Lender of last resort: making sense of the PWLB rate rise
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The government has finally lost its temper with ever increasing borrowing by local authorities and has added 1% to Public Works Loans Board interest rates.
Anecdotally, much of this recent splurge in borrowing has been to finance commercial property acquisitions for a combination of regeneration and investment purposes, although since government still doesn’t collect statistics on this, nobody can know for sure.
But with £1.6 billion borrowed in September following £2 billion in August, HM Treasury has called time.
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On the plus side, this move confirms that the government is happy to manage demand for PWLB loans by changing the interest rate, rather than by restricting supply.
It even gave the PWLB permission to lend another £10 billion if authorities request it.
This policy of changing the price rather than rationing availability is similar to the rate increase made in October 2010.
Then, the new coalition government was starting to tighten its own belt to keep a lid on the national debt, and didn’t want local authorities taking advantage of falling interest rates to an extent that it impacted upon national policy.
Last week’s rate hike can be viewed in the same vein – we may be nearing the end of austerity but if Brexit and/or the global slowdown require a fiscal boost, central government doesn’t want councils using up its headroom to buy investment property.
The big negative of course is that PWLB loans are now much more expensive.
So what should local authorities do?
A few councils have panicked and borrowed from the board immediately after they raised rates, but for most authorities that will be the wrong response (hint: it’s usually better to borrow after rates have fallen not risen).
Many local authorities still hold large volumes of short-term investments earning around base rate, and the cheapest and lowest risk course of action for those is to reduce these balances before borrowing any loans.
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Some people still see the capital financing requirement as the natural level of debt to hold, even 11 years after CIPFA refined its approach by introducing the liability benchmark as the key comparator.
Borrowing a fixed-rate loan only provides an illusory certainty of cost if you have a material investment balance exposed to fluctuations in short-term rates.
The next best source of cash is short-term borrowing, typically from other local authorities that have borrowed too much long-term and are looking for a safe home for it until it can be spent.
It is quite sensible to have a strategic allocation to short-term borrowing that exceeds the average balance of short-term investment.
This is partly because it’s cheap, but also now that local authorities are more exposed to the local economy through the localisation of business rates and council tax support, not to mention commercial property income, it is good risk management too.
If the economy weakens and other sources of income dry up, you’d prefer your interest costs to fall.
Conversely when the economy is strong and income is rising, you can afford to pay more on short-term borrowing.
There’s a limit to how far this is sensible, of course, and at some point long-term fixed rates will be the lower risk option.
But the PWLB shouldn’t be the first port of call. Private sector lenders that would previously have lent at 0.2% to 0.5% above PWLB rates will now lend at 0.8% to 0.5% below the new rates.
There will be more paperwork and a longer lead time, but if it saves you £1 million in interest over the long-term, you should be willing to invest a little time and money up-front.
For many local authorities it would be cost effective to employ an additional member of staff just to manage the process.
In the end, the PWLB rate is a political tool, and ministers can increase the rate when they want to restrict local authority borrowing and cut it when they want to encourage it.
It’s a reasonable bet that a change of government would lead to a downwards rate change.
And today’s ministers may well look to incentivise the eponymous public works with another round of the discounted local infrastructure rate. But for the time being, the PWLB has returned to its official role as the lender of last resort, rather than a bottomless well of cheap and easy money.
David Green is strategic director at Arlingclose Limited.
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