Bond Agency Q&A: Board power, rates and Treasury reaction

This week, the emerging Municipal Bonds Agency announced a number of key appointments to its board. The update follows last week’s news that the agency has been formally assessed by two ratings agencies and is ready to issue its first bond. Room151 caught up with agency chairman Sir Merrick Cockell and chief executive Aidan Brady on progress so far.

Room151: Can you tell us what ratings the agency has achieved?
Aidan Brady: The answer on ratings is very straightforward. We have had two private ratings which are in place. We can’t tell you what they are because they are private. When you are looking to issue debt then you will wait until before you are about to issue the debt before you announce the rating. So we are basically not going to tell anyone what it is and it won’t be made public until shortly before we go to the market.

Room151: Was the scrutiny by the ratings agencies more intense because it was a new type of venture?
AB: Look, at the end of the day, you can never compare two ratings processes. The starting point is it was quite a simple story to tell but when you go into the minutiae of it we needed to go through local authority finance and how local authorities work. You have teams that include people from other countries and have knowledge of their own countries. One lead analyst was American, and another was Swedish.

We also had to explain in excruciatingly minute detail, right down to the timings of when payments will go in and out, what happens if a payment doesn’t come in. Because we are a different model to the one we are all used to, they had to look at their own ratings methodology and work out how to apply that. So, it’s a very complex and detailed process. But the upshot is that they spent a few months looking at it but we have ratings that we are happy enough with.

Sir Merrick Cockell: The process of achieving the ratings was very full on. Not just the face-to-face sessions but lots of pre- and post-meeting detail as well. We can work on the basis of what they have told us.

I was the one that understood how local government operated and I could hopefully explain the nature of local government, that there has never been a local authority since the day the Corporation of London was incorporated that has ever defaulted, the legal powers that section 151 officers have, first call on taxation.

 Board power

Room151: What has the process been since you achieved the ratings last year?
AB: There has been basically three major pieces of work that needed to be completed. One was the conversion to a PLC – to issue bonds in the public market we need to be a PLC – so we had to crunch through that.

The next process we had to go through was to fill out the board and make sure it was fully loaded up.

MC: It is a powerful board. My self and Adrian Bell were announced by the LGA initially. Since then, we have had a very public and thorough advertisement process, and interviews done fully, and now have a combination of clear sector background and financial nous.

Our senior independent non-executive director is Steve Houghton, leader of Barnsley Council and chairman of Sheffield City Region Combined Authority. Then we have Michael Lockwood who was formerly executive director for local government finance and policy at the Local Government Association and has also been chief executive in several local authorities.

We have Melanie McLaren who is one of the leading figures in corporate governance as a board member on the Financial Reporting Council.

We have also got Mridul Hegde, who brings proven success in government and finance, built as director of financial strategy and director, public spending at the Treasury and as executive director of strategy at the Financial Reporting Council.

We have some serious figures there. They have all done their research and taken soundings on how we are viewed in various spheres and have decided to join us. That is a positive signal.  It has been a long process and we had very good candidates. That is the board full now. You will note that Steve is the only practising politician and his key role is to our 56 shareholders. We are a city financial focused institution – that was important to the ratings agencies as well. Had we been a traditional local government structure with proportional representation, it would have been unsustainable.

Room151: So what was the third main piece of work?
AB: The third piece of work was the framework agreement, which is in essence our agreement with the local authorities that become borrowers from the agency. So, this will include things like the joint and several guarantee, and we worked with three councils to negotiate that agreement. They worked with law firm Allen & Overy. It was a very thorough and rigorous process that finished literally days before Christmas so got the agreement distributed to our shareholders and a number of other councils we had been talking to. That was the longest of the processes and actually, at the end of the day, this documentation has to last forever, so that is quite right.

They will now run it through their internal approval processes. They will do what they need to do.

Room151: When do the borrowers actually sign on the dotted line?
AB: The way the agreements work is they can agree those now. They don’t go onto the joint and several agreement until the point we are ready to advance cash to them. So at the end of the day in our view that councils intending to borrow at any point should consider taking the documents through their internal processes. We are talking to a lot of councils and want to talk to more.

MC: We don’t know how many borrowers there will be at this stage. Obviously, we are talking to our shareholders but there is another group over time have expressed interest and said, at the right time, they would be interested in borrowing.

AB: We know there are other councils out there who want to become shareholders but we have told them to wait, principally because we have to focus on one thing at a time. Getting new shareholders on board would be lovely at the right time, but we don’t need more cash today. So, we will open it up again in due course when appropriate.

MC: The 56 shareholders took a bold step, partly because they believe they can borrow cheaper through us than elsewhere. Partly this was also the sector releasing itself from the shackles of central government as a principled step. But we know there are a significant number of councils that are watching. They don’t know if we are actually going to move ahead. Part of the process now is telling them we are ready for business, that everything is in its place and I think a lot of councils will go: ‘Great – it is not just a bright idea that somebody at the LGA has had. It is actually a live entity.’

We are a creature of local government, not venture capitalists but local government has to say, ‘you are ours we are going to use you.’

Ready to go

Room151: When do you think we will be ready to go for the issue?
AB: We are on the speed at which local authorities move. The documentation process was rigorous and valuable and worthwhile but clearly, and rightly, that process took longer than expected. So, I don’t think we want to hold ourselves hostage again. Individual local authorities have to go through their internal processes, their treasury strategies and their budgets. The message we want to get out there is we are ready to go today. If I had 10 or 15 authorities sat round the table now and they had their documents we would be in the market and issuing a bond within a few weeks, potentially.

