Rishi Sunak’s budget placed restrictions on the way PWLB loans could be used. Neil Waller and Scott Dorling examine the alternatives.
Following the budget announcements, it is likely that the Public Works Loan Board will remain the lender of choice to councils funding social housing. It is also likely that, following the consultation announced by the chancellor Rishi Sunak, PWLB will also remain the “go to” borrowing source to fund service delivery and regeneration.
But for those councils that continue to have a borrowing need for other projects, particularly where there is need to generate yield, it should be assumed that the PWLB may no longer be available. It is for these types of projects that sources of private finance may still be a practical and cost-effective alternative.
Some of these products may also be viable alternatives even in areas where PWLB continues to lend. For example, they could offer protection against fluctuations in PWLB rates and other key features which PWLB does not.
Loan agreements
Many loan agreements provide for “committed” facilities, meaning that funds are available to be borrowed at an agreed price for a specified availability period. This is a key difference from PWLB where, although the availability of funds to councils is certain, the price is not.
Similar to PWLB, loan agreements may offer fixed and variable interest rate options. But there are other alternatives such as inflation-linked rates, caps and collars. Optionality can also be built in.
As reported in Room 151 (15 February 2018), one innovative variant already used by two authorities is the “forward start” under which a council will commit to draw a loan at a specified point in the future but locking in today’s interest rates. Whilst this could be more expensive than borrowing at today’s rates, it offers an element of budgeting certainty for future years.
Private placement of notes
These are simply promises to pay specified sum(s) at a future date (essentially “IOUs”). They could have a maturity of up to 35 years or even longer.
It is possible to agree bespoke terms, for example issuing on a deferred basis and/or with a range of maturities, all in the same agreement.
As with PWLB, the principal risk of entering into this kind of arrangement is payment of “make-whole” on any early repayment. This requires investors be compensated for the interest that they would have received through the balance of the term of the note—these costs could be substantial.
The private placement market is particularly well developed in the United States and councils may consider tapping this investor base. However, where a foreign investor buys notes in sterling, it will often enter into a swap transaction to manage exchange rate movements.
An investor would typically look to pass on to the issuer the costs of breaking this swap in the event of early repayment.
Entering into such arrangements could be a foreign currency borrowing, requiring Treasury consent under the Local Government Act 2003. This may limit the ability of councils to access foreign markets.
Public bonds
These are also IOUs, but listed on a recognised stock exchange. A credit rating is typically required.
Bonds are typically fixed-rate instruments although other variants (for example inflation-linked bonds) are possible. They can have a term of up to 30 years, or longer, and some of the bonds can be retained for an initial period to enable further funds to be raised later.
The set up and ongoing costs of a public bond are significantly more expensive than other types of financing, which means that we rarely see bond issues of less than £100m and more usually issues will be in a minimum “benchmark” size of £250 million.
UK Municipal Bonds Agency
Many councils will not have a need to raise this kind of money in one hit. For them, the UK Municipal Bonds Agency offers a viable alternative means of accessing the capital markets.
The agency’s sole purpose is to issue bonds to finance lending to local authorities. This will offer a significant cost saving to authorities and will be simpler for a council than issuing on their own. Loans will be available on standard terms and each council will give a guarantee proportionate to the amount borrowed (the previous joint and several liability structure having been modified).
The agency has just completed its first issue which has been used exclusively to on-lend to Lancashire County Council. A second issue is also reported to be well-progressed and is expected to launch shortly.
Private finance alternatives v PWLB
The principal key differences between a PWLB borrowing and raising any kind of private debt alternative are:
Cost factors: Other than payment of interest, there are no costs associated with a PWLB lend, but with any alternative there will be fees payable to funders, intermediaries and service providers.
Speed of delivery: Raising PWLB debt has been likened to going to the cashpoint. Any alternative will take significantly longer. A bond issue, including the obtaining of a credit rating, is likely to take four to five months at least. A private placement will typically take a little bit shorter and a loan agreement could be put in place within weeks. However, in both cases a council will need to allow time to select its preferred funding partners, who will then have to go through their own internal approval processes.
Documentation: PWLB loans are issued with limited documentation and there is no negotiation. Any alternative will require detailed, technical documentation and key terms that can be negotiated. There will likely be a need to obtain external treasury and legal advice.
Neil Waller and Scott Dorling are partners at law firms Trowers & Hamlins LLP.
