Estimates of levy for interest on legacy loans

10th May 2013

FSCS has received a number of questions as to how we calculate and estimate the potential future charges for interest in respect of the outstanding loans for the banking failures of 2008/9.  This interest is payable to HM Treasury in respect of loans taken out to fund compensation for the failures of Bradford & Bingley, Landsbanki (Icesave), Kaupthing Singer & Friedlander, Heritable and London Scottish.

Interest is paid annually, six months in arrears.  Therefore, the interest for the year ended 31 March 2013 becomes payable on 1 October 2013.  FSCS expects to raise a levy in the summer of 2013 in respect of these sums.  This will be apportioned based on the same deposit takers’ tariff data used to calculate the 2012/13 annual levy.

The loans are repayable by FSCS on 31 March 2016 for all failures except Bradford & Bingley which is repayable on 29 February 2024. Interest accrues on a daily basis, although it is charged each month based on a rate set at the end of the previous month.  Therefore, if there were a recovery during the month, the amount of principal would change and interest could be calculated on the two principal amounts for the relevant number of days.  Interest is charged on each outstanding loan at the higher of:

• LIBOR plus 100 basis points; and
• the relevant gilt rate published by the Debt Management Office.

LIBOR is calculated as the arithmetic mean of the 12 month GBP rate issued by the BBA for the last five business days of each month.

The relevant gilt rate is set on the last business day of each month, using the rate published by the UK Debt Management Office applicable to public sector lending from the National Loans Fund for a maturity as close as possible to the relevant loan. The NLF rates can be accessed here:  http://www.dmo.gov.uk/index.aspx?page=PWLB/NLF_Rates

The higher of the LIBOR and gilt rates is then applied to the outstanding balance for the next month.  For example, on 28 March 2013, the remaining maturity for the Bradford & Bingley loan, from 2 April 2013 to 29 February 2024 was 10.91 years.  On the DMO website the new loan maturity rate for “over 10½ not over 11” years on 28 March 2013 was 2.07%. This was higher than the 12 month GBP LIBOR rate +1% margin averaged over the last five business days of March (i.e. 1.9094%). So, for April 2013 the applicable interest rate for the Bradford & Bingley loan is 2.07%.  For the other FSCS loans (LSB, KSF, Heritable & Icesave), with a shorter remaining maturity, the LIBOR rate average is higher than the NLF rate quoted on the site so the LIBOR based interest rate of 1.9094% applies.

These rates are reset each month.  While FSCS believes that it is for each levy payer to set their own provisions for the levy expense in relation to this interest cost, we note that the balance at the start of the current financial year was published in note 16 of our annual accounts.  While this balance will reduce due to recoveries received during the year, levy payers may wish to use this information when considering how to set a provision.  We also note that some information regarding recoveries is published during the course of the year in our other publications, including Outlook and the Plan and Budget.

To further assist levy payers, FSCS publishes its estimate of future interest levies calculated on the following basis:

  1. FSCS obtains estimates of 12 month LIBOR for the year ahead from a major UK bank;
  2. FSCS identifies the gilt instrument (with a quoted price) with maturity closest to the expected maturity of our borrowings from HMT and obtains a forecast yield for that instrument from the same UK bank; and
  3. FSCS takes the higher of the forecast gilt rate and forecast LIBOR plus 100 basis points to determine the forecast interest rate for the year ahead.

The forecasts for LIBOR and the gilt rate are identified for the start of each quarter of the period for which we are forecasting.  In estimating interest payable, we do not take into account any recoveries which may reduce the loan balance during the year.

Clearly there will be a range of forecasts from different banks and, as a result, there will be a range of forecast levy costs, all of which could be reasonable.

We note that the estimated interest cost for the 2013/14 year will not be levied until summer 2014 as FSCS’s agreement with HMT is that interest is payable in arrears.

Any estimates that FSCS provides are for guidance based on current information and are subject to change.  In particular, given that both LIBOR and gilt rates are subject to movement as a result of a variety of factors which affect pricing in the financial markets, FSCS cannot give certainty over what these rates will be in the future and, therefore, the amounts of interest which will be levied on the industry.  This information is provided to assist levy payers to make their own estimates and provisions; it remains their own responsibility to do so, in discussion with their external auditors as necessary.

We hope that this explanation is useful to levy payers who will want to plan ahead for their likely obligations to pay interest costs.