DBRS Morningstar: UK Local Authorities’ New Lending Terms With PWLB is Credit Positive For the Sector

On 26 November 2020 the United Kingdom’s (AA (high), Stable)[1] Treasury (HM Treasury) published its response to a consultation that started in March 2020 regarding the lending terms of the Public Works Loan Board (PWLB). The PWLB is the UK government’s facility, managed by the debt management office (DMO), that provides loans to local authorities (LAs) in England, Scotland and Wales. With this publication, HM Treasury announced that it would revise the conditions of the loans provided by the PWLB to LAs, reducing by 100 basis points the interest rates for LAs from 26 November 2020. On top of the interest rate reduction, DBRS Morningstar considers credit positive for the LAs the indications of a strengthening of the DMO oversight over LAs’ financing operations, particularly with regards to their capital plans.

The timing of this publication and its related changes is very relevant, as it follows the announcement on 11 November 2020 by the London Borough of Croydon that it would trigger a Section 114 Notice given its inability to balance its budget. The Section 114 Notice restrains the type of expenditure that can be realised by a LA, preventing all new non-essential spending, and formally flags the Council’s budgetary difficulties. Croydon like other LAs over the last decade, has made a number of investments into commercial real estate in search of a greater diversification of their future resources and a higher return on investments, partly in response to the reduction in government grants. Such investments, that are not directly tied to LAs’ key public service responsibilities have been classified by the government as “debt-for-yield” projects.

The publication on Thursday last week confirms that the central government is well aware of the types of investments made by some of its LAs and acknowledges the greater risk inherent in such operations. “However, the current COVID-19 pandemic is likely to have accelerated and compounded some of the potential difficulties well anticipated by the UK government for some of the LAs’ exposed to commercial assets and may have prompted a swifter implementation of new measures” says Nicolas Fintzel, Vice President at DBRS Morningstar.

The government announced revised lending terms under which LAs will continue to access the PWLB for the financing of their public service responsibilities. Besides the interest rate reduction, these new terms require the provision by the LA of a high level description of its capital spending and financing plan over the next three years. In this plan, the LA will have to describe whether it considers entering at any point into operations consisting of the purchase of an asset primarily for a financial return. In such scenario, the LA will be unable to access the PWLB for any new financing; whether directed to the operation in question, or not.

HM Treasury has also clarified that the refinancing of existing loans, even if previously used for investment in properties (debt-for-yield), will continue to be covered by the PWLB. “This is a positive credit feature for the sector, as it substantially reduces the uncertainty that could have arisen if the refinancing of these loans would have been excluded” says Mehdi Fadli, Vice President at DBRS Morningstar.

Notes:
[1] The United Kingdom of Great Britain and Northern Ireland’s ratings were downgraded to AA (high), Stable from AAA, Negative on 13 November 2020. Latest press release available at: https://www.dbrsmorningstar.com/research/370024/dbrs-morningstar-downgrades-the-united-kingdom-to-aa-high-trend-changed-to-stable

This press release titled: “UK Local Authorities’ New Lending Terms With PWLB is Credit Positive For the Sector” is available at www.dbrsmorningstar.com.

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