Sponsored article: The PWLB consultation raises the prospect of restrictions on council borrowing while the UKMBA remains a cheap alternative open to all local authorities, writes Christian Wall.
It remains to be seen whether the government will cut the PWLB’s margin and if so, by how much. The consultation, necessarily delayed due to Covid-19, gave the government considerable scope to deliver various outcomes and, most importantly, stated any reduction on the PWLB’s margin would be dependent on interest rates. Given that interest rates are lower than a year ago and one justification for the increased margin was a decrease in interest rates, it would be remarkable if the increased margin is fully reversed.
Other than the well-publicised moratorium on borrowing from the PWLB to invest “for profit”, the consultation also raised the prospect of other restrictions on councils borrowing through the PWLB.
Seemingly unnoticed, there may be limits to the maturity of loans offered by the PWLB with the document asserting that local authorities do not have assets with lifespans greater than 25 years; news, we suspect, to most local authorities.
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Alternatives
PWLB rates have always been arbitrary. In recent memory the effective headline rates have been 0.15%, 1.00%, 0.8% and 1.8% over gilts. None of these are market rates and none reflect the actual risks of lending to councils. In fact, higher PWLB margins work against councils seeking alternatives because investors can ask for higher rates than they would receive from borrowers in the housing, higher education and commercial sectors.
The arguments for setting up the UKMBA have been validated. The key goal has always been to insulate councils from arbitrary changes to the PWLB’s terms and conditions. If the retroactive introduction of repayment penalties in 2007—a move that was either illegal or would have been blocked by the courts in any other sphere—was not enough to convince everyone that an alternative is necessary, sudden changes to interest rates should.
There are other alternatives to the PWLB and the UKMBA. Whether these alternatives are appropriate depends on pricing, risk, flexibility and the specific needs and capabilities of each council.
Embracing, or rejecting out-of-hand, new developments without knowing the details and risks involved, while asserting the absolute moral, legal or financial certainty of one’s opinion, is wrong, but there are no simple answers.
Advice
It is increasingly apparent that the quality of advice provided to some councils and some councils’ understanding of the products, and related risks that they have entered into, is lacking.
One large financial services firm recently told potential local authority clients that a bond issued at CPI + 0.8%, with an inflation floor of 0%, had a negative real terms interest rate. This advice was, and is, plain wrong: the real terms coupon on a bond is the nominal coupon less inflation and thus the real terms interest rate could not be less than 0.8%. If you or your adviser do not have a clear understanding of long-term inflation rates and linked bonds, inflation linked bonds and income strips are best avoided.
More than one firm has told clients, even as late as June, that the opportunity to borrow from investors at spreads of 1.5% was “unprecedented”; we assume the spread of 0.8% to SONIA achieved by the UKMBA and Lancashire in March was deemed irrelevant. That the UKMBA and Lancashire then achieved a 1.00% spread to gilts in August for a 40-year bond must rankle.
Open
The UKMBA remains open to all authorities, although some will not clear the agency’s credit process and thus will be unable to borrow through the its pooled lending programmes, but the UKMBA offers alternatives. The UKMBA is a cheap alternative to the PWLB for any council seeking to borrow less than £250 million.
For those needing more, the UKMBA, in the year since its platform was opened up, has not turned down any council seeking to issue a benchmark bond issue through the UKMBA and nor will it.
It remains owned by local government, for local government and will always act in the interests of local government.
Christian Wall is a director at PFM Financial Advisors.
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