James Sullivan imageWith global debt creeping towards $250 trillion, it is at a level that, to be understated, raises a few eyebrows. We must acknowledge however, that for the time being, the cost of servicing such debt remains remarkably low. For context, the US alone represents about $70 trillion of that debt, with US government debt alone equal to circa 100% of GDP. We’ll come back to that ratio later.

Let’s imagine for one moment that the cost of that debt jumped overnight unexpectedly by 100bps (1%). We have no doubt it would send shockwaves through the debt market, and in turn, the equity market. It would also signal that policymakers were concerned that the quantum of debt in the system was too fast and loose.

Well, that’s precisely what happened last month when the Public Works Loan Board (PWLB) moved rates from 1.81% to 2.82%. The PWLB is a government body whose function is to ‘lend money to local authorities’.

Councils throughout England have amassed huge debts by drawing down cheap finance from the PWLB and invested in real estate projects to supplement their income following cuts in government funding. Loans are covenant light and there is no limit to how much a council can borrow, or indeed justify affordability.

In recent years, the number of councils investing in real estate has doubled, with a total spend of £1.8bn in the last financial year alone. Property agents Carter Jonas highlighted that Councils spent £2.3bn on office buildings between 2013-17 and a further £1.5bn on retail property, which took total cumulative spend beyond £10bn.

Spelthorne Borough Council are a case in point. They don’t shy away from the fact they are reliant on investment income to fund its services, and has to date borrowed £1bn from the PWLB in spite of having a net annual budget of just £22m. It makes the US government debt to GDP ratio of 100% appear somewhat conservative. The Council has stated that “commercial investments are currently valued at £933m” with the flagship deal being a £360m purchase of a business park in Sunbury-on-Thames. It’s remarkable to learn that Spelthorne had no debt whatsoever just 3 years ago.

Numerous examples also exist of councils buying up assets outside of their boroughs, with Surrey Council alone reporting that 80% of their investments are outside the county. Isle of Wight Council paid £11m for an industrial estate in Salford Quays and Torbay Council paid £32m for a warehouse in Oxfordshire.

Despite the Government stating that “it is unlawful to borrow with the sole purpose of investing at a profit and without any spending objective”, parallels could be drawn with the 2008-09 Financial Crisis where Councils had leveraged up to deposit almost £1bn with Icelandic banks in pursuit of enhanced returns.

In isolation, we find this all pretty alarming, however it was compounded when we recently met with a real estate fund manager. The manager chose his words carefully, but suggested that Councils had been overpaying for assets, and had been used as a source of liquidity by more astute real estate managers looking to offload non-core assets.

So the executive summary could be that we have a situation where many Councils in England are hugely indebted at a time when borrowing costs are going higher, backed by an investment portfolio of real estate assets that the private sector doesn’t want.

One of the many quotes attributed to Warren Buffet was ‘Only when the tide goes out do you discover who was swimming naked’. Whether English Councils are naked when the debt tide turns, remains to be seen.

With thanks to the team at The Bureau of Investigative Journalism

 

Address

MitonOptimal UK Limited
Royal Mead
Railway Place
Bath
BA1 1SR
UK

Phone

t: +44 (0) 1225 632 250
f: +44 (0) 1225 439 442

Regulatory Information

MitonOptimal UK Limited is part of the MitonOptimal group of companies. Registered in England and Wales No. 09138865. Authorised and regulated by the Financial Conduct Authority.

Send this to a friend

Terms & Conditions

TERMS & CONDITIONS

By using or accessing any part of our website, aside from the Terms and Conditions page, you agree to be legally bound by those terms and conditions. We may amend these terms and conditions at any time without notice. Your continued use of our website following any change will constitute your acceptance of such change. Our full terms and conditions can be found at https://www.mitonoptimal.com/uk/terms-conditions/

Regulatory Information

The MitonOptimal Group (“MitonOptimal”) of companies is authorised and regulated in their respective jurisdictions, as required by law. For further details, you may visit the regional sites via https://www.mitonoptimal.com.

MitonOptimal UK Limited is part of the MitonOptimal group of companies. MitonOptimal UK Limited is registered in England and Wales No. 09138865. Authorised and regulated by the Financial Conduct Authority.

Risk Warning

Potential investors should be aware that our models and funds may make investments in equities, bonds, cash, commodities alternative strategies and commercial property. Investors should be aware that there is no guarantee that investments will go up.  Past performance is no guide as to future performance. As the price of units and the amount of income distributed or accumulated may go down as well as up, the Manager has no obligation to redeem units at the subscription price originally paid. If you are in any doubt about the content of these terms and conditions, you should not enter the site and consult your stockbroker, bank manager, solicitor, accountant or professional investment advisors.

If you have any questions or concerns about our website please email us at [email protected].

Please indicate below, whether you accept/do not accept our terms and conditions of use.