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David Green: Dispatching with LOBOs

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  • by David Green
  • in Treasury
  • — 30 Jul, 2015

It’s been an interesting month so far for the local authority treasury management community.  At the start of July we had the Channel 4 Dispatches programme “How Councils Blow Your Millions”. Then, Parliament’s communities and local government select committee held the first oral evidence session of its “Inquiry into Local Council Bank Loans”, featuring the TV programme’s presenter and some of his interviewees.

Both the Dispatches episode and the committee hearing attempted to explain “lender’s option, borrower’s option” or LOBO loans to their respective audiences.

In simple terms, these are very long-term bank loans where a council initially pays a lower interest rate than on a traditional fixed rate loan, but gives the bank the option to increase that interest rate on pre-set dates in the future.  If the bank exercises its option, councils have the option to repay the loan without penalty.

At first glance, the borrower’s option to repay the loan appears to offset the lender’s option to increase the rate. But over the 40-70 year term of these loans, it seems likely that interest rates will rise far enough at some point that banks can increase the loan rates.

A council’s option to repay the loan is then only an option to refinance elsewhere at a higher rate, or to lose investment income at a similarly high rate.

I had mixed feelings about the Dispatches programme. The catchy title might have attracted a wider audience, but I didn’t see much evidence of millions being blown, not even on Cornwall’s windy beaches.

And the average man on the Newham omnibus seemed just as shocked by the council having millions of pounds of loans in the first place, let alone interest rates of 7.3%. He might well have been equally surprised that local authorities borrow at 0.3% too.

But I suspect that all the surfboards and game boards were the necessary comedy that enabled a primetime TV programme to be made on the subject in the first place.

And it moved into more serious territory in the second half, culminating with an interview where Clive Betts MP was visibly shocked by allegations that local authorities did not fully understand what they were signing up to; that they are paying too much interest given the additional risk they have taken on; and that various private sector firms have made substantial profits as a result.

The select committee hearing was a much more sober affair, and the main stars of the documentary backed up their claims admirably in 90 minutes of detailed questioning that could never have made it into a 30 minute TV show. It didn’t have quite the formality of a court of law, but you could certainly say that the case for the prosecution was made thoroughly.

I understand that the committee is now considering whether there is a case to answer, and given the evidence before them, I would guess that local authorities, their representative bodies, the lending banks, money brokers, treasury advisers and regulators will all be called before the committee after the summer recess to make the case for the defence.

Having worked for a local authority, a money broker and now an independent treasury adviser, I have seen LOBOs from many angles.  I know that when our brokers and advisers visited me as a junior council treasury officer, the initial low interest rate looked superficially attractive.

But I also remember asking what I would be charged for a plain fixed rate loan from a bank, and on finding that it was much more expensive, I gained some idea of the value inherent in those options.

And in retrospect, I really can’t imagine a local authority treasurer asking for a loan whose rate stays fixed if market rates fall, but whose rate can rise when market rates increase, in what was called a lose-lose situation at the Committee.

Hopefully a search for the truth, the whole truth and nothing but the truth by Parliament in the autumn will find out why more local authorities didn’t follow my director’s lead and dispatch with the LOBO salesmen at the earliest opportunity.

David Green is Client Director at Arlingclose Limited. This is the writer’s personal opinion and does not constitute investment advice.

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  • 151 BRIEFS – WHAT’s NEW?

    • Homes England agrees strategic partnership with two authorities
    • Soaring inflation and pay pressures to add £3.6bn to council budgets
    • Underfunded social care reforms could ‘exacerbate workforce pressures’
    • Nottingham City Council leader labels proposed intervention as ‘disappointing’
    • Government preparing to intervene in Nottingham City Council
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