LOBO stands for Lender Option Borrower Option and it is a type of long term loan provided by the private sector.
LOBO loans are typically very long-term – for example 40 to 70 years. The interest rate is initially fixed, but the lender has the “option” to propose or impose, on pre-determined future dates, such as every 5 years, a new fixed rate. The borrower has the ”option” to either accept the new rate or repay the entire loan. The starting interest rate of a LOBO loan is usually quite low, designed to undercut PWLB loan rates, and is known as a “teaser rate”.
Due to the complexity and ‘optionality’ of the contracts, the overall interest rate of the loan is difficult to price over the long term, without sophisticated pricing tools that the majority of Local Authorities will not have direct access to.
As ex Barclays Capital employee Rob Carver reflects: “You just need a Bermudan swaption pricer to know the relevant volatility surface, some kind of interest rate model calibrated to the appropriate processes and the full forward and spot curve” – not the things the average Mr Perkins in a council finance department has to hand.
Analysis of LOBO loan contracts shows that some Councils are facing 7-9 % interest rates, which is twice the current rate of lending at the PWLB.
With LOBOs, Local Authorities are replacing safe fixed rate 50-year loans from Central Government with new variable rate loans that could end in 5 years time and need to be repaid in full. This creates a significant refinancing risk for Council that could have drastic effects in the present context of recent austerity cuts.