Local government bond agency set to break new ground

19 Feb 15

Councils are embracing a fundraising scheme that could save them nearly £1.5bn over 30 years even if they only refinance half their debt. Richard Johnstone on the first ever municipal bond issue

With days to go until the new financial year, local authorities across the country are putting the finishing touches to their budgets. Spending plans for 2015/16 will deal with the impact of funding reductions for an unprecedented fifth successive year.

April could also prove a historic month for UK local government finance for another reason, with the first ever issue of a UK municipal bond set to take place.

The scheme, which has been in development by the Local Government Association for more than three years, was initially devised after Chancellor George Osborne increased the interest charged by the Public Works Loan Board to 100 basis points above the rates on government gilts in 2010.

Now, following a cut to +80bps in 2012 for authorities that produced information on their requirements in advance, the bonds project is also intended to increase the sector’s financial independence from the Treasury.

Under the plan, an LGA-backed firm called the Local Capital Finance Company has been formed to issue bonds. The money raised from investors will then be lent onwards to councils to either invest in capital projects – bonds have already been used by Transport for London as part of the funding package for Crossrail – or to refinance existing loans.

An analysis by the LGA found that councils could save nearly £1.5bn over 30 years if just half of council debt was refinanced through bonds.

Speaking to Public Finance, Aidan Brady, who led development of the agency’s business case for the LGA and is now interim managing director of the company, says councils have embraced the scheme. Nearly 50 authorities are already either signed up to be LCFC shareholders or expressing an interest, with more expected in the weeks ahead.

‘We’re building our shareholder base and we’re getting expressions of interest from councils on a regular basis,’ he says. ‘I think we’re getting a lot of positivity from the sector and a lot of people want it to succeed. The numbers of people who are naysayers are reducing, I’m certainly seeing a lot of positive feedback.’

For councils, there are clear potential benefits. ‘It’s the opportunity to drive greater value for money and lower borrowing costs for councils,’ says Gill Kilpatrick, treasurer at Lancashire County Council. ‘There are associated benefits of more control and self- determination for local government, but ultimately the absolute driver is to reduce costs for council taxpayers and to deliver better value for money for councils.’

In preparation for LCFC’s launch, Kilpatrick says her authority’s treasury management strategy for 2015/16 would authorise it to participate. Lancashire is also already one of the committed shareholders of the new firm.

‘Quite some time ago we put the appropriate governance in place when we put a proposal to our cabinet in preparation,’ Kilpatrick adds.

‘Lancashire has always said the municipal bonds agency is one tool in our treasury management toolkit. Because our ultimate responsibly is to provide value for money for taxpayers, we will be looking at what the most cost-effective way of borrowing is, at the point that we need to move into the market.’

The plan is gathering momentum across local government, she adds. The appointment of former LGA leader Sir Merrick Cockell as the LCFC chair in January to lead the first issue has helped further. ‘As the first issuance and the second issuance is successful, that is what will galvanise most local authorities [to join],’ she says. ‘I don’t think it will take long. If you think about how local government tends to work, you have a significant number of authorities that are moving the agency forward, and then success convinces others.’

Brady agrees that once the bonds company is established and demonstrates it can provide cheaper borrowing than the PWLB, more councils will want to borrow from it. Eventually, the aim is for the majority, if not all, councils to become shareholders of the firm, he reveals. When it is able to demonstrate savings versus the PWLB, it could become the first point of call for a local authority wanting to borrow.

‘For the agency, we are already in a strong position with nearly 50, and building, councils either shareholders or committing to become shareholders,’ he adds. ‘The broadest sector involvement further strengthens the agency and makes us a more attractive counterparty for funding providers.’

As well as getting formal commitments from councils to sign up to agency processes – which include a proposed guarantee where councils provide collective backing of their fellow borrowers’ obligations – a key final step before any issue is for LCFC to receive a credit rating. Brady was anticipating that work to get a rating will begin in ‘short order’ as PF went to press.

Matt Thomas, a director in debt capital markets at Barclays Corporate, is following the agency’s development. He says that achieving a good rating is critical to providing the cheaper borrowing sought by town halls.

‘The key objective here is trying to achieve pricing that is as favourable as possible versus the PWLB,’ Thomas tells PF. ‘To do that they will need at least a single credit rating, and in an ideal world multiple agencies – the stronger the credit rating backdrop, the better in terms of the ultimate spread outcome.’

An issue in April would coincide with the peak borrowing month for the PWLB, but it is vital to get the credit rating firms comfortable with the structure of the agency, he adds, including the cross-guarantee. The business case for the agency stated this level of security for investors could reduce interest rates charged by as much as one-third compared to the PWLB certainty rate, or about 25 basis points.

With this structure in place, Thomas says the initiative will come into its own once a large number of councils are involved, as the scale of local government can drive down borrowing costs.

‘We’re hoping that the credit agencies will take significant comfort from the diverse borrower base within the agency and recognise the strong internal credit processes being put in place. It’s also important to remember that the UK Government sits behind the whole sector via the PWLB.

‘Once it gets to the critical mass of borrowers within the agency, each individual name within the agency is less important. Strength is very much in the diversity of numbers – as it grows, bond investors will become less focused on the individual constituents of the agency and more comfortable with the guarantees in place between its members.’

As well as being the start of the financial year, April will also be the peak of the general election campaign, which Brady acknowledges as a potential factor in any issue as the market quietens towards the vote.

However, he concludes: ‘I’d certainly like to get something done in that timeframe. We still have some work to do, but equally we want to get going, we don’t want this to be an academic exercise. We want to start delivering cheaper finance to councils.’


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