I have received a copy of a note from the Portfolio Holder together with a briefing on LOBOs.
There are two errors:
1. The best way to minimise your borrowing costs is to borrow only
what you need for the period you need it and, if it is important to have
certainty, fix the rate.
It is a mistake for the Council to enter into a cocktail of complex
financial instruments which the Council thinks will minimise its risks
but in fact carry different risks which the Council is not well placed
The way of calculating the price to exit an 'inverse floater' is an example.
Banks would not ordinarily run the risks that the Council is running on these deals. They swap out their risk.
2. The Council has a good credit rating. It is better than the banks
it is borrowing from. So the banks should ordinarily have to pay higher
rates of interest than the Council.
This should put us on red alert to start with that the deals might be
too good to be true. It also means that we should be aware that the
terms of these deals would look jaw droppingly attractive to the
If the banks lent to central Government, they would get peanuts in
comparison. Can anyone imagine the Government offering National
Savings Bonds where the rate is fixed except that if rates go up the
investor can raise the rate and the Government has to redeem the bond
early if it does not like the new rate ?
Comparing fixed PWLB loans with LOBOs is like comparing apples and
oranges. On the PWLB loans the rate is fixed. So the Council takes a
view that it is comfortable to pay the fixed rate on a PWLB loan for the
designated period - like a fixed rate mortgage.
The LOBOs are not fixed as the lender can ratchet up the rate on the option dates.
If the Council has to carry liquidity (which pays derisory interest
rates - on average, 1.17%) to hedge against suddenly needing to repay
the LOBOs then that is another cost that the LOBOs are causing the
I did not raise this issue until 1 December last year because the
Council does not disclose in any of its documents details of these
deals. Other Councils do.