Government consults on how to stop councils using Public Works Loan Board loans for commercial property investment

The government has launched a consultation this month on the development of a targeted intervention designed to stop ‘debt for yield’ activity where local authorities use low-cost loans from the Public Loans Works Board (PWLB) to buy investment property primarily for rental income.

The consultation document issued by HM Treasury, Public Loans Works Board: future lending terms, said: “Local authorities have long owned buildings that could serve a commercial purpose, and they often use commercial structures to advance their core role in delivering public services, housing, and regeneration to the benefit of citizens and taxpayers. The government is committed to continuing to support this valuable investment.

“However, a recent report by the National Audit Office highlights how a minority of local authorities have started using low-cost loans from the Public Works Loan Board (a public body that lends to local authorities for capital projects) to buy investment property primarily for rental income.”

The consultation acknowledged that the case for this ‘debt-for-yield’ activity could be compelling for the individual local authority.

But it warned that it introduced risks locally and nationally. “At the local level, it exposes ratepayers to the risk that the income does not materialise, leaving the local authority with an inflexible commitment to keep up with the repayments on their loans. Within the wider public sector, it diverts money from core services such as schools, hospitals, and roads. And, because local authorities can often access debt more cheaply than the private sector, it becomes hard for businesses to compete. In the wider economy, it could crowd out public investment, and risks distorting property markets.”

The Treasury said it wanted to stop this activity while protecting the work that local government does on service delivery, housing, and regeneration.

It insisted that the government’s overall aim in this was “to secure the effective operation of the prudential system for local councils, taxpayers and for all of us that rely on local services”.

The Treasury said it would work with the sector through the consultation and a series of regional workshops to develop a solution that resolves the debt-for-yield issue without impinging on the wider freedoms of the sector. As a starting point, the government proposes:

1. requiring local authorities that wish to access the PWLB to confirm that they do not plan to buy investment assets primarily for yield;
2. publishing guidance defining the activity that the PWLB will no longer support, “with clear protections for service delivery, regeneration, housing, and the refinancing of existing debt”;
3. standardising the information currently gathered through the application process for the PWLB Certainty Rate and using this as the primary way to confirm with local authorities that their plans conform with the guidance.

The consultation said that local authorities that wished to buy investment assets primarily for yield would remain free to do so but would not be able to take out new loans from the PWLB in the year in which they have bought the asset. Any loans taken out under the old system would not be affected by this change.

The Treasury said the change was only intended to apply to capital spending – treasury management strategies were not affected.

It will also only apply to larger authorities in England, Scotland, and Wales. The government does not propose any change to the PWLB lending arrangements for smaller local authorities – used here to mean parishes, town and community councils, and drainage boards – “as the debt-for-yield issue seems to be limited to larger authorities”.

The consultation confirmed that the government intends to lower the interest rate on new PWLB loans, subject to market conditions, once a new system can be introduced to address the debt-for-yield issue.

The Ministry of Housing, Communities and Local Government is meanwhile planning to undertake a project of work to improve its understanding of borrowing and investment activity. “This will be done through a planned review which will explore what additional data can be collected in order to develop a more comprehensive understanding of LA borrowing and investment activity. This work will form an evidence base which can be used, in consultation with the sector and working with HM Treasury, to gather further evidence about the wider functioning of the prudential framework.”

The consultation will run for twelve weeks, ending on 4 June 2020.