Fixed or variable?

To fix or not to fix, that is the question:
Whether ‘tis nobler in the mind to suffer
The rises and falls of outrageous interest rates,
Or to take arms against a sea of risks,
And by opposing, end them?

Hamlet was the Prince, of course, not the treasury manager of Denmark, so Shakespeare decided on a slight variation of these words to open Act 3 of his famous tragedy.  With a little less drama, 138 English housing authorities received confirmation on Monday of the amounts they need to pay central government next March to exit the housing subsidy system.  Since most of them will need to borrow their share of the £13.7 billion, treasury managers have some big decisions to make to avoid writing their own local tragedy.  And one of the biggest is whether to go fixed or variable.

Local government has traditionally been a big borrower of fixed rate debt – only 2% of long-term loans from the PWLB in the last five years were at the variable rate.  With the blessing of hindsight, that doesn’t seem to have been the best decision, with interest rates having fallen recently and looking likely to stay
historically low for some time.  But of course that’s only half the story; the holders of fixed rate loans at least know that their rate payable won’t rise before the loan matures.  That can provide much peace of mind when budgets under pressure.

The humble variable rate loan hasn’t even been the second most popular variety recently.  Around 20% of outstanding loans to local authorities are of the LOBO variety where rates can go up, but not down.
If Shakespeare had been Spanish, el Lobo would no doubt have been one of his shadier characters.

Since the PWLB is offering a once in a lifetime deal to HRA borrowers, el Lobo has been sent packing for the time being, and it’s just a question of low-risk fixed versus low-cost variable.  The short-term attractions of cheap variable rate loans are obvious, especially if the 30 year business plans forecast cash
surpluses in the early years.  Over-cautious treasurers may opt to go 100% fixed and forego the short-term savings, even though cash will be tight for the next couple of years.

But with the abolition of the old consolidated rate of interest on housing debt, authorities will want to be fully conversant with the new freedoms in the self-financing regime before committing to certain
loan types.  The various options for debt un-pooling, fixed rate internal loans and the potential reassignment of loans between pools in the future, together with the need for equitable treatment of
the council tax payer and the council house tenant, mean that the decision will be anything but simple for many.

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.