Liz Wilkinson on setting up a local bank and inward investment

Liz Wilkinson is the executive director of finance at Bournemouth Borough Council with responsibilities covering all corporate services and the council’s resources agenda.

Room151: How are you responding to changes in local authority funding?

Liz Wilkinson: We have had to take a fresh look at financial strategy. There are all sorts of challenges facing conventional sources of local authority funding and so, as a council, we spent the last budget setting round devising a new medium term financial plan which, in part, sought to address those challenges. There are several strands within that strategy and one of them was recognising that we can’t just keep cutting our cloth because eventually you end up losing critical mass and services fall over. So while we carry on trying to be efficient we also had to start thinking about how we could become more proactive and self-sufficient, in financial terms.

So we came up with four principal pillars underpinning our strategy. The first pillar was to ask what can we do to be more entrepreneurial and to actually make money to put back into the town and services? The second was to ask how can we use strategic partnerships to greater effect and lever in investment in the town? The third area was to look more closely at how we could work with the third sector groups and the fourth was to explore how we could make more use of, and generate more yield from, our asset base – across property and reserves.

One of the key projects that has come out of that review is the establishment of our community finance initiative the purpose of which is to operate a commercial banking activity on a local basis.

R151: Where are you with that?

LW: We had cabinet approval for the outline business case in July 2013 and we’re in the implementation phase now with a view to the first business loan being approved this coming November and the first mortgage in January 2014. So we’re currently finalising the full business case which will go to cabinet in October for final approval. We’re establishing a new company and a company board with appointments expected over the coming weeks.

R151: Are you restricting the commercial activity to SME loans and mortgages?

LW: In the first instance we’re not able to act as a bank given the legal constraints we’re working in but our strategy is an incremental move towards full banking accreditation. Initially we’ll be offering business loans under licence, then mortgages constrained by the Housing Act but with a view to using that experience to gain accreditation and then offering a fuller range of mortgages and deposit accounting. One of the ambitions for the bank is for it to become self-financing and the deposit accounting is the bit we need to achieve that.

R151: What kind of size bank are we talking about?

LW: Well we’ve forecast returns by year ten of £7-8m per annum – that kind of order of activity. The council is providing an initial capitalisation of £15m for initial lending and investment purposes and that’s where we’ll start from. The business plan shows us moving into a positive return by year three at which point council will take a view on whether profit will be reinvested through the bank or channelled back to the authority either to pay down the initial investment in the project or to go towards service costs.

R151: What kind of return do you expect on that investment?

LW: I think we’re looking at five per cent plus. And when you think that our £15m of reserves is sitting in the bank currently earning around 0.8% then it’s a complete no-brainer that we try and help the local economy and generate a positive return on our treasury investments. We see it as an opportunity to support people who are currently struggling to access finance easily through the traditional banking sector  and also to generate a level of return from our assets that banks are not offering us.

R151: What kind of default rates have you built into those assumptions?

LW: What I can tell you is that we’ve been extremely prudent about the level of loan activity that will take place, what default rates will look like and what provisions we’re able to make for bad debt.

R151: So if the business model looks sound, even with very prudent assumptions about default rates built in, do you think banks are mispricing the risk that you’re willing to take?

LW: My view of that is that high street banks are prioritising other objectives at the moment and have been focussed, since 2008, on recapitalising their positions. The issue in my mind is not that the banks have reassessed risk in the market place and retrenched because of the likelihood of increased defaults but they’re less willing to build up their loan books because they’ve been required to shore up their balance sheets. The economic indicators we’re seeing are very supportive of our business model – research we’ve done locally for example strongly supports the view that there are lots of people out there who are working and who are paying more in rent than they would be doing in mortgage repayments, but simply can’t get access to capital.  The rental sector has become a trap for a lot of people who could afford mortgage payment – rents have increased in our area by 35% in the last four years. Our business is very much about first time buyers and new entrants to the market place.

The question I usually get asked is, well why don’t you provide them with the initial capital so they can go and access a high street mortgage – like the government’s scheme and LAMS? And my response is that we don’t want to take all the capital risk and then make nothing on the mortgage.

R151: Are you building a new department to run the credit analysis and the banking business?

LW: We’re putting in place a service that includes underwriters, actuaries, professional bankers etc. so that we’re fully equipped to make the calls we need to. We’re building up a new service over time – it’s something that needs to evolve as the business develops. I have appointed a head of service very recently who has a long track record in the banking sector.

R151: Going back to the strategic partnerships you mentioned earlier, what can you tell us about the investment the L&G pension fund is making in Bournemouth?

LW: I was looking at various ways of bringing finance and investment into the town and we spoke to various parties, one of whom was Legal & General’s property investment team from their pension fund. They were looking to diversify and get a better yield on some of their assets that might otherwise be getting very little in fixed income and we were looking for inward investment. What has come out of those discussions is an investment in Bournemouth housing and town development. Being a local authority we have a strong credit story and are able to look at long-term initiatives and the pension fund is more interested in length and indexation than up front profit so that has given us some space to work together in.

R151: What does the deal look like?

LW: It’s a deal worth up to £300m to 2025. We’ll draw the money down in chunks as and when new projects go live and in each case – given the varied nature of the work – we’ll negotiate commercial details and yields on a project by project basis. The initial pilot is yielding under 4%; below PWLB rates.