Blog: Granite City introduces fresh thinking with bond issue
Michael Watson, head of finance and projects group at Pinsent Masons, discusses an innovative approach by Aberdeen City Council to raising cash.
The economy of Aberdeen and the north east of Scotland has been sailing against sustained headwinds for more than two years now, with the lengthy Brent crude downturn hitting the region harder than most others in the country.
The city and shire’s reputation for innovation has been carved like granite over the 50 years’ lifetime of North Sea exploration, so it should come as no surprise that Aberdeen City Council introduced its own fresh thinking when arranging financing for the proposed £333 million Aberdeen Exhibition and Conference Centre, which will replace the existing facility at Bridge of Don.
The council took the somewhat unusual step of going to the bond market to attract the required funds, culminating in council leader Jenny Laing and finance convenor Willie Young being invited last month to perform the opening of the market at the London Stock Exchange, when the Bonds began trading.
In so doing, Aberdeen became one of the first councils to raise money this way, and the first Scottish local authority to obtain a credit rating, with Moody’s awarding an Aa2, just one notch below the UK as a whole. The sum raised was £370 million, which affords the council additional funds to support other activities which could include infrastructure projects, school and housing developments, and roads construction.
Traditionally, local authorities will borrow from the Public Works Loan Board, a well-established and cost-effective method of financing projects. However, the Aberdeen example is a model worthy of consideration by other councils and bodies with significant capital programmes, as a bond issue offers a number of advantages when it comes to funding big-ticket projects. It also evidences the potential for public bodies to diversify their sources of finance which in the current funding climate is a very sensible approach.
It’s not stretching things too far to suggest current market conditions present a once-in-a-generation opportunity, which offers forward-thinking public bodies the chance to raise money for capital projects at historically low levels of interest. Talk of a global ‘wall of capital’ and ‘dry powder’ may be the in-vogue jargon, but there is undoubtedly a surplus of funds, both globally and locally, looking for a home but frustrated by a deficit of attractive investment opportunities.
Low interest rates are forcing fund managers (on behalf of their investor clients) to seek out vehicles for capital preservation as opposed to capital growth, and such is the high demand for bonds which satisfy this need, that local authorities are able to borrow big sums very cheaply.
The fiscal case for such an approach is that government, both local and national, can be confident that by spending money that benefits consumers – users of infrastructure in this case – the increase in economic activity in their respective region should comfortably outweigh the cost of the debt. A bond issue can also be structured so that the lending is not project-specific, allowing councils to on-lend to support capital projects that they are ambitious to deliver as part of a regional focus.
For investors, this type of index-linked bond is hedged against inflation and offers greater security from dealing with a well-established public body, which is extremely unlikely to default. Indeed, the strength of Aberdeen’s credit rating by Moody’s took in to account that the risk was lowered due to the local authority’s proximity to national government – viewed in some regards as a de facto guarantor of debt issued.
It’s little wonder therefore that with these attributes, alongside the lure of a long-term income stream which is RPI protected at a time when we are in a near deflationary environment, that the council’s bond issue was over-subscribed.
Aberdeen City Council’s initiative received warm support from Scottish Government Finance Secretary Derek Mackay, who said: “Investment in infrastructure throughout the country is vital to Scotland’s future and this bond issue has the potential to support a number of key projects in Aberdeen in the years ahead. It is a funding mechanism which has great potential for wider use in Scotland.”
With such endorsements, it is a safe bet that other local authorities and devolved bodies across Scotland are, or should, be taking stock and exploring bond issues as a cost-effective, relatively-safe route to funding larger projects which will replace out-of-date infrastructure or bring forward new developments which add to, and secure, the long-term economic prosperity of their regions.