As local government treasurers look to diversify their lending, Room151 examines why there is a lack of alternative borrowing options for councils outside of the PWLB.
Reading through councils’ Treasury Management Strategies (TMS) for the next financial year, it quickly becomes evident that borrowing from the Public Works Loan Board (PWLB) overwhelmingly dominates other forms of external lending.
However, with gilt yields experiencing dramatic changes over the past 18 months, PWLB borrowing is no longer as affordable as it once was, leading treasurers to question whether there are any alternative cheaper lending options. Unfortunately, the answer is often no.
Historically, local authorities did not just rely on the PWLB for financing. The UK Municipal Bonds Agency (UKMBA) has been an option, as have commercial lenders such as banks.
So, what changed? Why are local authorities now struggling to find cheaper borrowing options outside of the government’s offering?
Financial distress narrative
Christian Wall, director at financial consultancy PFM, argues that one of the “major barriers” to accessing other borrowing options, particularly available through the UKMBA, is the “narrative” that the sector has put around itself.
“The sector has been telling everybody that it’s in financial distress, so you’ve had a whole string of councils that actually aren’t in financial distress in an objective sense, telling the government that they are going to cut services due to financial distress. Enforced cuts and financial distress are not one and the same.
“If you’re a commercial lender that does not translate very well.”
Last year, in lobbying efforts for more government funding, dozens of councils warned that they were facing section 114 notices, leading to Exceptional Financial Support being granted to 19 local authorities.
Alongside this, six councils have issued section 114 notices since 2021, with the most high-profile case being Birmingham.
This has ultimately led to hesitancy among private investors to lend to local authorities, driven by their concerns over the risk of default. However, those within the sector, as Wall explains, know that the default risk for councils is zero.
“So, a lot of the challenges local authorities face about cheaper finance is really correcting that narrative and misunderstanding. If we can tackle that, alternative sources of finance, particularly in the public bond market, should be cheaper,” he adds.
Wall tells Room151 that the rates of borrowing from the UKMBA should be gilts + 0.2%- 0.3%, considerably lower than the PWLB at gilts+ 0.8%, with fixed rates on a 10-year loan currently being 5.14%.
“Historically, the PWLB was the last resort, more latterly it has become the lender of first resort, arguably at last resort rates on occasion.”
He explains that just before the invasion of Ukraine, a loan through the UKMBA presented to the North London Waste Authority offered rates at gilts+ 0.6% or 0.7%, cheaper than the PWLB. Unfortunately, the deal didn’t go through due to market changes caused by the war.
Administrative burden
Nazmin Miah, director at advisor Link Group, argues that while factors including “uncertainties” and “negative press” have made investors think more “carefully” before lending to authorities, there are also other factors to consider.
A “predominant” one is that currently investors are not able to compete with the PWLB, “both in terms of the margin and also the time it takes to secure alternative long-term borrowing”.
This sentiment is also shared by David Green, director at advisor Arlingclose. “While there may be savings for local authorities from time to time by borrowing from elsewhere, this doesn’t outweigh the extra administrative burden,” he says.
Wall adds to this argument by suggesting that the ease of local authorities using the PWLB is cutting them off from ever achieving better and cheaper rates.
“Another barrier is that local authorities are very comfortable with the PWLB, it’s very easy, but the alternatives need some work. I think local authorities need to step back and develop their options.
“Local authorities need to work more on the outcome. If you want cheaper rates you have to get away from the PWLB. You need to make the alternatives, such as bonds and the UKIB, work and you need to fully understand what you are getting into,” he adds.
LOBO fiasco
Alongside narrative issues, instances such as the Lender Option Borrower Option (LOBO) “fiasco” have caused hesitancy from both sides, Wall explains.
The LOBO loan scandal was first highlighted in 2014, when it was revealed that around 240 local authorities took out £15bn worth of loans from private banks, with some authorities claiming that the banks had manipulated interest rates on the products.
“Given the track record you have with LOBO, Hammersmith and Fulham’s issue, banks are now wary. Some of that is reputational risk.
“The banks for various reasons are less able to lend to them than they were, and the LOBO fiasco has proved that to some banks. Most authorities have to accept that they need to work together to get the best external finance, otherwise they are left with just the PWLB,” Wall adds.
From another perspective, Miah explains that banks are no longer a source of finance due to the “cost of capital”, which has made it expensive for long-term borrowing.
“Even with the institutional investors, the cost of capital is important and factors such as credit of the local authority will have an impact on how they price long-term borrowing in terms of the margin added over the respective benchmark,” she adds.
Credit ratings
Miah thinks that what may help ease lender anxiety is local authorities getting credit rated.
“In some instances, for example a private placement with an institutional investor, a credit rating may be helpful especially if there is uncertainty on where the rating should be for the local authority,” she explains.
However, if the credit rating is bad, it could have a “knock on effect” in terms of lenders not wanting to lend to certain bodies. There is no obligation to make that public, though, if it could be perceived as “unattractive”, Green says.
Green argues that one way in which the government could help open up cheaper borrowing alternatives for local authorities is through “guaranteeing local authority debt or allowing them to secure loans on their assets”. However, there is no incentive for the government to encourage private-sector lenders into the market.
Until the landscape shifts, PWLB borrowing will continue to dominate. And while there are actions that can be taken to make alternative options more attractive, there appears to be no quick fix.
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