The UK Municipal Bonds Agency borrows money, primarily in the capital markets, to lend to local authorities. The UK Municipal Bonds Agency is not a bank and will only borrow to fund loans it has already agreed to provide.
The UKMBA has three lending programmes:
For all loans with a maturity greater than one year, an authority will be required to enter into the UK Municipal Bonds Agency’s Framework Agreement, although those authorities borrowing on a standalone basis are not required to enter into the proportional guarantee.
To enable local authorities to enter into short term loans without needing to follow lengthy governance processes, the UKMBA will use a separate loan agreement for those loans.
Any local authority wishing to borrow for the medium-term and long-term through the UK Municipal Bonds Agency is required to enter into the UK Municipal Bonds Agency’s Framework Agreement. This legal document forms a contract between each local authority and the UK Municipal Bonds Agency. It comprises:
In most cases, it is anticipated that the executive and full council will approve an authority’s entry into the Framework Agreement.
The UK Municipal Bonds Agency will use one or more Special Purpose Vehicles (“SPV”) to issue its bonds. Doing so eliminates the UK Municipal Bonds Agency from the credit structure enabling it to operate with limited capital.
Credit quality is at the heart of all debt financing and the interests of the UK Municipal Bonds Agency, local authorities and investors are all aligned towards ensuring that the UK Municipal Bonds Agency maintains a rigorous and smart credit process.
The UKMBA will undertake its own credit ratings of the borrowers and will exclude those whom it believes either do not have the necessary credit standing or whose business model, particularly level of commercial property investment and attendant debt, are deemed excessive.
The UK Municipal Bonds Agency uses a proprietary credit methodology that is built upon those used by the major credit rating agencies, particularly that of Moody’s. The process is based on four key elements:
These elements are combined to calculate a credit score for each borrower. The score that is required for a local authority to be eligible to borrow through the UK Municipal Bonds Agency is set by the Board and periodically reviewed. In addition, there are a series of “red lines” that should they be crossed by a local authority, automatically mean that a local authority will not be able to borrow e.g. if the accounts of a local authority are qualified.
More information on the credit process can be found here.
Concentration limits are used to cap the proportion of the pooled loans that can be lent to a single local authority. This ensures that if a local authority were to default, the exposure of other borrowers under the contributions mechanism and the proportional guarantee is capped. The limits are set as a percentage of the total loan book. The concentration limits are decided by the Board of Directors and will reduce as the volume of pooled loans grows.
Each year, for a variety of reasons, a small number of local authorities are late paying their debts and other bills. In order to prevent non-payment triggering a default and call on the proportional guarantee, the contributions mechanism provides funds to the UK Municipal Bonds Agency, if it cannot cover non-payment of interest or principal owed to it from its own resources or credit lines.
Under the mechanism, if a local authority fails to make a payment and it cannot be quickly rectified, the other local authority borrowers are required to lend money to the UK Municipal Bonds Agency pro-rata to their share of the loan pool. For example, if an authority’s borrowing totals 1 per cent of the pool following non-payment by another local authority, it will be required to lend the UK Municipal Bonds Agency 1 per cent of the default. Interest will be payable on the loans.
The amount a borrower is liable to lend under the contributions mechanism is subject to a cash limit equal to the total amount borrowed by the council. This puts a ceiling on the liability of a council if there were a significant number of defaults by local authorities.
To borrow through the pooled loan programme, local authorities are required to give a guarantee to the UK Municipal Bonds Agency’s bond holders and lenders that fund the loans. The guarantee is proportional and several:
No UK local authority has ever defaulted on a loan. This dates back to the granting of a Royal Charter to the Corporation of London in 1067.
The proportional guarantee is in favour of those providing finance to the UK Municipal Bonds Agency and its Special Purpose Vehicles. The guarantee does not cover any other expenditure of the UK Municipal Bonds Agency or its Special Purpose Vehicles i.e. running costs such as salaries, service charges and rents are not covered by the proportional guarantee.
The proportional guarantee is markedly different to that previously required by the UK Municipal Bonds Agency and as set out in its business case:
The proportional guarantee is “unconditional” and “irrevocable”. This means:
For medium- and long-term loans, it will take 6-8 weeks to complete the first three pooled bond issues from the point there is sufficient demand for loans to support a benchmark bond of £250 million. This is to allow the credit rating agencies sufficient time to confirm the credit rating of the bonds. Thereafter, the time needed to issue a pooled bond will progressively shorten. In time,
The time necessary for a standalone bond will vary and depending upon whether or not an authority has an existing credit rating. For those authorities with a credit rating, it will take 2-4 weeks to issue a bond and for those without, 6-8 weeks because it will take the credit rating agencies up to 6 weeks to undertake their initial credit assessment.
For short term loans funded by the commercial paper programme, it is anticipated that it will initially take up to three weeks to undertake the issues due to local authorities needing to approve the loan agreement.