In the light of the recent North Tyneside PFI Housing Project, Paul McDermott looks at the scope for the public sector to use bond finance for long term capital projects.
North Tyneside Council and Solutions 4 North Tyneside have entered into a PFI Agreement for the delivery of some 600 new homes and 300 refurbished homes for older people in the Borough. This is one of the largest programmes of new council house building since the early 1980s and will ensure that older people in the Borough are able to enjoy modern, decent homes which are suited to 21st century living.
The North Tyneside project represents more than a nostalgic footnote to the completion of one of the last housing PFI schemes. The use of bond finance (as opposed to the more traditional bank debt) is being used or actively considered for a range of public and local authority capital projects. This together with the recent use of bond finance for PFI schemes in Leeds and Manchester heralds a possible new dawn for public sector bonds in England.
The bond finance option for public sector long term capital projects is being stimulated by a number of converging factors. The banking sector with its well-known tribulations and its requirement for each bank to build up its capital means that this sector is increasingly reluctant to lend significant sums for long term capital projects. This has resulted in the lack of availability of the type of lending which since the 1990s fuelled public sector PFI and PPP projects.
Local authorities before the public spending cuts were able to rely on PFI credits and other central government support are also adapting to self-funding capital projects. Many local authorities have significant "head room" to borrow under the prudential finance system and they are having to consider new methods for financing social and community infrastructure. The goal is projects which provide an independent income stream which helps to support the delivery of a public facility.
The new era of self-financing and local innovation has raised concerns within the local government sector that the public sector's favourite lender, the Public Works Loan Board, will either not be able to satisfy increasing demand or even that HM Treasury will cap the amount available for it to lend. A number of local authority finance directors I have recently spoken with are planning for this eventuality by adopting borrowing strategies which assume they will borrow at least some of their authority's requirements from the market.
The banking sector's reluctance to lend for long term capital projects has therefore ushered in bond finance as a possible alternative funding option. This helps to explains why the Local Government Association, as well as a number of local authority consortia, have begun to examine how local authorities (whether individually or consortia) could access bond finance as their North American counterparts regularly do. This approach is not entirely new, before the 1980s English local authorities did extensively use bond issues and finance to fund capital projects.
For those new to bond finance it is in essence the issue of a commitment to repay capital (or more plainly IOUs) by the end of a set repayment period with a commitment to make interest payments on that capital. This provides an acceptable repayment profile for public capital projects. These IOUs can be traded between investors. Generally bond issues are listed on a recognised stock exchange, the bond for North Tyneside project has for instance, been issued on the Irish Stock Exchange. Prior to issue it is necessary for each bond to be rated, this indicates its attractiveness to potential investors. The higher the rating the lower the return investor will require for a 'safer' investment.