UK local authority debt in six charts

20 March 2017/No Comments
By Nick Dunbar

Risky Finance has updated its database of Lender Option Borrower Option (LOBO) loans, a form of structured loan which were once popular products for UK councils and public housing associations.((The database has been compiled using 788 loan contracts to 49 different councils, obtained by Freedom of Information requests. Pricing was done with the help of Vedanta Hedging Ltd. Data on PWLB borrowing and council tax revenues is sourced from the Department of Communities & Local Government and the Scottish Government))

LOBOs are characterised by their very long maturity, as well as their trademark feature which allows banks to periodically raise the interest rate and councils to repay the loan at par. This option to terminate the loan before maturity is most valuable when market rates are high, but since rates moved lower instead, the option is currently worth little.

The impact of interest rates

Data source: Bank of England

2016 was the year that UK long-term interest rates reached all time lows. Long-dated gilt yields sank to 1.21% in August – their lowest level since records began in 1703. The ten-year swap rate – a benchmark for private sector loan rates – ended the year at 1.33%. The Public Works Loan Board (PWLB) 20-year rate – a benchmark for the borrowing costs of councils from the government – was 2.55%. In both cases, these are also record lows.

The question that observers of local government should ask is, how much of this is a surprise. Council officers and their advisers talk about the unprecedented low rate environment of quantitative easing. Rates of 4.5 or 5% – typical during the boom in council LOBO borrowing ten years ago – might have seemed low back then compared with the double-digit rates seen between the 1970s and 1990s. However, focusing on this period is myopic in the context of a 300-year timescale, over which median long-dated UK interest rates are 3.6%.

How debt burdens councils

How important is debt to councils? This question can be answered by comparing the annual interest cost of the debt with the amount of money the council has coming in. Almost two thirds of the money that UK local authorities spend is given to them by central government in the form of grants, so it is best to focus on council tax revenues which they can raise directly from residents.

The data show that out of our sample of 49 authorities, 20 of them pay more than 10% of annual council tax receipts in interest on borrowing from central government. 10 authorities pay more than 10% of their council tax to banks in the form of LOBO loan interest. For these councils, debt really matters: the interest burden constrains their freedom and forces them to cut services to local residents. As an extreme case, consider Newham council, which pays more than 50% of council tax receipts to LOBO lenders such as Barclays or Royal Bank of Scotland.

The figures are summarised in the chart below, which shows LOBO and PWLB interest cost as a percentage of council tax revenues for each local authority.

How councils are trapped by their debt burden

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