As Local Authorities’ requirement for borrowing has increased, so have the structures employed to minimise the costs of borrowing. At Arlingclose we often advise clients that borrowing should only be undertaken when necessary, as borrowing in advance of need incurs the costs of carrying that debt. If borrowing is required, due to the low return on investments in the current environment, borrowing on a short-term basis will generally present the cheapest form of borrowing.
Local-to-local borrowing: The LA market has increased dramatically over the last 10 years. Borrowing on a monthly basis for a year at an average rate of 0.8% (which is a high rate for demonstration purposes), compared to a one-year PWLB maturity loan at the Certainty Rate which is currently 1.57%, the shorter-term rate is an obvious saving. This short-term rate is variable, as each month may be slightly different, however cumulatively the savings would be significant. There is a risk that rates may go up, but it can be expected that a one-month rate will not change too drastically in the short term. Short term LA-to-LA lending can also prove cheaper than variable-rate PWLB due the higher flexibility of rates, whereas the PWLB rate reset is at least once a quarter!
This raises the question of timing of taking on longer term debt. The decision to lock out debt should not be rushed into. Poor timing can result in unnecessary costs associated with that debt. Arlingclose has assisted clients with the timing of this borrowing to maximise the savings and maintain a balanced portfolio of both short and longer-term debt. In the event of locking out long term debt, there are various options available to Local Authorities.
The Public Works Loans Board: The PWLB is the most common source of financing for Local Authorities. They offer 3 types of borrowing; Maturity, EIP and Annuity, each have their own structure and associated rate. Maturity: interest payments are made throughout the period of the loan, and the principal borrowed is repaid at maturity. EIP: Equal Instalments of Principal pays back principal over the life of the loan, and the interest associated with the loan goes down as the principal outstanding reduces. Annuity: Equal payments over the course of the loan, with principal paid back over the course of the loan in an increasing amount.
However due to the scale of some projects, alternative structures can be explored to achieve a lower interest rate and savings over the course of a loan.
Forward Starting Loans: these are dependent on the scale of the project, however there are counterparties within the marketplace that are willing to lend to local authorities with this structure. This is where a rate is agreed now, for you to take the required borrowing at a specified point in the future. The benefits of this are that it can guarantee a source of funding now, at a specified rate, for some time in the future; there is potential for significant savings. The risks are that rates could fall in that period, or the Council no longer requires the financing due to capital reprofiling, and the Council is still obligated to take the specified amount. This could work in a scenario where a Council is committed to a project starting in the future such as a committed housing project.
Local Authority Bonds: Again, these require scale. If a local authority has a significant borrowing requirement, it can be possible for LAs to issue a bond and the resulting cost of financing may be cheaper. The bond's security is from the proceeds from the specific project that it applies to. This is separate to the Municipal Bonds Agency, which would issue a bond to raise finance; however these funds would not be applied to a specific project. Some issues with issuing a bond include the time taken to issue a bond, the added costs to the local authority (these include acquiring a rating from a rating agency, legal fees, broker fees). Given that the PWLB is readily available, the admin involved in issuing a bond is relatively cumbersome.
Structuring borrowing is certainly a factor in achieving the best rate. There are many complex options available; a more tailored structured approach will often lead to savings compared to the Council’s plans. A simple maturity loan for 50 years, whilst tempting due to low rates, will always cost more due to the extended duration, during which the Council will be paying interest. Borrowing should also be tailored to the specific project and where possible aligning cash-flows can minimise costs, which can include short term, variable rate, forward starting and a combined structure culminating in significant savings!
A couple of simpler structures have been outlined below:
A basket of maturities approach: this mimics the structure of an EIP, which involves taking multiple maturity loans of differing maturities. By using this structure, the average rate of the basket of maturities will be lower than an EIP.
A combined EIP/Maturity approach; this involves taking one EIP loan for the starting period of the project, and a series of maturity loans for the remaining period of the project term. This aims to capture the lowest rates available to the local authority market.
Arlingclose would be happy to discuss borrowing options, please contact the Debt Team on 08448 808 200.