Room151: Do you have an idea how much the bond issue will be for?
AB: The amount we would do in any bond issue would depend. To do a public issue you are looking at £200m to £250m plus, but you could do private placements for less and that might be attractive at the time, because private placements, as often as not, are cheaper than public market issuance. Or, we know there are people interested in inflation linked returns and, given where inflation is, that could be very attractive right now. But then £200m to £250m would be the wrong number – it would be more like £100m or £150m or less.

The demand will always dictate how we fulfil it. We are not borrowing for our own book. It will dictate the amount issued and, to a greater or lesser extent, how we fulfil that in due course.

Room151: You know roughly the demand and have ratings now – does that give you a clearer idea on the rate you will be able to offer to borrowers?
AB: At the end of the day what we have consistently said is that we will not lend at Public Works Loan Board rate. Otherwise, what’s the point? Who is going to come back if we charge above that? Depending on the source of that borrowing it will be determinant of the rate we charge. If some was local authority borrowing then you just take the PWLB rate and divide it between the two councils. So, it really will depend. We will not do anything above the PWLB rate.

Room151: Do you now have a better idea about what the duration of the bond will be?
AB: A lot of authorities like borrowing 40 to 50 years. However, that is probably not realistic for a first bond issue. We would like to go shorter, but will have to see if authorities want to do that. Whether we do one big or demand for two smaller ones, we need to work our way through that.

Rugs and spikes

Room151: Have you talked to the Treasury – are you worried they will pull the rug from under your feet by lowering the PWLB rate?
AB: It is a key risk to us, as an agency, but not to the local government sector. We have had conversations with the Treasury and they have no interest in spiking this, I don’t think.

MC: When we were setting this up, the LGA and senior figures in local government said: ‘If being in competition to PWLB brings down the rate then the job is done’. That still holds.

Room151: You have taken longer than expected to get to this stage. Have you got enough money to keep going?
AB: We will be publishing our accounts in a couple of months’ time. We have absolutely no need for any additional cash at this time. At some point we may open it up to take more investment. Trying to get equity investors is hard work and takes time, and not something we are interested in at the moment.  In due course, if the business grows we will need to add people. We have five at the moment. There is an inevitability in the nature of how our income structure is set up.

MC: We don’t need much capitalisation, but we have to handle coupon payments on time and day-to-day things. We are not a bank, we don’t need that sort of size. And we need commitment.

100 Years

Room151: Are you happy with the shape of the shareholder group that you have?
AB: Ultimately, we want every council to be a shareholder and we believe councils will want to. Then you have a perfect match between shareholders and client base. We have always said that.

MC: When I was at the LGA, every council bar two were members. Why wouldn’t you want to be a shareholder? It is a club that represents the sector. It took the Danes 100 years, but the final municipality signed up last year. We would like to do it rather faster and nobody is pushing anyone, but why wouldn’t you be a part of it?

We couldn’t have designed a more representative group of shareholders that we currently have. It was important to the ratings agency to show it is not dominated by one party or another, the tiers of government are all well represented – districts, metropolitan cities, London boroughs, counties and geography is pretty well covered as well. We would like to add to that, but it is very well set for early days.

Room151: How do you see the environment developing in coming years in terms of demand from local authorities or borrowing?
MC: A number of combined authorities and new local government structures are emerging. Clearly the deals being done at the moment include ongoing income streams for up to 30 years. Whether Manchester or Sheffield, you are talking about £27m or £28m a year. In local government terms, that is not a huge amount of money but if that is a 30-year income stream, what can you borrow against that for your transport or housing projects? That was not an area that was originally in our thinking because combined authorities with an income stream were not in existence. That is something where we could offer an opportunity. The length of those agreements with government are actually quite close to the length of bond terms.

There will also be new opportunities as local government has to look for different ways of operating long term. Sevenoaks, for example, is saying it won’t have any income from government in a couple of years’ time but is looking for other sources of income. They are investors in their community.

AB: A lot of councils do have capital investment plans which they are implementing. The timeline over which they get implemented will vary. When you are talking about new housing projects it will take them a while to get kicked off. They mean new schooling etc. Local enterprise partnerships are starting to do stuff. You have a number of areas where councils need to get back into the investment game. They also need to work out how to deal with business rate retention.

We have also been through a period of low interest rates and a lot of local authorities have moved from long-term borrowing to shorter term borrowing in response to that. We, as an agency, would be blind not to recognise that fact and address that appropriately in what we do next. We are looking at ways to address that. It is an issue we can deal with without changing the basic model of bond issuance.

The level of borrowing from PWLB reached a high when HRA reforms were done. It has dropped a bit but there has been a constant stream of borrowing from PWLB over the past years.

The removal of revenue support grant will also have an impact on what they do. When you are doing capital expenditure it has an impact on your revenue budget.

Needs and opportunities

Room151: How have your plans developed since the initial business plan?

MC: We currently have three strands to our work. The first is bond issues, private and public. Another is looking at alternative sources of funding that could be offered to local government – it could be European money or things like that. And the third is facilitating peer-to-peer lending in a more efficient, cost effective way. The business plan was written just on the basis of the bond side, but we are alert to the needs of local government and the opportunities for them to get better value for public money.
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