The year that transformed Britain’s LOBO landscape

12 July 2019/No Comments
By Nick Dunbar

The last 12 months have been remarkable for changes at UK councils hobbled by lender option borrower option (LOBO) loans.

After years of denying the problem, attitudes at councils are changing, typified by the toppling of Newham’s long-standing mayor last year in favour of a transformative candidate, Rokhsana Fiaz. Multiple lawsuits have been filed by councils against the biggest LOBO lender, Barclays.

Meanwhile, there has been a wave of restructurings of LOBO loans by UK councils. According to results of Freedom of Information requests conducted by Risky Finance, among 55 of the largest LOBO borrowers surveyed, 21 of them reported refinancing some of their loan portfolio during this period.

In particular, two banks – RBS and Germany’s Commerzbank – decisively changed the LOBO landscape by offering terms that allowed councils such as Croydon and Cornwall to repay £1 billion of loans at a significant discount. The majority of these redemptions came before Newham council announced repayment of £150 million of RBS inverse floaters in May, a deal that I helped negotiate as a senior consultant for Vedanta Hedging Limited.

Prior to the Newham transaction, I analysed FOI responses and mark-to-market valuations in collaboration with Vedanta. Based on this data, we found that the councils paid a total of £300 million in breakage costs in addition to the £800 million face value, while the banks have written down £500 million in mark-to-market breakage costs to which they were contractually entitled. According to our analysis, RBS alone took a haircut of £430 million on the fair value of its LOBO portfolio.

A history of bank P&L for LOBO loans. Over £600m of trading profit was booked between 2001-2011, while £500m of writedowns occurred in 2018. Screenshot of interactive visualisation available to subscribers.

Why would a bank voluntarily write off £430 million rather than stick with the full value of assets that aren’t in default? Is RBS a template for Deutsche Bank, which claims that it can reduce its derivatives-heavy balance sheet by €180 billion with just €2 billion of restructuring costs?

Why would 20 councils voluntarily pay an extra £300 million now rather than letting the loans run for another 40-60 years? Is it possible for councils to get to a better position compared with the counterfactual of having borrowed from the government a decade or more ago instead of using LOBOs?

To answer these questions, Risky Finance has written an in-depth report that can be downloaded by subscribers..

In the report, 1) we explore how councils go about refinancing LOBO debt from an accounting perspective, and 2) we look at the redemption terms achieved by some individual councils. 3) We examine the regulatory capital motivations for banks to offer discounts, and how RBS may be a playbook for Deutsche Bank. And finally 4) we explore the implications of the recent redemptions for the three big lenders (Barclays, FMS and Dexia) that have resisted offering discounts.

Councils across the UK still have about £14 billion of LOBOs left outstanding, mostly with these three lenders. Four years after I helped produce a documentary for Channel 4 Despatches called “How Councils Blow Your Millions”, the redemption wave could yet turn into a tsunami.

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