Related Dispatches: How Councils Blow Your Millions, where reporter Antony Barnett uncovers unknown deals between cash-strapped councils and banks that are costing taxpayers millions of pounds a year.
Programme producer and financial journalist Nick Dunbar provides a guide for the perplexed:
1. What is a LOBO?
LOBO stands for Lender Option Borrower Option. It’s a kind of long-term loan that used to be provided by banks to councils at a slightly cheaper rate than offered by the government. Councils across the UK have an estimated £15 billion of these bank loans, accounting for around 20 per cent of their long-term borrowing. The largest council borrowers include Newham and Cornwall.
2. How can banks provide loans at below government rates?
LOBOs contain a number of twists that made these discounts possible:
1) they were very long term, in some cases running up to 70 years, with an average lifetime twice that of government loans
2) if market rates fall, councils wanting to move to a better interest rate have to pay large exit fees to get out of the contract
3) banks have the option of putting up the LOBO interest rate, which they are more likely to do when market rates increase. The council can then exercise its option, which means it can repay without an exit fee, but it still has to pay back the cost of the loan itself - so the council has to borrow again in the market, probably at a higher rate than before.
In the words of one of our experts, some believe they are “hard wired against the best interests of the local authorities”. Others, including some banks, say this is untrue. Barclays told us that “these loans have helped councils build new schools, roads and parks. They are straightforward, fair and easily explained. The average interest rate was about 4.5%, typically cheaper than the public sector loans available”.
3. What made LOBOs attractive products for the banks to offer?
Clever traders at banks could turn these LOBO twists into cash by trading in the derivative market.
One former Barclays Capital trader, Rob Carver, told us he felt moral qualms about the trades, including the degree of upfront profits Barclays was making. Whilst he didn’t deal with Councils directly, millions of pounds of LOBO contracts passed across his desk. Dispatches estimates that banks earned more than £1 billion in upfront profits from LOBOs, while the cost to Councils to exit the contracts today could be more than £8 billion.
4. How does Dispatches know this?
Some Councils and banks have resisted disclosing certain information about their LOBO contracts on the grounds that they are commercially confidential, but Freedom of Information campaigners have succeeded in putting a lot of the contracts in the public domain. For Dispatches we worked with financial experts and analysed over £7 billion of LOBO loans from 46 councils with the same software systems used by City traders.
5. Why does this matter to councils today?
Interest rates have fallen to record lows and the twists in LOBO contracts mean that many councils would find it particularly painful to exit them today, so they can’t take advantage of today’s low rates at a time when budgets are under severe pressure. Councils have told us that the LOBOs they took out had lower interest rates than government loans and on average that’s still the case. While it is true that government loans also carry early repayment exit fees, pound for pound it costs twice as much to exit a LOBO versus a government loan, according to Dispatches estimates.
6. What are inverse floaters?
Inverse floaters are a type of LOBO containing an additional twist: after an initial teaser rate period, the council pays an interest rate that goes up when market rates go down and vice versa. Councils like Newham and Cornwall that took out inverse floaters are paying rates as high as 7 per cent todayin some cases. Some experts believe that inverse floaters amount to a gamble on rising interest rates which went wrong.
The Local Government Association say LOBOs are legitimate for councils to use but should be assessed as part of its overall portfolio, not judged in hindsight.
Newham Council told us that it has made £65m of savings on its borrowing since 2002. They say they have ensured their borrowing protects the council’s finances from different interest rates. Further, that after refinancing its debts between 2002 and 2009 their interest repayments were halved. They add that they comply with accounts and audit regulations.
Cornwall Council told us they take expert financial advice and are happy their portfolio provides value for money and protects against the risk of fluctuating interest rates. They added that two of its inverse floaters rates are higher due to the extended period of extremely low interest rates that could not have been foreseen.
7. What is the role of advisers in LOBO borrowing?
Councils employ qualified finance officers who make borrowing decisions in accordance with prudential codes. However, in practice, many councils also take external advice in relation to their borrowing. One of the biggest such advisers is called Sector, owned by services group Capita, and its advisers whose clients entered into LOBOs could earn commission from brokers that served as middlemen for LOBO deals between councils and banks. This POTENTIAL conflict of interest prompted MP Clive Betts to call for an inquiry. Capita says it strongly refutes any allegations of inappropriate business activities. They say they provided: “generic, factual, comparative information to local authorities regarding their funding options. We did not and do not direct local authorities to seek funding from any specific organisation.”