All change again at the PWLB

We learned in the budget this week that the Public Works Loan Board will be changing the interest rate at which it lends to local authorities again this year. Not content with having tinkered with new loan and/or repayment rates in November 2007, April 2010, October 2010, and (for one day only) on Monday of next week, another change has been announced to take effect from an as yet unknown date in the coming financial year.

In return for receiving three-year forecasts of local authorities’ borrowing requirements, the PWLB will give a 0.20% discount on new loans that fall within the forecasted amount. Loans will still be available for sums in excess of the forecast, or if no forecasts are provided, but they will be at the normal rates.
The Treasury has termed this discounted rate the “certainty rate”. It gives no certainty to local authorities though, as rates will still change twice a day based on underlying gilt yields, i.e. the cost of central government borrowing. But the hope is that Treasury and the Office of Budget Responsibility will get better information from councils to build into their forecasts of public spending and the national debt. Improved data collection from central government departments and the NHS has led to local government spending often being mentioned as the reasons behind revisions to national economic data.

Whitehall is also a little worried about plans by several local authorities to issue capital market bonds instead of borrowing from the PWLB. Raising the margin between gilt yields and PWLB rates in October 2010 from 0.15% to 1.0% was expected at that time to raise an additional £1 billion for the Exchequer in the next three years. But with five new local authorities getting credit ratings in recent months, and a number of new LOBO loans having been borrowed last year, the government doesn’t want to lose any more interest income.

The new margin for councils that play ball will therefore be 0.80% above gilt yields. It is probably no coincidence that this is exactly the level at which the Greater London Authority issued a £600 million bond last year. And under the strange method that central government sets its budgets, reducing the PWLB rate is also expected to raise an additional sum for the Exchequer, although just £45 million this time.

I’m rather doubtful that Treasury will get the certainty it is looking for though. Since loans borrowed above the forecast level will be more expensive, there will be an incentive for local authorities to over-forecast their borrowing needs. Coupled with the long standing tendency for capital programme managers to over-forecast and under-spend anyway, an aggregated over-enthusiastic forecast could conceivably worry ministers enough to consider the use of their reserve powers to limit local authority borrowing. Some caution in setting your forecast is therefore advised!

There is also much uncertainty over when the “certainty rate” will be implemented. PWLB will take time to change its computer systems, while HMT, CLG, CIPFA and LGA will debate the exact nature of the information to be requested from local authorities. Councils thinking of deferring their borrowing decisions until after the discounted rate is available might therefore want to think again. In six months time, underlying gilt yields could easily have risen more than the 0.20% they are expecting to save.

David Green is the Head of Sterling Consultancy Services, a provider of treasury management advice to local authorities and other not for profit organisations. This is the writer’s personal opinion and does not constitute investment advice. It should not be relied upon when making investment decisions.