Return of the bond

1 Nov 11

Wandsworth has put on hold its plan to issue a council bond to finance housing improvements. But the London borough's finance director believes that this form of borrowing still has a role to play in local government

By Chris Buss | 1 November 2011

Wandsworth has put on hold its plan to issue a council bond to finance housing improvements. But the London borough’s finance director believes that this form of borrowing still has a role to play in local government

Return of the bond  FREE


For many people, the word ‘Bond’ brings visions of car chases and suave secret agents, not the normal things that occur in the everyday life of a local authority finance director, unless you live in a parallel universe to me. However, recently the worlds of 007 and 151 have come ever closer at the London Borough of Wandsworth as we have investigated borrowing on the bond market.

We came very close to issuing a bond – preparations were in hand to launch in March next year – but pulled back last month following changes to the interest rate regime at the Public Works Loan Board. And yet, despite this setback, there could still be a future for bonds in local government.

The association of bonds with town halls dates back to at least the nineteenth century. The Local Government Act 1888 made reference to local authority stock issues and also to the Local Loans Act 1875. Coincidentally, this was the same year that the PWLB was established in its current form.

As recently as the late 1970s and early 1980s, many councils were issuing both tradable and non-tradable bonds. In Wandsworth in 1979, for example, around 40% of the £200m of debt outstanding was from the PWLB. The remainder included almost £60m in Wandsworth bonds.

However, within ten years all this had changed and bonds were passé. This was largely due to the controls introduced by central government on town hall borrowings and the ‘Hazell v Hammersmith & Fulham’ judgment, which ruled the council’s use of interest rate swaps ultra vires.

Most local authority treasury teams played it safe, for valid reasons, and went cap in hand to the PWLB when they needed to borrow. So why the recent revival of interest – temporary or otherwise – in bonds?

A bit of history might help. The ­prudential borrowing regime introduced by the Local Government Act 2003 removed many of the constraints of the 1980s. However, PWLB borrowing remained relatively cheap, with the mark-up over government bonds or gilts being around 20 basis points (0.2%). This meant it was not financially viable in most cases for councils to go anywhere other than the PWLB.
However, in the 2010 Pre-Budget Statement, the price of borrowing from the PWLB was raised to 100 basis points (1%) over gilts. This made borrowing via bonds potentially viable as, despite the set-up costs, it became cheaper in some circumstances for councils to go to the markets.

There are upfront costs involved in either publicly issued or private bonds. A public bond requires a financial rating to be obtained, and both private and public bonds involve paying banks to act as book runners – running the ‘order book’ of interested investors – plus legal and other costs.

But these costs could potentially be outweighed by the prospect of a lower rate of interest over a long-term bond.To make this worthwhile, the interest rate obtained after taking account of the costs incurred in obtaining the bond has to be below 100 basis points (1%) over gilts. If it is, then it’s a no brainer to go for the bond.

In our local circumstances, the idea of borrowing is an alien proposition, almost like 007 being teetotal or celibate. Our current capital programme, both for the General Fund and housing, has achieved the holy grail of decent homes, a balanced Housing Revenue Account business plan and investment in schools and other assets. This has been achieved on a diet of site and asset sales and government grant. We have not borrowed since the 1990s and the Prudential Code has remained a closed book.

But the government’s decision to reform the HRA as part of the Localism Bill will change this. While it will give councils control of our rent income, it will also move Wandsworth from a position of £6m of council debt to almost £400m after taking on our share of the proposed national settlement of housing debt. On the plus side the council will no longer have to fund negative subsidy in the HRA of almost £30m a year and rising. So, in typical Wandsworth fashion, we have looked at how to eliminate the debt as quickly and as cheaply as ­possible, while continuing to improve overall living standards on our housing estates and without affecting future ­service standards such as maintaining decent homes.

Over the years, Wandsworth has accrued significant capital balances within the HRA that can now in part be used to pay down the debt arising. But the likely amount due to be paid as our contribution to the national debt settlement means that we will need to borrow in the region of £250m, a sum that in cash terms places our debt back up at 1980s levels. It is also a sum that would make a public placement viable if we were going to the bond market. Subject to obtaining a suitable financial rating from one or more rating agencies, this could have been at a rate of interest more favourable than the standard PWLB rate.

One thing we have quickly found is that the bond market is not an area to enter without suitable financial and legal advice. However, that’s not to say that this advice should be accepted without question. The due rigour of competition should also be applied to all such appointments, in particular the investment banks that will place the bond. Fortunately, this area is outside European Union procurement rules so it is possible to open negotiations on price with the banks that you chose to act as your book runner. Critically, it is important that they understand and recognise the particular culture of your organisation.

Our preparations were going well and we were on target for the March deadline. And then, like a twist in the best of Bond novels, the plot suddenly changed and the need for a bond to finance the HRA reforms disappeared. The killer blow for the bond market came in a speech by Chief Secretary to the Treasury Danny Alexander at the Liberal Democrat conference in Birmingham on September 19.

Alexander announced a special PWLB rate for the HRA reforms, which means that a bond is no longer the cheapest way to raise the funds for this large one-off transaction. This might be seen as the death of bonds but there could still be a future. Like 007, bonds could return and be the hero again – in this case, for non-HRA borrowing where the PWLB rate remains at the higher level.

One example could be as part of a Tax Increment Finance arrangement. Indeed this structure would be very similar to that used by the Greater London Authority. In July this year, the GLA raised £600m for the Crossrail project, with the borrowing costs funded by a 2p supplemental business rate on larger properties throughout London.

Crossrail, which will connect ­Maidenhead in Berkshire with Shenfield in Essex, passing through London’s West End and Canary Wharf, is the biggest single extension to the Southeast rail network in half a century.

According to London Mayor Boris Johnson, the bond issue will save businesses £65m in tax. He said at the time: ‘I hope this is a model local government can develop for other important improvements we make to the capital and beyond.’

Future infrastructure projects might not be of Crossrail dimensions, but a bond issue could certainly be the way forward to ensure that local business growth is developed at the lowest ­borrowing cost.

Chris Buss is director of finance at the London Borough of Wandsworth. He is speaking at CIPFA’s Treasury management conference on November 3Transparent


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