Cheap Local Authority Lending – Squaring the Financial Circle?

It is undeniable that Councils are faced with a clear challenge of covering growing financial deficits, whilst still delivering services for all, as a consequence of the financial austerity of recent years.

According to the Government’s ‘Local Authority Revenue Expenditure and Financing budget’, released in June 2018, the actual outturn of ‘centrally distributed income’ to Councils was £79.2bn (financing 75.9% of Council revenue expenditure) in 2010/11. This has fallen consistently towards a budgeted £47.98bn (50%) in 2018/19. With this snapshot, one can see the additional finance required from locally retained income, such as the Rate Retention Scheme or Council Tax, appropriations from Council reserves or by other means.

Generating income

Local authorities are therefore scrutinising alternative ways to generate income and balance the books. An obvious option is the disposal of underutilised land and buildings, achieving the dual aim of reducing running costs and generating significant tranches of income. Indeed, apartments are springing up across the country where council offices once existed, quickly changing the dynamics of urban areas. Sales of such assets have increased following a rule change in 2017, dictating how such proceeds could be invested. The Chancellor, then George Osborne, clarified these funds could be spent in redesigning service delivery, providing synergies were realised, rather than solely employing them into new capital acquisitions.

Local Authority loans

Whilst useful in balancing the books, this is clearly a stop-gap solution. Hence why interest in recent years turned towards leverage provided by the Public Works Loan Board (PWLB) across the country, a statutory body issuing loans to local authorities and other specified bodies, from the National Loans Fund. Such lending is now under the banner of the United Kingdom Debt Management Office (DMO), a government agency.

This finance is predominantly for capital projects and is made on a non-discretionary basis, meaning that providing the borrowing costs are affordable to them, local authorities do not require Government consent, albeit the Secretary of State can, of course, veto borrowing of any kind.

Repayment options are available over fixed and variable rates determined with reference to gilt yields. Initial advanced fees for a fixed rate loan set at £350 per £1million drawn down, per Circular 159 of the UK Debt Management Office, released in May 2018. Of further appeal is that authorities can also select the loan term, of up to 50 years for a fixed rate lend. Therefore, access to this funding appears to be relatively simple, swift, flexible and is clearly below market rates compared to alternative funding sources.

Such lending has attractively positioned local authorities to become more aggressive in the pursuit of alternative income streams. The result has been some £2.7bn in PWLB/DMO lending during the three years to June 2018, invested in property acquisition and development. Expectations are that this run rate has further increased since.

Investment opportunities

Local authorities are making a greater number of commercial investments, potentially through a corporate vehicle. These could be in office blocks or car parks or through lending to third party entities for social housing projects amongst other things. It seems reasonable that any local authority planning department may possess a wealth of knowledge over local land and property, leaving them well placed to identify the most favourable opportunities.

The theory behind this is of course that short term income from dividends and a rental yield, allied to long term capital appreciation appears ideal and should give rise to an enhanced return when compared to any bank deposit and most share portfolios, in the long term.

A perspective on such behaviour could be that local authorities are seeking to control alternative types of property within their areas, such as retail spaces. A coherent strategy surrounding the regeneration of a town’s retail offering can drive further third-party investment and entice homeowners back to the area, driving a multiplier effect which benefits the locality. This is what some would argue should be at the core of any local authority’s aims, so furthering the implied fiduciary duty towards the council tax payer.

The alternative view is that local authorities should not be competing with the private sector and potentially using what some may term as state aid to create an unfavourable playing field to their advantage, whether this be wittingly or not. This economic armoury enables local authorities to outgun much of the private sector in a bidding scenario, exploiting a clear gap between the yields on offer and the cost of capital.

The other obvious advantage of an elongated borrowing period is the potential to purchase strategic land parcels which can become the ransom strips of the future, as local authorities have enhanced flexibility to take a longer-term view and, hopefully, generate a greater return.

Read more in issue 12 of our construction and real estate newsletter series.

Read Real Estate Matters Issue 12

If you would like to discuss this with us in more detail, please contact our team on 01903 234094.