So how does a City Council suffering from acute spending cuts borrow £280 million?
Since 2004, major local authorities have been able to borrow (mainly for capital projects) without government consent, provided they can afford the borrowing costs, a limit defined by “prudential” borrowing guidelines. Put simply if a council met the guidelines then it could determine which capital projects it could invest in without reference to anyone else.
The loans were administered through an ancient body formed in 1793 (I kid you not), the Public Works Loans Board. This body (under the guidance of 12 unpaid parliamentarians) had, and has, no say in whether the loan is sensible or not, it’s a purely administrative function. Its function has been consumed in recent times by the Treasury, but even as the consultation papers on its abolition stated, this would have no discernible effect on councils’ ability to borrow subject to the guidelines.
Thus, particularly in recent times, councils have been using this facility to buy income generating assets to assist in meeting budget shortfalls. The reason they can do this, is that the lending rates of the PWLB are extraordinarily cheap. Without being too technical the borrowing rates are linked to the rates paid by the Government on its debt. In a very low interest rate environment such as now, that means councils can lock into very low fixed rates over long periods of time.
Low cost of debt
For example, Liverpool City Council could today (Thursday 18 January 2017) borrow £280,000,000 for a capital project, repayable over 25 years at 2.54% (source: UK Debt Management Office).
The Government secures the repayment against the future central government funding of the council, not the actual asset that the council is acquiring (usually a large commercial property).
The situation with Everton
As is widely known Mayor Joe Anderson is proposing that Liverpool City Council funds a large proportion (2/3rds according to Robert Elstone, CEO of Everton) of the cost of Everton’s new stadium at Bramley Moore.
In return for security over the income (and I suspect the assets) of the club, the Council would lend Everton the £280,000,000 it borrows from the PWLB.
As Joe Anderson explained last week, the repayments Everton make on the loan would create a £7 million profit a year for the council to spend on essential public services.
As a result of this it is possible to calculate the implied rate of borrowing and the annual repayment amounts charged by the Council to Everton.
Borrowing £280 million at 2.54%, repayable over 25 years would require the Council to repay the Government fixed annual payments of £15.192 million.
In a simplified calculation (there are likely to be other costs for administration and monitoring) adding £7 million to this amount gives annual repayments by Everton to the Council of £22.192 million.
From this it is possible to calculate the implied interest rate (or cost of borrowing) for Everton.
That figure is 6.25%
The benefits for the Council are very clear, at minimal risk they have £7 million additional funding to pay for essential services across the city of Liverpool.
However, does 6.25% represent a good deal for Everton?
It’s certainly affordable based on projected turnover in the future and capacity or near capacity crowds at Bramley Moore. Indeed a 60,000 seat stadium, full for 19 games a season would produce more revenue after financing and running costs than Goodison does currently.
It is extremely difficult to find comparisons given the size and length of the deal, and the fact that Everton are a private limited company.
The most immediate thought would be to look at Spurs. They’re paying a substantially lower rate of between 2.75 and 3.5% (not fixed, based on current short term interest rates) and that deal is only in place for 5 years. It also represents a smaller proportion of the overall funding required than the Everton deal. However, they will have to renegotiate within this period, perhaps looking at longer term finance in the form of a bond issue (similar to Arsenal).
Arsenal’s long-term debt associated with their stadium build now stands at approximately £190 million. The fixed rate debt (£140 million) is the most comparable to the debt proposed by the City Council, and Arsenal’s rate is 5.148%.
Although not uncommon, it is interesting that Arsenal must keep approximately £35 million on deposit to safeguard against their inability to pay interest and capital repayments. Of course, it is well documented that Arsenal carry significant cash reserves making their net debt almost insignificant. However as with Everton when Moshiri repaid the long-term Prudential loan, it is assumed that there are significant early repayment penalties – hence the continued existence of the debt.
In the terms proposed for the initial guarantee deal last March, Everton would have had to hold significant cash reserves for similar reasons, although perhaps only in the early years, the details were not specified. It is reasonable to assume similar terms would be in place in the loan agreement.
A deal to suit both parties?
On balance, assuming the cost of borrowing is not greater (or significantly greater) than borrowing from commercial lenders, the deal as proposed seems to suit both parties.
As we spoke on our podcast #EvertonBusinessMatters there’s a lot to be said for making loan repayments that fund local services indirectly through increasing the Council’s income. In positioning terms it cements Everton’s stature within the city. A scheme of this sort combined with the legacy project at Goodison and the other significant EITC projects demonstrate real commitment to the City of Liverpool and its citizens. It would be a unique representation of the bond and co-dependence between both, and something which would differentiate our club from all others, locally and nationally in many ways.
If as seems the case, the proposed scheme matches the commercial test in terms of pricing, then that and the benefits above make the arrangement highly attractive, enabling the stadium to be built (alongside the funding power of Moshiri, as it appears he will meet the balance) to the benefit of the club.
That combined with a return to excellence on the pitch, and the odd trophy would be truly the embodiment of NSNSO……