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Moody’s warns of ‘adverse impact’ from capex borrowing

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  • by Gavin Hinks
  • in 151 News · Treasury
  • — 22 Sep, 2016

Moody’s expects an “adverse impact” on the credit profile of local authorities that have increased borrowing to fund commercial projects using capital spending, the agency has said.

In a report called English Local Authorities: Plans to Boost Revenue through Capex Adds Risk, Moody’s said the borrowing would bring added credit risk for authorities while revenues from such projects are not necessarily guaranteed.

The report adds another voice to concern about the debt levels of local authorities following a paper from the National Audit Office in June which said servicing debt could threaten revenue spending.

Roshana Arasaratnam, a VP-senior credit officer at Moody’s, said: “Borrowing to invest in commercial projects exposes local authorities to additional credit risk as the revenues that flow from these projects are inherently uncertain.

“Those adopting this strategy also face increased project execution risk and greater competition from the private sector.”

The Moody’s report adds that councils faced risk if business or project-related revenues fall short of expectations. “LAs in this position will have the hard liability associated with the investment on their balance sheets, without the increased income on which the initial undertaking was based,” the report said.

The comments are understood to be aimed at local authorities in general, though Moody’s cites Sevenoaks, Warrington and Newham councils as examples of those that have taken on commercial projects.

Warrington issued a £150m bond in 2015 to support an economic development plan; Newham has set up a housing company focused on private sector rentals; Sevenoaks is generating investment income from a property portfolio.

Sevenoaks issued a statement denying that the council’s property venture relied on borrowing.

“We are the first self-sufficient council in the country and this has been achieved, in part, by investing in property. But we must stress these purchases have been made using our own financial reserves without the need for external borrowing.”

Danny Mather, corporate finance manager at Warrington Borough Council, said the authority’s debt risks were included in its current credit rating. “Whilst we are aware of all risks associated with our programme, we are also aware of the balancing risk of opportunity, which is evident in some of the great outcomes the local government sector is generating.”

Newham were unable to comment by the time of publication.

Moody’s said that even though local authorities can expect an adverse impact on credit profiles it does not anticipate capital spending trends to change.

Immediately following the EU referendum in June Moody’s placed 52 sub-sovereign public bodies on “negative outlook” citing the vote to leave as the reason. Moody’s said: “A downturn in the economic outlook in the UK has direct implications for UK sub-sovereign budgets through (1) potential or slowing transfer received from the central government, which make up a significant share of their revenue; and (2) further potential austerity measures included in the government’s next Budget and next Spending Review.”

June also saw the NAO express concern about the levels of debt currently serviced by local authorities. Debt servicing, it said, accounted for 7.8% of council revenue spend, though for single-tier and county councils the proportion is as high as 9.9%.

The NAO said: “If authorities cannot reduce their debt servicing costs, this will place further pressure on revenue spending.” It added that minimising the revenue cost of capital programmes is the “primary challenge facing authorities.”

There was concern too that so much capital spend is focused on new projects that investment on existing assets was being delayed. “This raises concerns about the possible degradation of authorities’ assets and pushes the costs of the maintenance backlog into the future,” said the NAO.

However, some see current low rates of interest as an opportunity for local authorities. The New Local Government Network (NLGN), a think tank, recently published a paper in which it called for councils to take advantage of cheap borrowing for investments to “drive self sufficiency”.

NLGN director Simon Parker said: “We should welcome the fact that councils are going into business using smart commercial investments to maintain local public services.

“Low rates represent a huge opportunity for local authorities to increase their financial resilience.”

In July the Public Works Loans Report published figures showing that loans had spiked 1,600% in June compared to May rising from £74.2m to £1.326bn.

Meanwhile, Standard & Poors (S&P) this week issued a statement declaring a “negative outlook” on the Borough of Kensington & Chelsea. But it added that this “solely reflects the negative outlook on the United Kingdom.”

The borough was “affirmed” as AA, long term, and A-1+, short term, in S&P’s report.

S&P said: “The negative outlook reflects the negative outlook on our unsolicited long-term credit rating on the UK. We would lower the rating on Kensington and Chelsea if we were to lower the rating on the UK. In our view the borough’s economy and finances are not sufficiently robust to withstand country-specific stresses.”

S&P acknowledged the borough has maintained a “strong budgetary performance” but said it expected a “slight weakening” towards the end of the financial year ending March 2019.

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