The surprise 1% hike in the rates of interest offered by the Public Works Loan Board (PWLB) in October last year has focussed attention on possible alternative methods of borrowing for local authorities.
In principle there is no reason why local authorities should not look to the private sector for borrowing both for housing and their general financing requirements. This article looks at some of the key features of each of these alternative types of financing and, where relevant, contrasts these with the products available through PWLB.
Loan agreements
Loan facilities may be on a term basis, where loans are drawn and remain outstanding until they are repaid, or on a revolving basis, which operates like an overdraft or a credit card.
As with PWLB, it is possible to structure term loans on an amortising basis or to provide that they are repaid at the end in one “bullet”.
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. PWLB does not offer this option nor does it offer revolving credit. It also lends on a fixed rate basis only, whereas loan agreements could offer a range of different interest alternatives.
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 £100 million and more usually issues will be in a minimum “benchmark” size of £250 million.
Unlike most bond issuers, a local authority does not benefit from the “quoted Eurobond exemption” under which issuers can pay interest to any bondholder without deduction of UK withholding tax. For this reason, it may be necessary for a council to issue a bond through a special purpose vehicle.
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 is planning to issue bonds for the exclusive purpose of on-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 is reported to be making its first issue imminently with Lancashire County Council as borrower. A second issue is also being reported which will create renewed interest.
Private finance alternatives v PWLB
For most councils, the interest rates available through alternative financing will be cheaper than PWLB. But this comparison does not take account of the complete picture.
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 4 – 5 months at least. A private placement will typically take a little bit shorter and a loan agreement could be put in place within weeks but 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.
Terms required by investors
There are no on-going terms and conditions in a PWLB loan, other than to pay interest and to repay on time. It remains to be seen what terms funders in these various markets will offer to local authorities. Some lenders will look for compliance with financial ratios and all of them will expect to receive regular financial information. Some may want to discuss control on a council’s activities, such as limits on the ability to on-lend or invest in joint ventures.
Understand the alternatives
Given the recent increase in PWLB rates, the headline interest rates available from other sources of borrowing look particularly attractive. But councils should take care that any comparison takes full account of all associated costs, the timing implications and the additional legal responsibilities that these structures bring with them.
