“Revolution in council lending could tackle irresponsible borrowing”

“Most coverage of local government finances falls into two categories of story. The first concerns the egregious rewards paid to “town hall fat cats” for often mediocre performance. The other concerns “savage cuts” being made to this or that service due to a reduction in central government grants.
There is truth in both of these. What has not gone reported so much is that a genuine revolution in local government finance is under way.

The traditional model of financing, in which grants are doled out by central government, is gradually being replaced by a system in which councils, collectively, are self-funding and individual councils bear more risk as a result of their own spending and revenue-raising decisions.

Some of these reforms have already attracted attention, chiefly the changes to business rates, over which individual councils will have greater, but still limited, autonomy in future.

Another big change coming has attracted surprisingly little attention. The UK Municipal Bonds Agency (UKMBA) was launched in 2014 with the aim of helping councils to finance their spending. The agency, a public limited company owned by 57 local authorities and the Local Government Association, aims to issue bonds with maturities of between ten and twenty years. Because it is backed by a number of councils who have pooled their borrowing requirements, the theory is that it should be able to create “benchmark” size issues for which there should be greater demand from institutional investors. And because more than one party is responsible for repayment of the bond and servicing the interest payable on it, a “joint and several guarantee” in the jargon, in theory the bonds should be less risky to investors. That should also, in theory, lower borrowing costs for councils.

The idea is common elsewhere. Kommune Kredit has been operating in Denmark for more than a century, while BNG in the Netherlands has been going since 1914. Kommunalbanken has been funding local authorities in Norway for 90 years; other such funding agencies exist in Canada, New Zealand and Switzerland, among others.

One of the key aims of UKMBA is to allow local authorities to borrow more cheaply than the existing lender of choice, the Public Works Loan Board (PWLB), a 224-year-old body that currently accounts for about three quarters of local authority borrowing. Traditionally, the board has charged 20 basis points above the prevailing gilt rate but in October 2010, in an attempt to discourage borrowing by local authorities, the coalition government raised this to a 100 basis points premium.

The board now, in most cases, lends to local authorities at 80 basis points over the gilt rate. It was when the cost of borrowing from the board was increased that leading figures in the local government world began to talk about an alternative finance provider.

Aidan Brady, the former Deutsche Bank chief operating officer who is chief executive of the UKMBA, is on record as saying: “Clearly, we have to beat the Public Works Loan Board [in terms of offering a cheaper rate], that’s as simple as it gets.”

The irony is that just as the new agency is about to offer some proper competition to the board disquiet is growing about the extent to which local authorities have been borrowing from the latter.

The Sunday Times reported last weekend that a number of local authorities had gone on a “£1.3 billion binge” of buying commercial property with the aim of using rental incomes from those assets to supplement spending or reduce the extent of budget cuts they would otherwise be making. The danger is that these authorities have exposed themselves and future generations of council tax payers to swings in the commercial property market. Traditional property market buyers have been astonished at the prices paid for assets such as some sub-prime shopping centres, grumbling that local authorities are distorting the market.

This has been made possible over recent years because by linking the PWLB loan rate to the gilt rate and allowing the latter to be depressed by the Bank of England’s asset purchase scheme the government has created a “carry trade” opportunity for local authorities in which they can borrow at about 2 per cent and invest the proceeds in an asset yielding between 6 per cent and 8 per cent.

None of this has made the job of the fledgling UKMBA any easier. The agency was reported as long ago as June last year to have signed up nine local authorities to participate in the first debt issue, which was expected by the end of 2016, with a panel of eight banks, including three to act as “lead runners”, in place to run it. But no issues have yet taken place. Market sources suggest that this is because the agency is still waiting on one more council to sign off on its participation.

This ramp-up in local authority activity could be because the PWLB, which is currently an arm of the Debt Management Office — the Treasury agency that issues gilts and manages the national debt, is about to be absorbed into the Treasury, which may lead to more control being exerted on its future lending. That was certainly suggested in a government statement last year noting that transferring the PWLB back into the Treasury would “secure greater accountability to ministers and enhance the efficiency and effectiveness of central government lending to local authorities”.

In other words, local authorities are borrowing now, while they can. The sooner they are subjected to either greater Treasury scrutiny on the one hand or the superior credit checks being promised by the UKMBA on the other, the better.

The Times Comment (paywall)