PWLB Future Lending Terms – The Sooner the Better? David Blake

For most of the past decade, forecasting Public Works Loan Board (PWLB) rates has been relatively straight forward. If you had a decent gilt yield forecast, generally assuming yields would continue their intractable downward trend, you just needed to add on 0.80% to get your estimate for PWLB loans. This has become much more complicated over the past twelve months, with PWLB policy and margins lurching up, then down, for Housing Revenue Account (HRA) loans at least, and now sideways, with HM Treasury’s consultation on Future Lending Terms extended until the end of July 2020.

When setting your budget and managing you funding strategy, finance officers will need to consider a host of additional questions. Will the PWLB’s new lending arrangements be implemented along the lines outlined in the consultation document? Will the authority be undertaking “debt for yield” activity and be prohibited from accessing the PWLB that year? Is expenditure in the HRA and therefore eligible for the HRA loan rate? Do projects qualify for the Local Infrastructure Rate? How much will HM Treasury reduce PWLB margins by for qualifying projects? How will a loss of access to PWLB impact on wider strategies and what are the alternatives? What will happen to be underlying gilt yields?

Arlingclose believe most authorities will benefit from a swift resolution to the consultation. The National Audit Office’s report “Local Authority Investment in Commercial Property” estimated £6.6bn was invested in commercial property over the three year period 2016/17 to 2018/19. This occurred across 105 authorities, but with 80% of investments attributed to just 49 authorities out of a total of 352 (in England). Less than one third of English authorities were actively buying commercial property and there will be a large subset of this group conducting activity that will continue to be supported by PWLB loans, including projects focused on regeneration, adding social value, service delivery and housing. These could all benefit from reduced PWLB margins post consultation. While the deadline extension is understandable in current circumstances, given the coronavirus pandemic and implication for resources, PWLB access at fair margins is crucial and local authorities should do all they can to maintain this; we would encourage all authorities to contribute to the consultation process, the ramifications could be far reaching.

If authorities continue “debt for yield” projects, with a subsequent loss of access to the PWLB in that year, what are the alternative sources of funding? These may be more limited than you think. While in theory there are a host of options covering bonds, loans, the Municipal Bond Agency (MBA), “LA to LA” and other financing arrangements, there is already a stigma around direct commercial investment. Investors will be wary of lending to authorities to support lower yielding, higher risk projects, particularly those at odds with central government policy, for both reputational and financial reasons.

Lack of access to PWLB debt, in the year assets are purchased, will deal a harsh blow to any authority. Unhindered access to the PWLB is a fundamental pillar of Local Authority credit worthiness, a fact highlighted by the major rating agencies. In their April 2020 Coronavirus update, Moodys’ stated “PWLB is available as a lender of last resort for the sector”. The MBA’s rating summary also reference the PWLB as a credit positive, supporting the underlying credit worthiness of the sector and providing liquidity that could help protect bond investors if required.

Arlingclose believe removing access to PWLB loans would be an unwelcome policy shift, undermining perceived government support, and removing a liquidity facility that has proved vital in recent months. This could result in suppliers and partners charging higher rates or requiring security or collateral to be posted. Institutional investors also consider the PWLB to be vital, at least one public bond issue includes a covenant whereby a lack of access to PWLB funding is defined as a change in status, potentially triggering prepayment with penalties. Losing access to the PWLB could mean losing access to many of the alternatives too.

Arlingclose suggest a different approach, to avoid these unintended consequences that could penalise the whole sector. A higher interest PWLB rate would be a fairer penalty, whereby no authority will lose access, but those that don’t conform will pay a higher margin, say the current gilts plus 1.80%, if undertaking “debt for yield” projects.

Whether the penalty for not complying with the new PWLB rules is a higher rate or loss of access, investments in commercial property for the purpose of generating yield is becoming increasingly difficult. CIPFA, MHCLG and HMT are all tightening the screw and many authorities are reappraising their plans. The economic impact of COVID-19, reduced asset prices, increased voids and rent renegotiations and an impending structural shift in how we live and work are all likely to dent the appetite, particularly for commercial property projects. Net yields on these investments were already struggling to top 2%, with many contributing much less. As is consistent with HM Treasury’s stated intention, the proposed new lending terms may well mean it is no longer viable to pursue marginal yields and risk substantial increases in interest costs for other areas of the capital programme and debt refinancing.

Assuming HM Treasury implement the new lending arrangements over the next year, Arlingclose expects that any increase in underlying gilt yields is likely to be exceeded by a reduction in margin for qualifying projects, (excluding HRA loans which can already be borrowed at gilts plus 0.80%). Consequently, many authorities will continue to delay locking in long-term debt. For authorities that comply with the new PWLB lending terms, a swift return to margins at or around the pre-October gilts plus 0.80% would provide welcome relief and remove the uncertainty that currently prevails.