Hard choices: how the PWLB rate rise could hit councils’ service budgets

The local government sector reacted to last week’s hike in the Public Works Loan Board interest rate with emotions ranging from dismay to anger.

As finance directors raced to re-evaluate their spending plans, the Local Government Association warned the move “presents a real risk that capital schemes, including vital council house building projects, will cease to be affordable and may have to be cancelled as a result.”

This week, however, ratings agency Moody’s said it does “not expect the sector to cancel or postpone the majority of these projects as they fulfil important statutory duties”.

Anticipating councils will choose to bear higher interest costs on their planned capital projects, Moody’s issued a “credit negative” judgement on the sector.

But pressing ahead with schemes could also mean revenue budget cuts leading to service reductions, according to sector experts.

“Furious” reaction

Last Wednesday, hours after the rate rise was announced, officials from the department held a conference call with senior local authority finance officers.

A source who was on the call describes the mood among the council officers present as “furious”.

“The decision to increase the rate meant they would have to start their budget planning for 2019/20 over again,” the source said.

Room 151 is seeking council finance officers’ views on the PWLB rate rise – click here to take part

The officials told their audience that the sharp increase to the PWLB borrowing rate was due to the pace at which councils had been borrowing from the facility during the summer; £2.0bn was taken in August and £1.6bn in September.

With the PWLB only £2.3bn away from its £85bn statutory limit for liabilities, the decision to extend the cap by £10bn to £95bn was taken at the same time as the rate rise.

But the Treasury was worried the extra money could be gobbled up within less than a year, which would leave them with another decision on whether to raise the cap again.

This fear led to the decision to increase the rate of borrowing by a significant amount.

Andrew Burns, associate director at the Chartered Institute for Public Finance and Accountancy, says this explanation makes some sense when seen in the macro-economic context.

“You can’t separate what is going on here with the next Budget,” he says.

“The government has made a lot of spending pledges on hospitals and other areas.

“Another reason the Treasury is looking at its debt is that if there is a disorderly Brexit they don’t want one more thing making it difficult for them to respond.”

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According to accounts from those on the conference call, Treasury officials’ explanation for their move focused purely on these technical motivations.

There was no suggestion that the idea was to dampen any rise in councils borrowing from the PWLB to invest in commercial property.

Whether or not it was a primary motivation, the impact of the move is likely to stymie many of these types of deal.

Councils will be able to borrow more cheaply than the new PWLB rate from banks and pension funds.

However, going down this route will mean they face much more scrutiny as to the risk involved in their plans.

David Blake, strategic director at treasury adviser Arlingclose says: “If you go to a pension fund and ask for £40m one of the first questions will be ‘what is this for’?

If you tell them it’s for the purchase of an office block, leveraged at 100%+, to add to your already bulging balance sheet debt the answer will probably be ‘no thanks’.

“With skinny margins on many of these deals, it may not be practical to proceed.”

Cost of borrowing

However, even bigger worries hang over the future of “bread and butter” capital projects funded by local authorities – including housing, school, road and waste projects.

Last week, a number of councils told Room151 that a number of such projects are under threat, and it is understood that more than a dozen authorities have approached the LGA with examples of projects which may no longer be viable.

However, CIPFA chief executive Rob Whiteman says many councils could still try to press ahead with their planned capital schemes.

He says: “Of course this move will have an effect on councils’ business cases to provide more council housing.

“But they will be influenced by other motivations and you can’t just single out the cost of borrowing as the only factor.”

Richard Harbord, former chief executive of Boston Borough Council, says councils which are part-way through long-term projects will also have no option than to carry on with them, even if the cost of borrowing is now more expensive.

He says: “Some authorities will have already done the borrowing, but some won’t have done. This will put the screws them on a bit more.”

Other councils are likely to stick with the PWLB because of the ease of accessing the cash.

Blake adds: “Smaller councils that only occasionally need £5m or £10m might not see it as worthwhile spending the time going through the administration involved in accessing that money from the private market and might end up paying more from the PWLB.”

Others suggest that councils which are already over-borrowed with small reserves will be seen as too much of a risk by the private market, and will have no alternative other than to return to the PWLB well.

New market emerging

Signs of a new sub-PWLB market are already starting to emerge, according to many close to the situation. However, they say it might take time for pricing to settle.

One broker in the local government sector told Room151 that one or two private lenders are already touting loans at “aggressively priced” levels.

He says: “Some councils may see these deals at 20 or 30 basis points lower than PWLB and be tempted to grab them, But I think people should hold fire.”

Blake agrees. He says: “It will take time for some of the new offers to appear.

“There is a world of process – the speed of pension funds’ decision-making make local authorities look positively light-footed.”

He recommends that councils consider borrowing at low rates on short-term loans from other councils until the market for longer-term borrowing stabilises.

He added: “It could take a few months, but I hope that when a bit of competitive tension enters the market we will be looking at decent offers – I am hoping they won’t be too far away from the gilts plus 80 basis points previously offered by the PWLB.”

Those pressing ahead with projects and taking longer-term borrowing at higher rates, whether from public or private sources, could face some difficult decisions in this year’s emerging budgets, according to Burns.

He says: “If your annual interest payments are going up, you now have an extra cost coming into the revenue account. You might still do the project but you will have to find a saving elsewhere by closing a library or something else.”

It is understood that the LGA has told the Treasury that it backs proposals touted by the Society of District Council Treasurers for a new discount PWLB rate for housing and regeneration projects.

Burns says the proposal is interesting but potentially challenging.

He says: “If you make a special case for housing, you could equally make an argument for a discount rate for schools, roads and other projects,” he says.

It is too early to say whether councils will scale back their capital projects or press ahead with them and find revenue savings from elsewhere to fund higher interest payments.

In the meantime, the government says it will keep the rates policy under review and “continue to work with individual authorities on a case-by-case basis if they have concerns over their financial position”.

Whether councils choose to cut the scope of their capital projects, or cut spending in other areas to service higher debt levels, it is clear something is likely to have to give.

As they continue to prepare their capital and revenue budgets for the next financial year, council finance officers have another headache they could do without.

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