Pass the PWLB David Blake

Allowing local authorities to transfer PWLB loans between each other could dramatically increase flexibility in debt management, reduce risk and deliver substantial savings. In this Insight Arlingclose examine how this could work.

HM Treasury dedicated a few paragraphs in their recent consultation on “PWLB Future Lending Terms” to PWLB loan transfers.  This involves an existing PWLB borrower transferring their loan and associated obligations to another authority. There is some precedent for this activity, including the transfer of “managed debt”; loans held on behalf of one authority by another as a result of past local government reorganisation. Arlingclose has advised on the process of tidying these portfolios, arranging the transfer of PWLB debt from one authority to another, in conjunction with the PWLB, and reallocating loans or parts of loans on a pro rata basis.

But what about the transfer of debt between any authority? There are still plenty of authorities with too much debt, or, more specifically, too much fixed rate PWLB debt, that they would like to repay to reduce costs and risk. Some investment rates have now dropped into negative territory so it is not inconceivable that authorities could end up having to both pay interest on unwanted loans and pay someone to take the cash off them. 

How about repaying the loans early? Well, the current spread of around 2% between new loan and premature repayment PWLB rates makes this an eye wateringly expensive proposition. Some PWLB discount rates are negative; if you prematurely repay you must pay all contractual interest for the remaining life of the loan plus a bit more. There are dozens of better ways to deploy the surplus cash to offset interest costs and avoid hefty premature repayment penalties. HMT has stuck to their guns regarding this spread, saying it is required to protect the National Loans Fund from loss, but that argument has never made much sense.

Novating debt to another authority would offer a better value alternative to prepayment and avoids the 2% spread that has been the barrier to reducing debt levels for almost a decade. Of course, there would need to be agreement between authorities on calculating the settlement amount. Most existing loans have relatively high coupons compared to today’s rates; local authorities are not going to take on loans at 4% from other authorities when prevailing rates are 2%, not without some compensation.  A settlement sum would need to be agreed, based upon a rate somewhere between new loan rates and prepayment rates, that works for both parties. The authority taking on the loan obligation benefits from an effective interest rate below current PWLB levels, the authority passing on the loan exits their liability at a lower cost than PWLB repayment rates. Win Win?

There is also a third winner, HMT themselves. By recycling debt between authorities, they avoid increasing the amount of PWLB debt issued, important given HMT’s recent focus on PWLB headroom relative to the overall limit set by parliament. However, HMT will miss out on the opportunity to issue a new loan to local authorities at a margin over gilt yields, although I’m sure many would argue they have taken plenty of profits from recent PWLB lending at gilts plus 1.8%. Perhaps it is time to cut locals some slack?

There will be a few parameters required around any novation process, for example, HMT is unlikely to want PWLB loans passed to authorities on the ‘naughty step’ for conducting debt for yield activity. But transactions should be relatively easy to define, negotiate and execute that keep all parties happy. It would be great if HMT follow through and allow loan novation between authorities when they announce their new lending terms, expected at some point over the next 6 months.