(Updated 23/07/18 17.00)
In mid 2004, a pair of fresh faced, sharply suited bankers pulled out of the car park at Barclays Global HQ in Canary Wharf and drove south on the M20 headed for Maidstone.
Barclays was offering up a new structured loan product known as Lender Option, Borrower Option loans or ‘LOBOs’, and the bankers business that day was a presentation sales pitch to Kent County Council (KCC) as part of a national ‘LOBO road show’ to drum up trade.
The Barclays bankers knew first hand Kent was primed and ready to borrow. Butlers, a Treasury Management Advisory firm owned by ICAP, the global brokerage powerhouse run by Tory Party Treasurer Michael Spencer recommended Barclays to KCC as a preferred option for its long term borrowing needs.
Now, over a decade later, 14 local authorities have filed legal action against Barclays – Kent’s largest lender over the mis-selling of LOBO loans and the rigging of LIBOR interest rates, leading some to question why Kent County Council has failed to join the legal action to recoup taxpayer funds?
Arlingclose KCC’s Treasury Management advisors have said the following regarding LOBO’s:
Arlingclose: “We continue to believe that other banks will come under increasing pressure to restructure their LOBOs to the advantage of local authorities. This pressure comes from changes to accounting standards and capital adequacy regulations, as well as continued interest from politicians and lawyers into the circumstances that led local authorities into borrowing under this structure.”
An analysis of Kent’s LOBO debt undertaken by Nicholas Dunbar and Gary Kendall determined that Barclays, RBS and Dexia recorded an upfront trading profit on these LOBOs on the first day the loans were signed of £23,000,000. High fives, fat bonuses and champagne all round chaps.
It wasn’t just the bank and its salesmen recording a tidy profit, Butlers/ICAP would be paid a hefty fee of approx £27,000 for every £10 million Kent borrowed via LOBOs, while also being paid multiples of that amount by Barclays on the opposite side of the trade. All told, Butlers/ICAP received just shy of £1,000,000 from Kent in fees from LOBO commission and more money from subsequent loan restructuring.
“my personal feeling was that I would not do these deals if you put a gun to my head. I asked myself, when I was doing this job, why local authorities are doing them? One of the things that we might as well mention now is that, in terms of the mechanics of the market, there is a chain of fees that flow from the councils to treasury management advisers to brokerage houses, like ICAP, to advise them and protect them against potentially being mis‑sold these products, or whatever you want to call it.
We were paying commissions to the brokers as well and this made me very concerned, because I did not see how the brokers could be giving their ultimate clients, the councils, independent advice when they were being paid by us. Subsequently I found out that they were also being paid by the councils as well. The brokerage fees were quite large compared with the fees we normally paid, and there was lots of pressure always to pay higher fees. It smelt and felt to me like there was something really dodgy going on. I cannot prove that, but there is clearly a kind of moral hazard and that made me deeply uncomfortable. At the end of the day, we are dealing with councils. We were not dealing with hedge funds or other people who, in my opinion, knew what they were doing. We were dealing with local councils.”
Butlers advice to Kent County Council did not only extend to entering LOBOs. Kent residents may recall the £50m that was lost on deposit with Icelandic banks in 2008 was a result of Butlers advice.
Evidence provided by the Chartered Institute of Public Finance and Accountancy (CIPFA) and their document titled “Treasury Management Advisors – Regulations and Services” published in March 2010 suggests policy makers were concerned regarding conflicts of interest in the brokerage market.
“Authorities should also be clear as to the payment structures for services and these should always be transparent to the authority. This is especially the case where, for example, an advisor is receiving a commission for a specific product: here the authority should be made aware of this.”
“The Treasury Management Panel believes that there may be potential conflicts of interest in many areas of treasury management. It is therefore essential that local authorities clearly understand the relationship and associated fee arrangements between their advisors and any potential counterparties. Where a broker or counterparty is used, normal best practice regarding the selection should apply. Authorities should consider carefully the independence of the advice they receive relating to particular treasury products or strategies.”
What Is The Impact of Kent’s LOBO Loans On Interest Repayments?
