Lost Lobos

Municipal Finance

24 October 2014
By Nick Dunbar

For as long as most people can remember, UK municipal finance has been safe and boring. In the wild days of the 1980s, Hammersmith & Fulham council almost went bust speculating in derivatives, and was saved by a landmark House of Lords ruling. Since then, UK council borrowing has been tightly constrained by central government while derivative use has been banned.

Then again, the finance industry loves to innovate around regulation. It turns out that UK local authorities are still involved in derivatives after all. Many years ago, bankers found a way of embedding the pesky contracts inside perfectly legal loans, using so-called lender’s option borrower’s option (LOBO) agreements. These bank loans attracted councils because they offered a cheaper rate than offered by central government.

Lost Lobos Part 2

When I was in my twenties, I worked on a film being shot on location in the London borough of Newham. The film itself, which starred Jude Law and Sadie Frost, was forgettable, but one memory that stayed with me was the all-pervading smell of refined sugar from the nearby Tate & Lyle factory by the river Thames.Continue Reading

Newham’s cracked crystal ball

Between July 2007 and November 2008, Newham council entered into 10 range LOBO loans with Barclays worth a total of £238.5 million. New information on the council's controversial loan portfolio shows the impact of its relationship with Barclays, raising questions about risk management decisions.Continue Reading

How Newham came unstuck with inverse floaters

In my research for Channel 4 Dispatches, I broke through Newham council's wall of secrecy and learned that the council had at least £150 million of inverse floater LOBOs (believed to be with Royal Bank of Scotland), along with other councils such as Cornwall, Edinburgh and Newcastle that disclosed these RBS products in response to Freedom of Information requests. As discussed on the programme, these loans involve councils paying a variable coupon which goes up when market rates go down - coupons that recently have gone above 7 per cent. To understand these products, I priced a £25m Newham deal on a Bloomberg terminal, which allows the underlying cash flows to be modelled - from today until 50 years in the future. This is important because the concept of fair value involves combining all of a loan's future cash flows into a single number.