End of LOBO ‘lender’ option by Barclays both criticised and praised

 

Local authority finance chiefs have given a mixed reception to news that Barclays will end its option to amend interest rates on Lender Option Borrower Option (LOBO) loans.

The bank announced this week that it would fix the current interest rates on its £5bn LOBO book covering 15 housing associations and around 100 councils.

It said that the move would help it to reduce its costs, manage profit and loss volatility, and help councils with their long-term financial planning.

In a statement, Barclays said: “Under the changes, Barclays is permanently waiving it’s ‘lender option’ to amend the interest rate at given periods.

“This will create certainty for the client for the duration of the loan, by locking in the fixed rate for its lifetime.

“More than a hundred local authorities and housing associations will benefit from greater certainty that their borrowing costs will not rise in future.”

The bank also said that LOBO borrowers will enjoy reduced break costs under the new arrangements.

It is understood that Barclays will enter into negotiations with a handful of councils holding “range” LOBOs which have a degree of flexibility in their interest rates.

Alan Sanford, principal investment officer at Somerset County Council, welcomed the announcement.

“The semi-annual refinancing risk posed by the options in that part of the portfolio will now be certain at the end date.

“Of course, we would have been happy if they had called in the current climate, but it does give us longer-term certainty,” he said.

However, he added: “We haven’t received official notice yet, so the devil may be in the detail.”

A blog post by David Blake, client director at treasury adviser Arlingclose, said: “Local authorities will not mourn the loss of their ‘borrowers’ option’ to repay at par, this was always virtually worthless given it would only be triggered if the lender exercised their option to increase the rate.

“The lenders option would only ever work in the banks’ favour.

“It will now be much easier for borrowers to manage interest rate and refinancing risk. There is even the chance of generating a discount on these loans, subject to negotiation and a surge in interest rates.”

But a local authority finance manager, who did not want to be named, expressed regret, saying: “I can’t see any benefits to this. I would rather take the risk and have the optionality.

“It could have been helpful for us to have an option, depending on the shape of the yield curve and where we were in terms of our capital programme and other liabilities.”

Nicholas Dunbar, founder of risk analysis website Risky Finance  and a long-standing critic of LOBOs, was also unimpressed by Barclays’ policy change.

“This is not great news – it is quite the opposite, in fact.

“Many councils use the embedded LOBO option as justification for treating the loans as relatively short term, say five years. This was on the basis of outdated interest rate forecasts.

“Barclays has now taken away this possibility for its LOBO borrowers, who will now have to amend their treasury management strategies to list loans of maturity of 50-70 years paying interest rates of 4-5%.”

He added: “Barclays is doing this because UK interest rates are forecast to remain low for the indefinite future, especially given the emergency action the Bank of England is likely to take over Brexit.

“Under Basel rules, Barclays would have to post additional capital against the remote risk of the option becoming volatile.

“Without much upside from the options, Barclays decided to write them off and avoid the capital hit.”

A director at a firm closely involved in LOBO restructuring with a number of lenders told Room151 that “borrowers should remain focused on their net interest cost – those with cash resources available will still face significant carry costs on these loans.

“We don’t suggest waiting for the day when banks offer repayment terms flat to new Public Works Loan Board borrowing.

“The wait could be a very long one indeed, and a very high carry cost in the meantime.”

He added that he did not expect other LOBO lenders to follow Barclays’ lead.

LOBOs have proved controversial, with a Channel 4 Dispatches programme last year implying that services provided by local authorities have suffered in recent years due to the interest rates paid on them.

A Parliamentary select committee last year heard concerns about the relationship between brokers and treasury advisers who originally arranged LOBO loans. Earlier this year, the committee decided to drop its inquiry.

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