For a moment lets assume the average rate of interest on Kent CC’s portfolio of LOBO debt is 4% interest.
On total KCC LOBO borrowing of £441.8 million that equates to £17,672,000 interest a year being paid to the banks, around 25% of all interest payable by Kent CC.
But how does that compare to interest rates available in the market today? As at 20 July the Public Works Loan Board advertised loan rates to councils for between 1.6% and 2.7%.
Lets say Kent were able to cancel its £441.8 million of LOBOs without penalty and refinance via the PWLB at 2% interest. How much would be saved?
Kent County Council would save a total of £8,836,000 year one, repeated over the next 40-50 years of the LOBO loans.
Coincidentally, the money saved in higher interest payments over 50 years would equal £441,800,000 – precisely the same amount the council borrowed from banks between 2004 & 2008 via LOBOs.
You will also note that in Note 38 of Kent’s accounts,
Why Doesn’t Kent County Council Refinance at Todays Lower Rates?
What prevents Kent County Council from refinancing its portfolio of LOBO loans via either the Government’s PWLB or from banks at today’s lower rates of interest are derivative breakage costs on the loans.
Broadly speaking the so-called “fair value” of the LOBOs is the cost of cancelling the loans today and repaying the breakage costs and the principal to the lenders.
You will note from KCC’s anual accounts that the “fair value” breakage cost of Kent’s LOBO loans is £737,551,000, around £300m higher than the carrying amount or face value.
LOBO loan breakage fees, which according to financial expert Abhishek Sachdev of Vedanta Hegding are approximately twice the breakage fees on equivalent PWLB loans are keeping Kent CC locked into the LOBOs, paying higher rates of interest than they otherwise would be.
This is why Sachdev describes LOBOs as a “lose-lose bet” for councils and note 38 on page 115 of KCC’s draft accounts as above states:
“The fair value of borrowings is higher than the carrying amount because the Council’s portfolio of loans includes a number of fixed rate loans where the interest rate payable is higher than the prevailing rates at the Balance Sheet date. This shows a notional future loss (based on economic conditions at 31 March 2018) arising from a commitment to pay interest to lenders above current market rates.”
Also at the Communities and Local Government Committee July 2015 Sachdev stated:
if you are being given these kinds of products and you are not being provided them in a transparent manner, there is no way you are going to be able to understand them.
He goes onto say:
I would categorically say that I do not believe you would be able to find a finance officer or a treasury officer in a council who would be able to accurately assess the relative risks and rewards of one of these LOBO products. I would even have to say that it does not matter if you are a qualified accountant or a chartered account at all. We deal with some very large corporates and even FTSE 250 businesses’ treasurers would not be able to analyse this on their own. They would literally need a specialist hedging adviser or for the bank to explain things in a very transparent manner to them.
Did McCullan & Vickers of KCC at the time, truly understand these products, sold by Barclays, when they signed them off? Did they realise the brokers were being paid twice in a potential conflict of interests?
What Could Happen If Kent joined the legal action with Liverpool, Leeds and Bristol?
As explained by William Turvill for the Daily Mail the 14 Councils who have filed legal actions as represented by Hausmans lawyers contend that Barclays rigging of LIBOR interest rates between approximately 2006 – 2011 and especially between 2007 and 2009 had a material impact on the rates of interest they pay via their LOBO loans.
The councils also claim that Barclays presented LIBOR used to to calculate the rate of interest on LOBO loans as a fair and honest benchmark, while knowing that the rate was compromised and being manipulated by Barclays and other banks.
On this basis, the councils are claiming that the LOBO contracts should be rescinded or torn up, any costs should be paid to the Council, meaning the local authorities would be free to refinance via other sources.
As stated above, such an outcome could save Kent County Council around £400 million in interest payments over the next 50 years, which for a cash-strapped local authority like Kent could mean the difference between survival and bankruptcy.
Surely, its time Kent County Council took the side of local residents, and joined a legal action which could save taxpayers nearly half a billion pounds over coming decades.
The Shepwayvox Team in conjunction with Joel Benjamin of Lada Debt Resistance