Lender option borrower option


Lender option borrower option or lender's option borrower's option is a long term borrowing instrument available in the United Kingdom. They involve periodic interest re-fixings, which incorporates two linked options:
They are provided by banks and the loan contract runs for between 40 and 70 years. There is no regulatory body responsible for overseeing their use.

Origins

Public bodies used to be only able to borrow money through government Public Works Loan Board loans. However borrowing from banks in the form of LOBOs was permitted from the early 2000s. A certain amount of borrowing from banks had been permitted since the late 1970s; these were typically for 5-10 years and £1-10 million, and involved rates being re-fixed at - typically - 3-month intervals. At this time, it was often the case that a loan might involve a borrower's or a lender's option, with the embedding of these dependent on prevailing interest rates and the council's own needs at the time. Such BOs or LOs might offer early repayment, or changes in the margin or rate-fixing frequency. LOBOs existed at this time too, and offered the borrower a chance to repay at no penalty if the lender's choice of new terms was unacceptable; rarer were rather more flexible sequences like BOLOs or BOLOBOs. These all rather faded from use in the late 1980s - early 1990s, and were replaced by "straight" fixed-rate term loans. Modern, more complicated LOBOs were made available with low teaser rates, cheaper than PWLB loans so they appeared to be an attractive alternative. Few councils had access to the complex option valuation models required, nor the market data needed as inputs for such models.

Criticism

LOBOs have provoked criticism because of high initial profits to the lender from day one and high subsequent interest rates. Clive Betts, MP and chairman of the Communities and Local Government Committee, has called for an inquiry into ‘outrageous’ LOBO loans. These criticisms have been refuted by some of the borrowers.

Local councils

Banks, such as Barclays and Royal Bank of Scotland, provide LOBO loans to about 240 UK councils with a total value of £15 billion. Out of this £15 billion it is estimated that about £1 billion in upfront profits was made by the lenders. LOBOs are currently almost a fifth of all council borrowing.
LOBOs were recommended to councils by specialist financial advisers who, unknown to the council, were in turn paid commission by the banks providing the LOBOs.
At least 12 councils have the most expensive types of LOBO loan. Most of these have "inverse floaters" taken out with RBS - interest rates for the loan are increased if general bank lending rates decrease.
As a direct consequence of making repayments on LOBOs, councils have had to make major cuts in services to their residents. It has been calculated that if councils were free to relinquish their LOBO contracts at no penalty and instead borrow at a more typical market rate it would save them about £145 million for 2015 alone. Some councils are considering taking legal action.
Some residents of councils with large LOBO loan books have requested that auditors take their council to court under provisions in the Audit Commission Act. Newham resident and Green Party spokesperson Rachel Collinson was the first to do so, requesting the then auditor of Newham Council's accounts, PwC, to declare the spending on LOBO loans to be ultra vires, or technically illegal, being beyond the council's powers. This is because LOBOs are packaged derivatives, complex financial products that councils are not permitted to purchase. The precedent for this was set in the court case against Hammersmith and Fulham in 1992.

Examples

Up to 30 housing associations have bought up to a total of £1.25 billion of LOBOs.