PWLB changes and local authority creditworthiness

David Green asks whether new borrowing rules should prompt lenders to reassess the risk of doing business with councils.

There are two main reasons why an organisation might default on its debts: insolvency, which is an accounting judgement that liabilities exceed assets and there is no reasonable likelihood of improvement; and illiquidity, which is the lack of ready cash to physically make the debt repayment.

The creditworthiness of UK local authorities is underpinned by statutory arrangements meaning that they cannot become insolvent, and by the presence of a lender of last resort meaning that they cannot become illiquid either.

However, recent changes to lending arrangements at HM Treasury’s PWLB lending facility (formerly the Public Works Loan Board) have brought this second safeguard into question.

Before agreeing a loan, PWLB will now ask for confirmation that the local authority is not planning to buy investment assets primarily for yield, such as commercial investment property, in the next three years.

Authorities unable to confirm this cannot borrow from PWLB to fund any capital expenditure, not just the investment asset in question.

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Outliers

This stance has been taken following concern in many quarters by the scale of investment activity undertaken by local authorities in recent years funded by public borrowing.

If central government doesn’t believe that investing in property is a good reason to increase the national debt, how can it be any different for local government with their higher cost of borrowing, the argument goes. There are also questions around the legality of borrowing to invest.

HM Treasury is hoping that the new lending arrangements will deter most authorities from buying investment assets primarily for yield, unless they are investing their own money which is much less of a concern.

But what about the outliers that intend to continue this activity, and borrow from elsewhere to fund this, such as other local authorities or the private sector? Can those lenders be assured they will be repaid on time when the PWLB taps have been turned off? Should interest rates on loans rise to cover additional credit risk?

The answer is that there is no need to worry. The PWLB guidance is clear that it will still lend to refinance maturing debt from any lender, even if the local authority is planning activity that makes it otherwise ineligible for PWLB support.

So, there is no need for lenders to reappraise the credit standing of local authorities as a result of these new arrangements.

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Loopholes

This does, of course, leave some loopholes that could be exploited. For example, an unscrupulous authority could fund an investment asset with a short-term private sector loan and then refinance from PWLB soon afterwards. But this is where you need to read the fine print.

Where HM Treasury has concerns regarding the continuing appropriateness of PWLB loans to a particular authority, it may make ongoing access to the PWLB conditional upon a borrower acting in accordance with HM Treasury’s reasonable instructions.

This could include requiring the authority to sell recently purchased investment property. If that is not done within a reasonable timeframe, HM Treasury can require the borrower to repay PWLB loans plus their early repayment premiums.

In this way, central government hopes to tread the fine line between curtailing what it sees as high risk activity and maintaining the creditworthiness of the local government sector.

The system may, of course, need tweaking further down the line. But they have made a clear statement that PWLB intends to remain the lender of last resort to avoid any local authority defaulting on its debt due to illiquidity.

David Green is Strategic Director at Arlingclose.