Treasury Today Country Profiles in association with Citi

UK ‘muni’ bond market on the horizon?

UK local councils are looking to the bond market to meet shortfalls in their capital expenditure budgets. It is a move that could signal a sea-change in the way the lower tiers of government in Britain finance themselves and give rise to a muni bond market similar to that in the US.

It is common practice in mainland Europe and the U.S for local and municipal councils to raise cash on the capital markets. In the UK it is a different story. Instead, local authorities in Britain have typically had recourse to bank loans and the Public Works Loan Board (PWLB), the government lender that allows municipal bodies to raise finance for infrastructure and capital projects.

But with Chancellor George Osborne raising the PWLB’s lending rate in October of last year, some UK council finance directors are beginning to view the capital markets as their best bet for raising cash at competitive interest rates. Until recently, the PWLB charged local councils 0.17% over gilts, but now demands a full percentage point.

“Changes to housing finance will result in many local authorities paying substantial sums to the government in March 2012. This has prompted banks and other financial advisors to propose direct bond issuance, with the aim of saving 20-40 basis points compared with PWLB rates,” says George Bruce, Treasury and Pension Fund Manager at Harrow Borough Council.

The London borough of Wandsworth was the first to declare an interest in the bond market when it announced last month that it intends to issue ten year notes later in the year. The council believes issuing a bond will allow them to make interest payment savings of between £625,000 to £1m a year.

While councils can still use the PWLB and/or their banks to meet shortfalls in their capital expenditure budgets, bond issuance is particularly attractive to those councils that face the prospect of large deficits as a result of central government belt-tightening.

“The main reason for looking at alternative sources of funding to the PWLB is that last year the government imposed a 1% surcharge over gilt rates on local authority borrowing from the PWLB. Direct bond issuance offers scope for lower rates than currently on offer from the PWLB. The Harrow debt portfolio is 50% PWLB and 50% bank loans and we have always considered both sources of funds,” says Bruce.

With the councils implicitly supported by the central government, many are hopeful that their debt would attract investment-grade credit ratings and ultra-competitive interest rates. It is believed Wandsworth has already sounded out Moody’s to determine its rating, which it believes to be investment grade, if not AAA.

Analysts say that councils with a track-record of good financial husbandry should be able to borrow at very attractive rates – around 0.6-0.8 of a percentage point over government bonds in most cases. The Local Government Association (LGA), the body that represents UK local government, is taken with the idea. It plans to look into issuing aggregated local government debt in the future.

Harrow council’s Bruce believes joint bond issuance may be economically feasible, but a political no-go. “For those local authorities whose borrowing needs are below that required to offer a liquid bond, collective bonds have been suggested. We are looking at the opportunities, but anticipate that the savings will be less than has been suggested and are concerned that collective bonds will require cross guarantees.