The credit risk guessing game

Over the years, there has been a fairly constant debate about the credit-worthiness of local authorities, and whether or not (if everything went pear-shaped) central government would have to step in. I think that there are other issues which differentiate local authorities in the minds of lenders, some of which are quite subjective and difficult to deal with.
It is I think more of an assumption than a legal fact that in the event of some unforeseen crisis central government would step in and take over. There have been a number of difficult treasury ‘moments’ in my career when intervention has been raised.
In 1991 the Bank of Commerce and Credit International went into liquidation. Once the 7th largest bank in the world, it had put considerable effort into attracting investment from UK local authorities. The selling point was better interest rates – which turned out to be too good to be true. Many local authorities were caught out.
One particular authority placed 100% of its available funds with the bank and lost it all. The select committee was very aggressive in its condemnation of local authorities although, as I pointed out during a hearing, most had spread their investments and were not rendered unworkable by the losses. The committee concluded that local authorities should pay more attention to risk and less to return, and this was the start of the regime which is now in place.
The other major issue was interest rate swaps. The Audit Commission challenged the legality of using swaps for local authorities and decided they had, in most cases, been used to generate funds rather than hedge interest rates. The commission reported that 137 authorities had used them. I represented the local authorities in discussions with the Treasury and government. The swaps had to be reversed.
It was a difficult time, and trust in the judgement of local authorities fell to an all-time low. There was, however, no offer of assistance from central government to help resolve the issues.
When I worked for an international credit insurer, a question about the security of local authorities was continually raised. Given that by this time there was a prudential regime, I took the stance that there was little to choose between them. In the main, authorities acted properly. Given that, and the fact that local authority balance sheets are generally meaningless thanks to accounting standards ensuring that no ‘real’ figures ever appear (a personal – and heretical – opinion), and that to international lenders all authorities were in any case potential bankrupts due to the operation of FRS17, discrimination between authorities was difficult.
However, it was felt that reputation was an important issue and lenders did not wish to be involved with authorities which would attract publicity and controversy. This was subject to great internal debate, and the views of American and European bankers did not always coincide. Moreover, receiving advance notice of controversy is not straightforward, and if an organisation was lending for a long period there was no knowing what might happen.
At the time, the Audit Commission’s Comprehensive Performance Assessments were current and, being an independent view, was seen as a way forward. Certainly, one could lend to excellent or good authorities without fear, and generally CPA was an indicator that if they were well-run now, they would be for the foreseeable future. Lesser scales of grade might lead to an interest premium, and being weak or poor might make it difficult to find funds from the market at all. In addition, there was an interest in political events and maverick authorities. This was, of course, all behind the scenes and would never be openly discussed.
Today we have moved on from the situation where there is any recognisable or reliable ranking of authorities. A welter of performance data is available, but this is time-intensive to evaluate and there is a lack of conformity from authority to authority. Collection rates of NNDR and council tax were always seen as a useful pointer to good stewardship but it has once again become difficult to differentiate between one authority and another.

Richard Harbord is chief executive of Boston Borough Council. This article was originally published in the Room151 Quarterly magazine.