It’s been three months since HM Treasury published its new PWLB Lending Terms. A major change was the 1% reduction in the Certainty Rate, which had been hiked up by the same amount back in October 2019. However, since the reduction in November 2020, borrowing from the PWLB, shown in the chart below, has remained at very low levels. So why is this?
Many local authorities’ capital programmes hold a significant degree of uncertainty, with regards to both timing and the extent of delivery. Some capital plans have been cancelled altogether for a variety of reasons, but often relating to affordability. In addition, many commercial projects have been abandoned due to the new restrictions outlined in the PWLB Lending Terms for ‘Purchasing Investment Assets Primarily for Yield’. These factors clearly reduce the underlying need to borrow.
Meanwhile, authorities are being flooded with central government grants for coronavirus-related expenditure, combined with slippage in capital programmes as a result of the pandemic, many local authorities are cash rich and simply do not require external funding. With investment yields at all-time lows, it makes perfect sense, at least in the short-term, for these authorities to reduce investment balances (and credit risk) instead of borrowing. For many, the prospect of borrowing in advance and depositing cash at very low or even negative rates appears to hold a psychological barrier, even if cash is only invested temporarily.
On the other side of the coin, incredibly low loan rates are being offered in the money markets, particularly in the inter-local authority market. For authorities that need to borrow, cash is being offered at competitive rates for those in need of short-term funding, and there’s no sign of this drying up either. Inter authority loans are typically less than 0.10% for most durations below 6 months, with one year funding at rates below 0.20%; fixing in PWLB debt is relatively expensive even with the reduction in the margin.
This leads on to the next reason for low borrowing levels of PWLB debt in recent months, budgetary pressure. Having spent over a year in the wilderness, funding away from the PWLB, many authorities have grown to like the low-cost flexibility offered via the inter authority market. At the time of writing, PWLB rates start at 0.76% for one year “Certainty Rate” loans, peaking at 2.12% for 25-year debt. With budgets tighter than ever, it is no surprise that authorities are currently turning to the lowest cost source of funding to help them through.
With plenty of scope across individual authorities to increase exposure to short-term interest rates, many are doing just that, reasoning that the probability of a hike in bank rate over the next few years is quite limited. The PWLB remains a back-up option too of course, with both fixed and variable rates available, should alternative funding sources dry up.
Of course, there will be some reading this that will no doubt be horrified. What about future risks? The threat of increased interest rates, both short- and long-term? Indeed, PWLB fixed rates have increased by around 0.30% in just a few days, although they remain at historically low levels. Valid points, but the argument on the outlook for interest rates should be balanced. UK interest rates have spent the last thirty years trending lower, and yield curves in Europe and Japan shows us that 0% is not necessarily the lower bound.
The nature of local authority cash flows and performance throughout economic cycles also supports retaining some exposure to short-term rates. Generally speaking, as the economy dips, pressures on expenditure across authorities will increase while revenue falls. As the Bank of England typically cuts Bank Rate in the face of economic headwinds, would it be sensible to retain some floating rate debt that becomes cheaper when times get tough, offsetting these budget pressures? As ever, the decisions on exposure to interest rates should be balanced and supported by a robust risk management framework.
In conclusion, while we would expect a pick-up in PWLB borrowing towards the end of the financial year, there will be many authorities that conclude they neither need nor want additional fixed rate funding at this time.