Monday, 6 July 2015

Council to have more borrowing powers?

 Part of Cornwall Council's "Case" to Government for more powers is to ask for more borrowing powers (current total Council debt around £800m). But would this be safe?

 It appears that the Council (almost exclusively the old County Council) has taken out bank loans totalling £400m, which are repayable in 40 to 60 years.

In the early years the Council claims that it was making a profit by borrowing cheaply and investing at a profit. The Icelandic bank debacle showed that this was not a risk free strategy for the Cornish taxpayer.

But there was a more fundamental problem: the Council was borrowing long but investing short term. So the market could catch it out, as indeed it did when the recession hit in 2008 and interest rates dropped like a stone: It was a massive bet on interest rates.

I also recently discovered that the Council's £400m bet on interest rates was actually a one way bet. It appears that the banks have the option to raise the interest rate periodically throughout the 40 or 60 year period. The Council's "option" at that point is to repay the loan early.  So the loans are called LOBOs ( lender option/ borrower option).  It sounds balanced but, of course, the borrower option is no option at all.  All the Council can do is refinance its loan at the new (higher) market rates with a different lender or lose the use of the money.

The banks lay off their (limited) interest rate risk by entering into complex financial products such as Bermuda swaptions.  The cost of these exotic instruments is effectively passed on to the Council.  The Council just hopes for the best.

 When challenged,  the Council says it is comfortable with its borrowing strategy. It is utterly impossible to understand why.

More borrowing powers for Cornwall Council?  I think not. My fear is that the Council are entering into transactions to make tiny savings but the risks of these transactions are huge.  If you do not understand it, best not to do it.

The Council weren't keen to explain what it had been getting into either.

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