Agencies, supranationals and local government bonds

Who issues government-linked debt below the national government?

Non-sovereign government debt is issued by bodies that sit below, beside or above the national government: agencies, government banks, supranational organizations and regional and local governments. Their credit follows a simple question: what stands behind the bond?

Non-sovereign government debtissued below or beside the national government

• Agencies Use it quasi-government bodies created by law; usually the sovereign rating
• Government-sector banks and development finance institutions Use it sovereign-sponsored; often an explicit guarantee; usually the sovereign rating
• Supranationals Use it owned by member governments; often very highly rated
• Regional and local governments Use it municipal bonds in the US, local authority bonds elsewhere
  • General obligation (GO) bonds Memorize backed by general taxing power; similar to sovereign analysis
  • Revenue bonds Memorize backed by one project; riskier; judged on cash flow and coverage

Agency bonds come from quasi-government bodies set up by a specific law to carry out a government mission, such as providing a public service. The law often lets the body borrow. Investors assume the government would support it in distress, either implicitly through the law that created it or explicitly through a guarantee, so the rating agencies usually give it the sovereign’s rating.

Governments also sponsor banks and development banks to serve a market or a policy goal. Like agencies, they are created or supported by the state and usually carry a similar rating, especially when a statute makes the government liable for their debts.

Supranational issuers are owned by several sovereign governments that join to pursue a common objective, such as lending to developing countries or financing regional development. Their bonds are backed by member capital and support, so their rating reflects the strength of the owners. The largest, owned by many strong governments, are among the highest-rated issuers.

Issuer	Backing	Typical rating vs sovereign
Agency	implicit or explicit government support	usually equal
Government bank / development institution	often an explicit statutory guarantee	usually equal
Supranational	members’ capital and support	often very high
Regional or local government: GO bond	general tax revenue	equal or below
Regional or local government: revenue bond	revenue of one project	depends on the project

Go deeper Why a regional government can rarely be rated above its sovereign

The usual rule is equal or below, because a regional government sits under the national legal and economic system. Strong own revenues, or protection from outside the country’s legal system, can occasionally lift a region above its sovereign, but exam questions treat this as the exception.

Go deeper Green bonds from development banks

Development banks are among the largest issuers of green bonds, with proceeds ring-fenced for climate and environmental projects. The credit risk is still the bank’s, backed by its sponsors, while the label describes how the money is used.

How are local government bonds analyzed?

Bonds of regional and local governments are called municipal bonds in the US and usually local authority bonds elsewhere. How they borrow varies by country. In some, the national government sets up a financial institution that lends to local authorities at the national rating. In others, tax revenue is shared across levels so local authorities can meet their obligations. In the US, state and local issuers are rated individually, and issue two kinds of bonds.

General obligation (GO) bonds are unsecured and backed by the issuer’s general revenues, so by its power to tax. Analysis resembles sovereign analysis: the ability to levy and collect taxes and fees, the local business climate, a diversified tax base with several major employers, prudent budgeting and sometimes implicit national support. But local governments have limited powers. They control neither monetary policy nor the national economy, and they are more exposed to a declining local industry or a shrinking population, which erodes the tax base.

Revenue bonds finance a specific project such as a toll road, bridge, sewer system, hospital or stadium. Repayment depends on one source of revenue, so they are riskier than GO bonds. The analysis is partly about the project (is it needed, how heavily will it be used, what economy supports it) and partly like a corporate bond: operating results, cash flow, liquidity and capital structure.

Some infrastructure revenue bonds also carry a government guarantee, or implicit national support, as a second line of defense. Classify them by the primary source of repayment: if the project’s revenue pays first, it is still a revenue bond. The reverse also holds: a bond that funds one project but is repaid from general taxes is a GO bond.

How does the debt service coverage ratio work?

The key measure for a revenue bond is the debt service coverage ratio . It compares the cash a project has left after running costs with the principal and interest due that year.

$$\text{DSCR} = \frac{\text{revenue} - \text{operating expenses}}{\text{debt service}}$$

A higher ratio is stronger. Revenue bonds often carry a covenant requiring a minimum ratio, and a breach can trigger a default under the bond terms.

$$\text{Rev}_{min} = \text{Opex} + \text{covenant DSCR} \times \text{DS}$$

To find the break-even revenue, set the ratio in the solver to the covenant (1.25) and solve for revenue.

Exam tip Ask what repays the bond. Taxes in general: GO. One project’s revenue: revenue bond. A government guarantee or sponsor: agency or development bank.

Go deeper Municipal bankruptcy

A sovereign cannot be forced into bankruptcy, but in some countries a local government can file for court protection from its creditors. Recoveries then depend on the type of bond, and general obligation holders may recover only part of what they are owed.