the PWLB interest rate by 100 basis points. Such was the fortune in this timing, some practitioners speculated that Westminster had “inside knowledge” that this PWLB rate increase was about to happen which, of course, was not true. However, all would not remain rosy in the garden for long.
Six months later, the timing of the most ambitious forward rate loan transaction in local authority history suddenly looked far from ideal. Interest rates and gilt yields plummeted as Covid-19 ripped across the globe and the PWLB 50-year rate later bottomed out at 1.25%.
Officers were required to justify to the Westminster Audit Committee what seemed to be very expensive borrowing rates compared with the lows of the early 2020s, with those who acted even earlier such as 2014 facing an eye watering bill for their timing decision.
However, fast forward to the start of 2022 and suddenly we had rampant global inflation, topped off by the ill-advised ‘Trussonomics’ debacle and the LDI crisis: the 30-year bull market for UK gilts was suddenly ended. Markets had reached 25-year highs for the UK government long duration gilt yields and short term PWLB rates were now topping 6%.
The worst-case scenario was what happened in 2022, with the very top end of borrowing costs in scenario planning peaking at 6.5%, to which some called this number totally unrealistic.
Since those historic, extraordinary times, the market has now stabilised but remains hugely elevated. Now the rhetoric from the Bank of England is ‘higher for longer’, and the talk of returning to 2% rates seems an absolute impossibility. This means that the unfunded part of the Westminster capital programme will likely be more than anticipated.
During May 2023, Westminster received the last tranche of its forward borrowing deal, secured at 2.89% interest for a £200m EIP loan.
More than luck
Perhaps it is at this point that we can look back to Seneca’s immortal words. There did appear to be an element of luck with Westminster’s forward borrowing transaction. Timing the market for the funds to arrive just as rates were rocketing may seem fortunate, but it was never the intention to time the market in this way. Westminster’s objective was simply to manage an unacceptably high risk to ensure affordability at what was felt the lowest cost way to do so.
The preparation that Westminster’s officers undertook over 18 months allowed the council to make the most of low interest rates while they were there and avoid a substantial cost of carry.
The next ten years will provide a multitude of new challenges in the markets, and only time will tell what preparations are needed to take advantage of the next set of opportunities. Opportunities are only controllable to a certain extent, but consistent learning and preparation ensure that, whenever those opportunities arise, luck will be on our side.
Phil Triggs is the tri-borough director of treasury and pensions at Westminster City Council, while Matt Hopson is now the deputy director of finance at the London Borough of Islington.
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