Aidan Brady on the municipal bond agency

Last week, the Local Government Association announced that it had approved the revised business plan for a new municipal bonds agency. So what happens next? Room151 sat down with chartered accountant Aidan Brady, lead adviser to the LGA on the scheme to find out more.

Room151: How many councils do you need to sign up to get the first bond issue off the ground?

Aidan Brady: The ideal number would be around 20 initially, which would allow for a good degree of diversification. This will be a manageable number, but if more want to join then it is a nice problem to have. We expect each will borrow around £10 to 20 million, but some are likely to want to borrow more than others.

R151: How much would the first bond issue be for, and when would it launch?

AB: We are aiming for £250 million, and if all goes to plan, we hope to start talking to the market later this year or early next, with a view to launching the bond in March or April next year. The initial bond would be for around 20-30 years, although as the agency develops, it will be able to issue shorter dated bonds.

R151: How many councils have expressed an interest in investing in the agency?

AB: We have a list of around 20 councils, which have publicly committed to exploring the agency, and a similar number which have expressed an interest privately. A number of councils have already made provision in their treasury management strategies for 2014-15 for an investment in the agency. We are seeking firm commitments from them by July before proceeding with employing permanent staff, engaging lawyers etc.

R151: When do you plan to launch the agency?

AB: We aim to launch in Q4 this year and will have a communication plan in place to make sure there is the right level of publicity and information about the agency. By then we should be in the position of saying we have identified a firm number of local authorities and the amounts they want to borrow from the agency. We will have also identified the board for the agency and made some key hires. It is from this point that the agency will start making commitments, such as selecting banks, ratings agencies and legal advisers for the bond issues.

R151: How will you fund the costs of setting up the agency?

AB: We estimate that the agency will need to raise up to £10 million in capital, but in a phased manner. The LGA is looking to commit around half a million pounds, and is seeking £400,000 from councils to fund the first few months of operation and set up the corporate structure.  We are looking to sell equity stakes in the agency to councils and local government pension schemes. These might not necessarily be the same councils as those borrowing from the agency. The agency should break even after three years, after which it should provide a nice dividend stream. Councils investing will also be able to transfer their stakes between each other.

R151: What do you think the appetite for the new agency is?

AB: We did a survey of 132 local authorities. Four of them said they had no borrowing requirements. Of the remainder, more than 90 per cent said they would be interested in making use of a new bond agency and they estimated that they had around £5 billion of borrowing requirements in the next 3 years. In general, we expect that local authorities will have borrowing or refinancing requirements of £3 to 5 billion annually, and the agency would aim to supply 25% of those requirements

R151: What are the protections for councils if another council defaults on payments?

AB: The model we are proposing is one where borrowers from the agency will give a joint and several guarantee. No UK authority has ever defaulted. Notwithstanding that, there are a number of safeguards, which mean that we think defaults are very unlikely, in addition to being unprecedented. The first is that to borrow from the agency a local authority will have to pass a credit assessment process. Local authorities are generally very good credits, but we will aim to lend to the strongest. In addition, the responsibilities on section 151 officers are quite onerous – if they become concerned that their council cannot meet their obligations, they need to report this and can’t take on new ones, for example. There is, also, strong implied government support for local authorities, as evidenced by the operations of the PWLB. In the unlikely event of a default, any amounts would be spread amongst councils proportionately – and they would then, through the agency, be able to go to the High Court to recover the money owed.

R151: Aside from a lower borrowing rate, are there any other benefits for councils?

AB: When I began working on the business case, my immediate thought was that we needed to strengthen the public interest case. Beating the PWLB rate is nice but in reality there are other strong arguments, which we needed to explore. Firstly, the new agency has the potential over time to become a centre of excellence and knowledge transfer, sitting between capital markets and local authorities’ financing requirements. It will bring a layer of oversight and review to local authorities and other municipal bond agencies experiences have shown that you can bring more to the highest standard over a period of time. There will over time be opportunities to help reduce costs for local authorities, over and above beating the PWLB rate. Lots of local authorities lend to each other at the moment, and the agency could help expand that and help bring down finance costs for the sector as a whole. In due course, it will also be able to provide more tailored lending arrangements to local authorities, again reducing financing costs

As it develops, we will have a rich new data source of where councils are making capital investments, which is another interesting side benefit.