Death Of A LOBO David Blake

This represents a significant break-through for borrowers and removes risk and uncertainty from a large chunk of local authority debt.

What has triggered this move? An increased sense of responsibility to public sector borrowers? A spontaneous bout of generosity?  No. Unsurprisingly, as anticipated in our April “Insight” on LOBOs, the decision is attributed to a desire to reduce the sensitivity of unpredictable market conditions on their business, in order to improve core capital. The bank has also taken into account the changing regulatory environment that would soon lead to an increased cost of holding these structured instruments.

No doubt the bank will also have considered reputational and legal issues before acting. Removal of controversial embedded derivatives will make it harder to demonstrate a loss relating to these loans, particularly as most were arranged at coupons below the prevailing long-term PWLB fixed rate. It will now be easier for the bank to sell these fixed rate assets on to third parties, should it choose to do so. The result is an increase in holdings of fixed rate debt for those affected. Who would have thought that would be the outcome when these deals were struck?

As things stand, the prospects of options being triggered, based on current market conditions, were remote. This is precisely why Barclays has been able to take action now, with rates at record lows, and remove the options at relatively low cost. Of course, local authorities will not mourn the loss of their “Borrowers’ Option” to repay at par, this was always virtually worthless given it would only be triggered if the lender exercised their option to increase the rate. The lenders option would only ever work in the banks’ favour. It will now be much easier for borrowers to manage interest rate and refinancing risk. There is even the chance of generating a discount on these loans, subject to negotiation and a surge in interest rates.

Arlingclose maintains regular dialogue with lenders with the aim of mitigating LOBO risk on behalf of our clients. Our view is that most banks are under more pressure to re-negotiate these transactions than local authorities; as such any restructuring should be at zero cost to authorities. This restructuring meets both of these objectives and is a welcome development. Arlingclose will be providing on-going advice to authorities holding more complex loans, such as “range LOBOs”, with a view to achieving a similar outcome.