LOBO loans (Lender Option Borrower Option) were once a significant concern for local authority treasury teams. Post-financial crisis scrutiny, legal challenges, and widespread media coverage cast a long shadow over a product that, at its peak, represented around £15 billion, approximately 20% of total local authority borrowing. Today, that risk has not only diminished, it has decisively shifted. As we enter the final stages of the LOBO journey, expected to play out over the next couple of years, local authorities are firmly in the driving seat.
In the wake of the 2008 crisis, LOBOs became the focus of public and political ire. Complex, opaque, and holding embedded derivatives skewed in banks’ favour, these loans exposed councils to interest rate calls with significant refinancing risks. However, the subsequent decade of low rates kept these options dormant, and activity largely paused.
The landscape changed dramatically in 2016 when Barclays took unilateral action to waive its options, effectively converting an estimated £7 billion of LOBOs into fixed-rate loans. Arlingclose welcomed this as a critical breakthrough: by removing the most controversial elements of the loans at no cost to the borrower, Barclays not only reduced risk for local authorities but also set a precedent others would follow.
From 2017 onwards, a succession of favourable restructurings ensued. Arlingclose negotiated prepayments with the major lenders at spreads significantly above gilt yields, allowing local authorities to refinance at materially lower rates without incurring net costs. Negotiations with RBS followed in 2019, with the bank exiting over £1 billion of LOBO debt. These actions collectively removed or neutralised around £10 billion of risk at zero cost to local government.
This was, and remains, a material shift: lenders have absorbed the financial hit, while authorities retained low rates and removed structural risk. Even where loans were sold on to institutional investors, options were typically stripped out as part of the process.
Today, LOBO exposure stands closer to £5 billion, just 3% of overall local authority debt. The remaining loans are concentrated among winding-down institutions: notably, Dexia and FMS Wertmanagement. These are no longer active banks but state-backed entities mandated to reduce risk and complexity. Dexia’s loan book has contracted from €133 billion to €7 billion since 2012, a reduction of 95%, while FMS has cut its exposure from €176 billion to €41 billion. Local authority LOBOs now make up a more prominent share of what remains and are increasingly costly and burdensome for these institutions to manage.
The strategic imperative for these banks is clear. They can no longer originate new business, have few exit options, and face on-going operational and regulatory costs. Remaining counterparty count is now a key unwinding metric and eliminating LOBO exposure to UK local authorities offers administrative efficiencies these entities actively seek. Arlingclose experience suggests that the closer we get to removing the final exposures, the better the terms offered to authorities.
Lenders have already begun calling loans, occasionally swallowing substantial break costs to do so. Where this has occurred, some councils have refinanced at higher rates, but many others have opted for short-term debt, benefitting from falling Bank Rate (now 4.25%) with markets implying further reductions over the next year. This dynamic has helped take the sting out of LOBO calls.
The lenders’ remaining tools are limited. While they may attempt to persuade councils to make upfront payments to remove options or reduce duration, such proposals offer poor value compared to the £10 billion already converted or repaid at zero cost. The logic is clear: where interest rates are unchanged and options are removed, the upfront payment simply represents value transfer from the public sector to the lender.
Local authorities are under no immediate pressure to act. The secondary market for LOBO assets remains extremely limited, and banks’ internal fair value assessments often bear little relation to prices they can realistically achieve in practice. Attempts to sell these loans at levels even approaching gilts plus 100 basis points, with options removed, have consistently fallen short. Until banks recalibrate their pricing expectations to reflect market realities, state lender-initiated calls are likely to remain limited. Break costs continue to make such actions uneconomic in most cases, except for the very lowest coupon loans. That said, where calls do occur, councils are well-placed to respond, short-term borrowing remains accessible and attractively priced, offering a cost-effective route to refinance and manage any resulting cash flow impact.
The LOBO endgame is underway and will likely play out over the next couple of years. But its direction is no longer in question. Banks are constrained, exposed, and eager to exit. Local authorities are under no pressure to act, but those who have done so to date have secured consistently advantageous terms.
The key messages for treasury teams are simple:
The LOBO chapter is closing with local authorities increasingly in control of the outcome.
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