Newham to save £143 million by terminating a big bad LOBO

Fantastic news! Newham will save some £3.5 million interest per year (including £1.5 million extra off our housing loans). Many thanks to all those who fought for justice so long including our new Mayor, Rokhsana Fiaz, Cllr John Whitworth as well as Newham officers and our advisers. Special thanks also to Joel Benjamin, Abhishek Sachdev and Nick Dunbar. 

NB We still have one wolf to terminate. 

(LOBO is also Spanish for Wolf) 

Newham Council to save £143m after terminating Lender Option Borrower Option (LOBO) loans with bank

"Newham Council has struck a deal with NatWest bank over its Lender Option Borrower Option (LOBO) loans that will save the Council up to £143m, allowing more money to be spent on services for residents.​

​The termination agreement will allow Newham to pay off the LOBO loans at a considerably lower rate of interest, saving the equivalent of £3.5m per year over 41 years, which was the length of time the loans still had to run.

Newham will now enter into agreement with the Public Works Loan Board (PWLB) to pay off the loans at much lower rates of interest. The PWLB is the Government body that lends money to councils.

The deal, agreed following lengthy negotiations with the bank, will put the Council in a better position to take advantage of current low borrowing rates.

The Council took out six LOBO loans, each worth £25million, with the bank in 2009. Terminating the loans will remove significant financial risk to the Council. This will improve its financial standing at a time of austerity and enable it to invest in services that benefit the Newham residents.

The Mayor of Newham, Rokhsana Fiaz, said: “I made a promise to Newham residents in my election manifesto last year that I would clean up the Council’s budget. A key element of that was to address the scourge of risky LOBO loans taken out under the previous administration.

“After just a year in office I have made an important step towards achieving this and it will save us significant amounts of money every year.

“Over the past ten years that the loans have been in place, it’s cost us an extra £31million in interest payments compared to borrowing from the PWLB. That’s money that should have been spent on Newham residents.

“Earlier this year, I made a promise to Newham residents that I’d make every penny count and that’s why this Council filed a claim against the bank in the High Court in February. The deal that we’ve successfully nailed down today means that we’ll be saving up to £143 million for Newham residents, which is a successful resolution of this litigation."​​

LOBOs: Putting up and not shutting up

At the Newham Full Council meeting last Monday, the Cabinet member for Finance, Lester Hudson, responded to the arguments that myself and Cllr Whitworth put forward here and here about the exposure Newham has to LOBO loans.

Cllr Hudson said that the Council had saved £64 million in reduced interest rates because it had redeemed old expensive debt and taken out "cheaper" new LOBO debt to replace it. He believes that this amounts now to £64 million of savings and this is a fact and has been checked by PwC (auditors). He invited us to check this.

He also explained that we were criticising the choice of LOBO loans with the benefit of "20/20" hindsight. The real test should be what a "Reasonable person" looking at financial forecasts at the time would have expected interest rates to be. At the time the Bank of England was predicting interest rates (in the short term) to rise. No one anticipated the fall in interest rates that has since taken place. In terms of financial modelling, you should look at previous recessions and there has been nothing comparable has happened in previous recessions except for 1929-1935. The key issue is that they took out fixed rate loans based on reasonable forecasts at the time. If he had a time machine and could have anticipated the collapse in interest rates we would have made different decisions. If we could dig out a different economic forecast he would listen to our argument so he challenged us to "Put Up or Shut Up".

Unfortunately neither myself or Cllr Whitworth was able to respond to his points so I thought I would take up his challenge and say what I would have said if I had the chance.

The key issue about the £64 million savings (I will as invited be contacting PwC for them to confirm this calculation) is not that we "paid off" early some expensive loans and took out newer "cheaper" loans but that instead of taking out the safer and transparent loans from the Government (called PWLB) we took out inherently risky derivative based loans (called LOBOs) from British and Foreign Banks? Also why did we put all our eggs in one basket and take out all "fixed rate" (not that LOBOs have turned out to be "fixed") loans instead of a prudent mixture of floating and fixed loans?

Why did we take out loans for up to 70 years that did not protect us against falling interest rates but allows the Banks to raise rates if the market rate rises?

With regard to the argument about "hindsight". The Bank of England and other forecasters report "market expectations" and not "predictions". All forecasts are educated guesses to a greater or less degree. No one really knows what interest rates will be in the future. The real "reasonable person test" is "what will happen if it all goes wrong" and interest rates do not go the way we think.

Robert Carver an ex Hedge fund manager and derivatives trader who used to work for Barclay's points out "Seventy years ago it was 1945. Who then could have predicted that (bank base) rates would go from 2%, to 17% in the late 1970's, then back down to 0.5%?!"

He also reminds us of Robert Citron, treasurer of Orange Country California on making a prediction that interest rates wouldn't rise. A few months later Orange County was bankrupt after losing $1.6 billion on interest rate derivatives). "I am one of the largest investors in America. I know these things."

I will also respond to the comments made by the Mayor at the meeting.

Hat tip Nick Dunbar and Joel Benjamin.

LOBOs. Cllr Whitworth's Response to Newham Council’s Annual Treasury Management Report 2014/15

This is the concerns expressed by Cllr John Whitworth during the discussion on item 14 at Monday evening (7.12.15) at Full Council. 

"The issue of the servicing and repayment of the Council’s debt is obviously of major importance at a time when we are obliged to make savings in most areas because of the progressive reduction in government funding.

In the Annual Treasury Management Report 2014/15 in Appendix 4 p.76 we have the statement in bold type that: “It is estimated that the Council’s prudent borrowing decisions generated £64m of savings to our debt portfolio since 2002”.

The state of the borrowing is shown on p.75, which indicates that the Council has a debt portfolio of Public Works Loan Board (PWLB) loans totalling £63.5 million and Lender Option Borrow Option (LOBO) loans totalling £563.5 million. This suggests that the Council’s savings are due for the most part to the taking out of very large LOBO loans.

However, the benefit of LOBO loans to local authority borrowers was called into question by the Channel 4 Dispatches programme on 6th July - to the point that the House of Commons Communities and Local Government Select Committee called in the Dispatches reporter and two experts on derivatives and hedging to give evidence at its meeting of 20th July. All three witnesses were of the view that under most circumstances borrowers did not benefit from taking out LOBO loans.

Financial journalist, Nick Dunbar has done a study of our LOBO loans using the Bloomberg terminal and concluded that: “By choosing to borrow from Barclays, RBS and other banks rather than from the government, Newham actually lost £10 million since 2002, using prevailing rates on PWLB debt” (http://nickdunbar.net/ Newham’s broken crystal ball). In other words, he says we have paid £10 million more since 2002 by taking out our LOBO loans than we would have if we had borrowed the same amount in PWLB loans.

I therefore suggest that, given the doubt cast upon the Council’s estimation, it should be re-examined to verify whether money is actually being saved by owing this large amount inLOBO loans and - if it is found that money is really being lost - then measures should be taken to try to remedy the situation".

I will post my contribution later.