David Green: Credit rating the Municipal Bonds Agency
0The Municipal Bonds Agency has achieved a credit rating from Moody’s. David Green explores what went into the decision.
Moody’s has assigned UK Municipal Bonds Agency plc a Aa3 credit rating, one notch below the Aa2 rating of the UK Government. The agency intends to issue long-term bonds to investors at low enough interest rates that, after adding on its own costs, it can on-lend the proceeds to local authorities at interest rates lower than the government’s own Public Works Loans Board.
At first sight the Aa3 rating seems entirely reasonable — Moody’s currently rates five UK local authorities: two at Aa2 (equal to the government), two at Aa3 (one notch below) and one at A1 (two notches below). Fitch and S&P rate three authorities between them at similar levels. Based on this albeit limited sample, the agency appears to be rated at, or slightly below, the average of UK local authorities.
However, the agency is designed to be better than average. As Moody’s notes, the rating takes into account the framework agreement whereby if one local authority borrower defaults, the others will provide cash to ensure the agency can continue to pay its bond investors.
The rating also reflects the joint and several guarantee whereby if the framework agreement fails, bond investors can obtain repayment from any single local authority.
Similar arrangements allow municipal bond agencies in other countries to be rated equal to the national government.
There must therefore be additional factors at play with the UK agency, and these are hinted at in Moody’s published rating methodology for “public sector pool financings”.
This document reminds us that the strength of a chain is its weakest link, and that an agency with few reserves of its own will run out of cash when its weakest borrower defaults.
Framework agreements and guarantees can then uplift the pool rating above that of the weakest link. But only if one member is strong enough to step up on its own to cover a peer’s default is the pool credit rating likely to be close to that of the strongest link.
Moody’s also notes that the agency faces stiff competition from the incumbent PWLB, so will struggle in the early years to cover its fixed costs from the margin between loan interest receipts and bond interest payments. And it has little cash of its own to make good on a failed loan payment without resorting to the framework agreement.
Bond investors will be interested in the credit rating of course, but they will conduct their own credit analysis too. With apparently just four local authorities backing the first bond, their individual strengths will be the most important consideration.
Additional authorities joining the pool at a later date should increase the usefulness of the guarantee, enhance the creditworthiness of the agency and hopefully lead to a credit rating upgrade in the future.
David Green is strategic director at Arlingclose Limited.
