By now, most readers will know that Birmingham City Council has issued a Section 114 notice, with the chief financial officer formally announcing that the council will struggle to pass a legal budget on its current trajectory, and so the council is now prevented from entering into any new non-statutory spending commitments until the situation is resolved.
The biggest local authority in the country is in financial difficulty, and so it is not unreasonable to ask how this might impact the local-to-local lending market.
The local authority sector has long had a healthy cash market; councils with excess cash balances lending for short periods of time to those with a borrowing need. This has been a virtuous circle with borrowers having access to plentiful short-term funding at fair rates of interest, whilst lenders make high credit quality investments which avoid bail-in and other risks of the banking sector.
However, with such a high-profile council having issues, does this picture still hold? Will investors begin to withdraw from the market, leaving borrowers with a need to find other sources of short term or variable rate debt?
The first thing to note is that the risk of loss to those who have already lent money to Birmingham is very low. As well as having the back stop of the PWLB for refinancing, section 13 of the Local Government Act 2003 gives lenders great comfort in receiving their lending back in full. Any loan made to a local authority is secured on the revenues of that authority. This is the quid pro quo of authorities not being able to mortgage their assets.
In practice what would happen is that if a council doesn’t pay owed monies within 2 weeks of a legal demand, the High Court can appoint a receiver with wide ranging powers, to collect the debt on the lender’s behalf.
Secondly, it’s worth comparing the impact of recent issues in the LA sector with those in the banking sector. At time of writing there have been 5 recent Section 114 notices issued by UK councils. The resulting losses to local authority lenders? Zero.
In contrast, when Greensill Bank announced it could not meet its liabilities in 2021, the losses to the German Municipalities which had lent it money were estimated to be as high as €500m. With insolvency procedures still ongoing it is still not known exactly how much those German Councils will get back.
So we expect that most local authority treasury managers in the UK will look at the risks and decide that on balance, other councils still deserve a place in their treasury portfolio, and that the risk of confused press articles and understandable questions from concerned councillors are worth the strong credit quality, especially where public money is concerned.
It is therefore unlikely that the latest high-profile council to issue a 114 notice will do too much damage to the intra-authority market. However, we can expect more scrutiny on such deals, so treasury officers will want to continue to demonstrate that proper processes and diligence is taken with all investment decisions.
iDealTrade, Arlingclose’s local authority matching platform includes a number of financial ratios and comparator information via the proprietary Financial Strength Ratings which can assist lenders in making an informed decision when lending. Rather than excluding borrowers, this tool can be used to manage risk and ensure a healthy balance to the portfolio.
Also, if the worst did happen, treasury officers will want to be assured that the lending contract in place is clear and comprehensive. Unlike some market deals, every iDealTrade agreement is backed by clear documentation which is fully compliant with the Bank of England Money Market Code. This means that both lenders and borrowers can supply colleagues or auditors with a clear understanding of what exactly the council is signed up to, rather than simply a deal ticket or confirmation email.
The local authority market will continue to provide value to both lenders and borrowers, however in a time of heightened scrutiny, treasury officers would be wise to demonstrate they are taking such agreements seriously.
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