LOBO Judgement Calls Nick Keeling nkeeling@arlingclose.com

A couple of weeks ago another chapter of the long-running LOBO saga seemingly came to an end. Eight local authorities had started a joint action against Barclays Bank back in 2019 over LIBOR manipulation, centred on Lender Option Borrower Options (LOBO) loans lent by the bank that had interest rates set in relation to LIBOR. The High Court judge dismissed the case, stating it had “no real prospect of success”.

Barclays was one of the banks implicated in the LIBOR manipulation scandal that came to light in 2012 and the bank was fined for its involvement by both the UK and US authorities. The councils’ claim was that Barclays had committed fraud by offering loans linked to that rate. The councils maintained that, given their supposed knowledge of the manipulation, senior managers at the bank could have stopped any representations about LIBOR. The High Court judgement was interesting in that it noted that the defendants cannot show that they relied on the representations they alleged were made; Barclays had not set out that LIBOR rates were being honestly set, so they could not have misled the councils.

LOBOs have been an intermittent source of controversy for both the local authority and banking sector and the above situation highlights some of the problems faced by borrowers. The value of the loans at inception has been questioned, whether the embedded options sold to the lender were adequately compensated for via the interest rate paid. However, many authorities have been unperturbed. LOBOs were typically arranged at rates below prevailing PWLB levels, options have not been exercised, and subsequently many have had the options removed or have prepaid on attractive terms. Good fortune may have been at play here, but many local authorities have found that increased diversity of loan instruments and lenders has resulted in more flexibility in negotiating long-term debt.

While the PWLB is a fantastic resource for the local authority sector and a key pillar of its creditworthiness, new loan rates and prepayments are set by formula and cannot be negotiated later. Prepayment rates in particular are set at levels to seemingly deter prepayment and restructuring, impeding local authorities that wish to reduce debt burdens. This is less than ideal in the current interest rate environment, when holding excess cash balances is providing little revenue benefit compared to the huge potential in reducing debt costs.

Arlingclose has been at the forefront in encouraging lenders to offer attractive prepayment terms to borrowers; we have managed to help our local authority clients pare back LOBO exposure significantly, reducing long term interest rate uncertainty and providing revenue savings. It’s a positive way of managing what could be defined as legacy debt: very long-term fixed rate loans at higher rates that may no longer meet the requirements of the borrower due to changing circumstances.

The stock of LOBO loan debt held by local authorities has reduced significantly over the past few years and will continue to fall as authorities take advantage of current market conditions to unwind these deals. LIBOR is on its way out too, with the transition to SONIA expected by the end of this year (see here for our recent insight on this).

While there are plenty of LOBO loans left in local authority portfolios, it seems more likely that proactive debt management and opportunistic prepayments, rather than legal action, will help unwind remaining positions.

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