Moody’s Q&A: Brexit risk for LA ratings
0Elizabeth Bergman of Moody’s Public Sector Europe, talks to Room151 about local authority ratings, devolution, housing companies and the looming threat of Brexit.
Elizabeth Bergman of Moody’s Investors Service,
Room151: orhat do local authorities looking for a rating need to think about?
Elizabeth Bergman: We currently have four public ratings on UK local authorities – Cornwall, Warrington, Guildford and Lancashire. All are AA rated.
One thing that it is important to stress is that a rating is not a judgment on a local authority – whether it is spending wisely or not. It is solely about the willingness and ability to repay debt on time.
In assessing credit strength, we look at a number of things. We have a global methodology where we communicate what factors we are looking for that applies to regional and local governments across the world – except for in the US, which has a different methodology.
The methodology breaks down into four areas – the economic fundamentals, the institutional framework, financial performance and debt profile plus governance and management.
We combine these factors with the systemic risk – in other words the sovereign rating. A council run in the same way in Greece and in the UK would have very different ratings because of the rating of the respective national governments.
We also look at the likelihood of the national government stepping in and providing support during a crisis. In the UK, there is a high likelihood of that. We have a very strong expectation that the sovereign would offer liquidity support to head off an immediate crisis.
R151: Is the current drive towards devolution beginning to change the way you think about rating local authorities?
EB: We are really at the very early stages of devolution. We did publish a report about Cornwall’s devolution deal when it was granted – we viewed that deal as credit positive for the county. It provided them with some opportunities to make revenue savings.
On business rates retention, the details will be important to evaluating the credit impact. We expect there will be winners and losers. But the top-ups and tariffs will limit that impact. If each local authority can only spend what it raises then clearly places like Westminster and Kensington and Chelsea will have advantages over places which do not have that kind of wealth.
Allowing councils to retain 100% of business rates could be positive for credit quality if the powers are used wisely. But we are also looking closely at whether the funding being handed down matches the responsibilities which are being devolved. If there is a mismatch then that could put authorities in a difficult place.
R151: Recently, Warrington looked beyond the PWLB to the bond market. How big do you think this market is likely to get?
EB: Local authorities are looking to cut costs and that includes scrutinizing borrowing costs. Local authorities have been thinking about new ways to borrow and lower the cost of capital – and in fact talking directly to investors about this.
There seems to be a lot of interest in broadening the way local authorities can borrow. The move to create a municipal bonds agency also reflects that.
Whether it will blossom into a full market of local authority debt remains to be seen. Government policy and the Public Works Loan Board rate will have some impact.
However, one thing that the Warrington issue signals is that local authorities may borrow outside the PWLB because they want structures that are a little less vanilla and that give them a bit more control. Obviously the cost of PWLB is something that councils take into consideration when they are thinking how they access the markets.
The PWLB will likely remain a useful option, particularly for smaller local authorities, but some authorities may want to be more in charge of their fate and have a wider diversification of funding.
R151: LA credit worthiness is often presumed to be copper bottomed because of sovereign support. How do you see that?
EB: Right now we see the UK as one of the most centralized states in Europe. Local authorities are tied to the sovereign and there is a strong institutional framework.
There is a lot of regulation and they must deliver a balanced budget every year. Devolution tends to pull that away a little bit as local authorities have more opportunities to make spending decisions.
The day to day ongoing ties look like getting a bit looser, as government funding is declining but the extraordinary support – the willingness of government to step in during a crisis hasn’t changed in our view.
R151: Are there any other trends that you think are likely to affect councils’ ratings?
EB: Apart from devolution, another thing at an early stage is the desire of many local authorities to set up housing companies.
Developing housing is a riskier business to running a local authority. Councils need to make sure they have risk mitigation strategies in place and understand properly what kind of exposures they are introducing, and whether they have the appetite and ability to take any losses on.
The Warrington deal also highlighted another trend – Warrington was borrowing in order to fund infrastructure such as roads in its city centre to support business development that they expect will result in additional business rates.
That kind of prospective borrowing – taking on liability for some uncertain returns is an understandable reaction to shrinking grants. However, it does introduce some credit risk.
R151: How could Brexit affect local authority ratings?
EB: We have said that we associate uncertainty with a Brexit scenario and that such uncertainty would likely lead us to put a negative outlook on the UK’s ratings.
Local authorities are entwined with the sovereign, so such negative outlook would likely be replicated in local authority ratings.
However, it is unclear what effect that would have on councils’ borrowing decisions. If both local authority ratings and the sovereign rating go down then it doesn’t necessarily change the relative positioning. However, our base case is still that the most likely outcome is a vote to remain.
Elizabeth Bergman is vice president sub sovereign at Moody’s Public Sector Europe.
Photo: European Parliament, Flickr.
