Councils warned over “son of LOBOs” income strip deals

Local authorities need to be alert to the potential dangers of signing “income strip” deals without carrying out proper due diligence, according to local government finance experts.

A growing number of local authorities are entering into “income strip” deals, which see them agree long-term leases, at the end of which they take possession of the property for a peppercorn fee.

However, speaking at Room151’s LATIF North conference, Warrington Council’s head of corporate finance Danny Mather said councils need to ensure they understand the implications of deals they are entering into.

He said: “The son of the Lender Option Borrower Option (LOBO) loan could have been born within local authorities.”

Explaining the remark afterwards, he said that some councils had entered into LOBOs without fully understanding the nature of the deals.

He said authorities must ensure that they have the skills in house, or by using consultants, to carry out proper due diligence on income strip deals which “seem very complicated”.

The total value of LOBO loans taken out by local authorities has been estimated at £15bn by debt campaigners who claim that taxpayers are being ripped off because councils didn’t fully understand the loans when they were taken out.

As revealed by Room151 in September, a number of banks are now offering councils a way out of their LOBOs without incurring large break fees.

Also speaking at the conference, Christian Wall, director of council finance advice consultancy PFM, said the income strip model provides risk for councils, because the lease payments are generally inflation-linked.

He said: “If you have a good view on what CPI inflation will do in the next 50 years then you are in a good position. If you don’t, and I don’t know anyone else who does, then you need to be very careful.”

Mather said that he was “not knocking” income strip deals but that councils should not just take the first deal that was offered to them.

He said: “I get about two phone calls a week from local authorities being offered these shiny income strip deals. Some of them are questionable deals.

“But if you go away, do some options appraisal and employ an expert, you could get a good deal.”

Last month, Room151 reported that London Borough of Barking and Dagenham has agreed an income strip deal, predicted to earn it £600,000 a year – and leave it holding the freehold of a central London development site worth almost £100m.

The deal will see it enter into a 50-year lease arrangement with an institutional investor who is set to own a new “aparthotel” in Aldgate.

The council will provide a guaranteed income stream to the new owner while sub-leasing the building to a hotel operator, with the council pocketing any difference.

In 2016, Portsmouth City Council agreed an income strip deal, selling a 41-year leasehold interest in a ferry terminal it owns the freehold to asset manager Canada Life.

The council continues to receive income from ferry operator Wightlink and, in turn, pays the same amount of rent to Canada Life.

A report to the council’s cabinet in September 2016 said: “The whole purpose of ‘slotting’ PCC above Wightlink as tenant is so that the purchaser can rely on PCC’s covenant strength for payment of the Wightlink rent and not that of Wightlink.”

Portsmouth used the £73m capital receipt from the lease sale to fund its property investment strategy.