PWLB: Rate cuts and diversifying funding sources
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The chancellor made PWLB borrowing cheaper for councils aiming to spend on housing. David Blake looks at the strategic implications.
It appears Christmas has come early for local authorities following the chancellor’s budget speech. Public Works Loan Board (PWLB) Housing Revenue Account (HRA) rates are down 1.0% to gilts plus 0.8%, a further £1.15bn is available at the Local Infrastructure Rate (LIR) of gilts plus 0.6% and a consultation process was launched, hinting at significantly lower margins for authorities that avoid “debt for yield” activity.
However, authorities that borrow to invest in certain commercial activities, could end up with restricted access to the PWLB.
HRA Loans
HM Treasury has delivered a targeted policy response via the 1% reduction in HRA PWLB loans, lowering funding costs in an area central government is keen to stimulate in their drive to deliver housing.
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The rate is available for loans that will finance expenditure within that account, with the section 151 effectively guaranteeing that loans will only be used for this purpose. Simple and effective.
Of course, it does throw up a few questions: Can the HRA rate be used for refinancing? Can it be used to close the gap between existing HRA debt and the HRA capital financing requirement? What about HRA premiums?
But the accompanying letter from the Treasury appears clear: If you are using PWLB for the intended purpose—HRA expenditure in this case—the rules and process are simple and loans will be available at gilts plus 0.80%; a rate I consider to be broadly in line with “market” pricing.
Future lending terms
These themes are then carried through to the consultation on “future lending terms”.
One of the key takeaways from the consultation process and discussions with officials is, if local authorities borrow for the purposes intended by the Treasury—including service delivery, regeneration, and housing—then there is a reasonable chance that lending margins could revert to around gilts plus 0.80% in the next six to 12 months.
The Treasury makes clear that PWLB is a scarce and valuable resource. While they want to remain supportive of the Prudential Code, it views borrowing to invest in commercial property and other “debt for yield” projects to be high risk and low value: Central government does not want to provide PWLB loans to support this activity.
Local authorities that wish to buy investment assets primarily for yield would remain free to do so but would not be able to take out new loans from the PWLB in the year in which they have bought the asset.
The consultation represents a frank, wide ranging and inclusive invitation, allowing key stakeholders to contribute to developing a system whereby PWLB can be made available at improved margins to support qualifying projects.
There is quite a carrot being dangled for those authorities that play ball. The consultation states: “The government intends to lower the cost of new PWLB loans, subject to market conditions, once this issue can be resolved, by lowering the margin charged over gilts.”
How much will the margin be reduced by? Well, the reduction in HRA lending rates by 1%, taking the margin back to gilts plus 0.80%, would seem to offer a guide. I understand the Treasury hopes to implement the new lending arrangements within the next six to 12 months.
Strategic considerations
What does this mean for local authority borrowing strategies? As ever, this is subject to individual requirements and projects. Certainly, those funding HRA projects have received a significant boost.
However, I don’t expect this policy to be reversed over the consultation period and our forecast for underlying gilts yields is broadly flat.
Authorities that require funding for projects under the new lending arrangements, once they commence, may benefit from a substantially reduced rate. But this could come with strings attached and the timetable and process remain uncertain.
For those authorities pursuing policies that fall foul of the new arrangements, well, there is a long way to go on this. We anticipate more detail on the eventual outcome will emerge as we approach the consultation close and subsequent reporting and implementation stages.
The past six months has seen an increase in policy risk, with PWLB margins lurching quite substantially. There remains a strong argument for diversifying funding sources, particularly where margins achieved on alternatives are sub gilts plus 0.80%, a realistic proposition for many.
What does appear be clearer is that unless you think there will be a substantial increase in gilt yields, there doesn’t appear to be much incentive to borrow PWLB now at gilts plus 1.80%.
While current market volatility does present opportunities to those with well-established plans, we think attractive borrowing levels will continue to present themselves over the course of the next 6 months. Market volatility is a double-edged sword; don’t rule out the prospect of lower rates and be aware of the risk indicators now flashing in financial markets.
David Blake is strategic director at Arlingclose.
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