By Angele Spiteri Paris
With the first issue from the Municipal Bond Agency (MBA) expected in March or April 2015, pension funds in the UK have the opportunity to invest in this burgeoning market which should provide them with the stability of sovereign bonds, while offering higher yields.
The market for municipal bonds in the UK is still growing and the paper issued by the MBA could mark a revolutionary turning point. Being in this nascent phase, the UK market can also benefit from the lessons learnt by other countries.
According to Paul Mansour, head of municipal research at Conning, one factor issuing bodies in the UK should keep high on their agenda is disclosure to investors. “One of the pitfalls that hold back value in the US municipal bond market is many issuing entities, such as school districts and municipalities, don’t necessarily have easily accessible financial information and undeveloped channels to deal with investor queries,” he says.
Mansour also explains the system in the US is very decentralised, adding: “If there was a central body administering the bond issues then there would be a better flow of information and, in turn, make investment in these instruments more attractive to pension funds.”
In this context therefore, the setting up of the MBA puts the UK on the right track. The Local Government Association (LGA) began building a case for the agency to be set up in January 2012. This came after the Public Work Loans Board (PWLB), where local authorities borrow the majority of their money, began charging a margin over gilts of 100 basis points on all loans.
The LGA identified “such an agency could reduce the funding costs of local authorities to 70 to 80bps above gilts”. The PWLB lending rates have since been reduced, but the LGA believes in the need for the MBA having appointed advisers in January 2014 to review the original business case.
Aidan Brady, lead adviser in this business case review and interim managing director of the Local Capital Finance Company, says: “The March or April issue will be the first in a number of regular issues we have planned.”
Referring to how the UK market compares to the US, Brady says: “In the UK, there are a few authorities issuing their own bonds, such as Transport for London (TfL) and the Greater London Authority, but having regular issues is a challenge for single entities.”
In fact, the last reported issue from TfL was in September 2013 for £300m. These 20-year bonds paid a 4% coupon and offered a 4% yield. On announcing one of its bond issues, TfL finance spokesman Guy Senior said: “This is an innovative and radical approach to raising funds that will enable us to make sizeable long-term savings on the current subsidy arrangements. “This is likely to save us something in the region of £6.4m to £10m over that period. This extra money will then be available to fund additional investment in our housing stock and improving local housing estates.”
At present, the MBA will be issuing bonds in its own rights and lending that money out to the local authorities. “It will take a while to build up to the whole volume… Eventually we would like to build a platform to allow individual authorities to issue their own bonds,” Brady says.
The target number of local authorities the MBA is aiming for is not public information, but to put the potential into context, there are 433 principal authorities in the UK. Having a central issuing body like the MBA can ease the flow of information for investors, however certain criteria that could impact the risk and the yield of the bonds issues should be taken into consideration.
Mansour at Conning says: “Certain questions may be asked of a central issuing body. For example, what happens if the local authority borrowers within the agency change? To make sure this is not detrimental to the investors in the bonds, such an agency should have clear guidelines and the new borrowers they expect to enter.”
In reaction to this, Brady says: “As the agency develops, we should have an increased diversification of borrowers, so if anything the relative risk should reduce. Nevertheless, we will have a credit process in place which would aim to mitigate the risk of taking on lower quality credits.” Having a central body issuing municipal bonds on behalf of local authorities also eliminates a potential conflict of interest. If a local authority were to issue a bond, then having its pension fund invest in that bond creates a potentially challenging situation.
“A local authority pension fund buying agency -issued bonds does not directly link the fund to the local authority,” Brady explains. The MBA expects to receive a public rating for its bonds between January and March 2015 and Brady is confident this will reflect the ratings of the underlying borrowers: the local authorities.
“The statutory framework and prudential code that govern local authorities are very strong, for example, local authorities can only borrow for capital or refinancing purposes. Furthermore, no local authority ever defaulted which all point to a robust underlying credit,” says Brady.
The agency aims to issue bonds in benchmark sizes, i.e. £250m to £300m, making them more attractive to pension fund investors. Mansour gives additional reasons municipal bonds would be appealing to pension funds: “They offer exposure to a sub-sovereign rated instrument with a higher yield. The default rate is very low and there is a little less liquidity than in sovereign or corporate bonds, something longterm investors should be comfortable with.”
The appetite for getting this exposure appears to be growing among UK pension funds. Warwickshire County Council recently invested £30m into the Threadneedle UK Social Bond fund, with a further £10m committed over the next few months.
The issue of bonds by the MBA will give pension funds like Warwickshire and its peers the opportunity to make further investments to support local authority growth and development.
Comments