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The power of diversifying your debt

Cash-strapped councils are looking at alternative options for borrowing, reducing risk through diversification. Fraser Mackay explores why.

Greater funding flexibility for local authorities

As they face ongoing challenges in providing essential public services during the pandemic in a tough financial climate, borrowing is an increasingly essential funding tool for the UK’s cash-strapped councils.

The good news is that, in practical terms, local authorities now have more choices and options available for acquiring loans, opening up opportunities to diversify their debt portfolio and introduce greater flexibility in their debt management strategy.

Until fairly recently, councils typically borrowed long-term from the Public Works Loan Board (PWLB) and short-term from the inter-local authority market.

But although the 100bps reduction to PWLB interest rates announced in November 2020 was welcomed and helpful, it came with some new restrictions, as loans cannot be used to buy assets primarily intended to produce yield.

Importance of diversification

In the current economic environment, it’s important not to put all your eggs in one basket. When the PWLB raised its interest rates in 2019 a number of councils suffered a degree of paralysis with many ‘ready to go’ projects stopped in their tracks.

For me, that highlights the risk of relying on one source of long-term funding, and regarding short-term options it’s worth remembering how prices can increase in the inter-authority market when liquidity is tight.

By diversifying their lending sources councils are better able to take advantage of the right funding and to create a strategy that best works for them.

Alternative options

Council treasurers are actively considering other sources of borrowing both to fund longer-term yield-based investment projects, including debt capital markets, private placement, banks and the Municipal Bond Agency (MBA).

Around a fifth of authorities have suggested they are interested or very interested in alternative funding sources, according to a Room151/CCLA survey†^ presented at the Local Authority Treasurer’s Investment Forum in January this year. This certainly reflects conversations we are having with our clients about long-term and short-term funding.

Yet, even as recently as the end of 2019, councils weren’t talking about debt with banks, and debt capital markets were off the table. Now however, banks are offering both liquidity and short-term funding options.

Furthermore, some banks offer a revolving credit facility, where debt can be repaid if not needed and built up when it is.

For our part, because we understand the underlying credit risk of councils, we will look broadly across a range of measures when considering the credit worthiness of a local authority. We recognise that some are struggling more than others, but know that irrespective of media hype around the possible issue of a Section 114 notice, a local authority cannot ‘go bust’.

Value for money

The cost of borrowing is always a key consideration of course, but it’s also about looking beyond margins and prices to overall value for money.

For example, in the process for drawing down funds the timing and profile needs to be considered. Are there any unnecessary costs you have to carry if you borrow all the funds you require up front rather than drawing down as and when you need them?

There is also additional value in the relationship that is created. Certainly, when you borrow from a bank there are additional benefits in the form of social value that can be really valuable to a local authority. These can range from additional support around digital strategy and skills to local programmes supporting the development of employability skills.

If you are borrowing for sustainability purposes, it’s certainly worth considering that there may be financing benefits and cheaper margins available to support this.

Looking forward

While many authorities may still consider going to the PWLB for long-term loans, the restrictions around them have created a number of grey areas for commercial investment by councils, and will impact those where more investment yield is likely to be used to pay for funding and long-term borrowing.

There is certainly a strong argument that more authorities will start to look wider and borrow for the longer term through capital markets the MBA and private placement.

And when other councils see the opportunities and benefits arising from that strategy – taking into account value for money and the chance to reduce risk through diversification – I suspect we will see an increase in authorities willing to go down that route.

Given that authorities are being discouraged from making commercial investments for yields, that brings into play the whole question of what the local authority funding model should look like – a debate that will be firmly on the agenda for a number of years to come.

How we can help

Working closely with many UK local authorities, we understand the ongoing financial pressures and challenges that councils face and are pleased to offer our support, advice and guidance wherever we can.

If you would like to know more about how we can help, please speak to your Relationship Director or speak to Barclays.

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