Councils ‘building up dangerous levels of debt and risk by investing in commercial ventures’

Credit agencies warn that borrowing to invest in such projects exposes local authorities to additional risk

Newham Town Hall

Cash-strapped local councils are building up dangerous levels of risk and debt as they turn to commercial ventures in a bid to raise funds, credit agencies and campaigners have warned.

Moody’s, the credit agency, warned that a series of ambitious plans to boost revenue by setting up businesses could put council tax payers at risk should they run into difficulties.

The warning, in a report into local government finance, comes amid mounting evidence that local authorities are increasingly turning to borrowing after a run of tough settlements with central Government.

Roshana Arasaratnam, a senior credit officer at Moody’s, said in the wake of the report’s publication: “Borrowing to invest in commercial projects exposes local authorities to additional credit risk, as the revenues that flow from these projects are inherently uncertain.

“Those adopting this strategy also face increased project execution risk, and greater competition from the private sector.”

Ms Arasaratnam said such borrowing contrasted sharply with local authorities’ traditional investments in schools, housing and transport which are underpinned by government grants and do not depend on generating revenues from commercial activities.

The report highlights a series of business ventures set up by councils, some of which are now on negative credit watch.

They include Warrington Borough Council, which in 2015 issued £150m of bonds to support an economic development plan aimed at increasing business rate revenues.

Its credit rating is on negative outlook.

Meanwhile, the London Borough of Newham has set up a housing company focused on the private rentals market, while Guildford Borough Council is investing in commercial properties to diversify its income. Moody’s also has its borrowings on negative outlook.

“Moody’s expects an adverse impact on the credit profile of these individual local authorities,” the agency warned.

Councils’ attempts to make money have become increasingly controversial in recent years. They have been exacerbated by the Government’s austerity policies, which have left them scrambling for new sources of revenue and seeking higher returns on their cash reserves.

Dozens of them deposited millions of pounds with Icesave, the Icelandic savings bank, in pursuit of higher interest rates before its collapse in 2008.

Concerns have also been raised about the use of so-called Lobo loans. Last month Barclays became the first bank to cancel about £8bn worth by turning them into fixed-rate loans at a cost of £182m. The move came in the wake of investigations by The Independent and London Evening Standard into their use by a number of local authorities.

Lobo loans allow banks to refix interest rates, leaving borrowers with a Hobson’s choice of either accepting the new rates or paying back the debt along with potentially huge exit fees.

Joel Benjamin, a campaigner on local government finance, said: “We have all seen how speculative investment works out for taxpayers with the Icelandic banking crash and Lobo loan fiasco – and so it will prove this time. The City will reap the profits, while taxpayers and councils will be left to count the costs.

“It appears – councils are being forced by cuts to burn the candle at both ends, spending existing cash reserves, while engaging in a borrowing binge to try and maximise income from the likes of property development and speculation, lumping further risk on local residents with scant regard for the social sustainability of this borrowing if things go wrong.”

Mr Benjamin said council finance officers could face jail terms when things go wrong, but added: “The blame should be levelled at Eric Pickles, George Osborne and David Cameron, whose scorched earth cuts to council funding and services left town halls with no other option but to turn their Treasury department into a profit-making casino to fill the black hole in council budgets.”

The Local Government Association also blamed funding cuts for councils having to look to commercial ventures to fill the gap.

“Councils have experienced a 40 per cent reduction in core central government funding over the last Parliament and are having to continuously look for new ways to generate revenue; this includes taking a more commercial approach to investment decisions. Councils have to adhere to strict rules and assessments before making a decision to borrow under the prudential borrowing system to ensure it is affordable,” it said in a statement.

Earlier this month Room 151, a news service for council finance chiefs, highlighted increased levels of borrowing from the Public Works Loan Board which provides financing for capital projects. It said that £249.6m was borrowed in August, almost twice the £133m taken out in August 2015. During the run up to the EU referendum, however, councils took out £1.3bn in loans.

A Department for Communities and Local Government spokesman said: “Local authorities have a duty to be responsible with taxpayers’ money, and our guidance is clear that the security of any investment must be paramount.

“Councils will have nearly £200 billion to spend over this Parliament, and should be able to manage their budgets to meet the needs of the people they serve.”