Agency, municipal and supranational bonds

Who borrows below and beyond the national government?

The level of government funding differs by country, depending on whether public goods are provided and financed nationally, regionally or locally. A non-sovereign government is a regional or local government. Some can levy taxes, as a sovereign does. Others rely on national budget transfers or user fees, with or without explicit government support as a secondary source of repayment. How steady and predictable that repayment source is decides how far along the maturity range the issuer can borrow, and it is the main driver of credit quality.

The simplest way to sort the issuers is to follow the money that repays the bond.

Government-linked issuersclassify by the source of repayment

• Government agency Memorize quasi-government; one government; primary: operating cash flows; secondary: the state
• Local or regional government Memorize a non-sovereign government
  • General obligation (GO) bond Memorize general purposes; repaid from tax revenue; unsecured
  • Revenue bond Memorize one project; repaid from its fees or tolls; longer-dated
• Supranational organization Memorize owned by several countries; member support; highest credit quality

How do government agencies fund themselves?

government agencies are quasi-government entities set up under national or local law to provide a particular public good or service, or to run infrastructure the law requires. Examples are a port authority and a housing finance agency.

Their primary source of repayment is the cash flow from the activity: fees, operating income or guarantee fees. The sovereign’s backing, explicit or implied, is only the secondary source. Agencies issue short- and long-term debt to match working capital and investment needs, and shape maturities and features to their activity (for example, callable debt to fund mortgage guarantees).

They usually borrow at a yield close to the sovereign’s. They do not enjoy the sovereign’s full liquidity premium, because their bonds are less liquid and less widely demanded.

How do local and regional governments borrow?

Non-sovereign governments borrow in one of two ways.

general obligation (GO) bonds fund general public services in the issuer’s jurisdiction and are repaid from tax revenue. They are unsecured and rely on the issuer’s broad taxing power. A government can attach a use-of-proceeds label: with a green bonds issue, the money goes to eligible environmental projects such as clean transport or energy efficiency. A GO green bond is still repaid from taxes, so the label changes how the money is spent and not who pays it back.

revenue bonds finance one project, such as a road, bridge, tunnel or water utility, and are repaid from the project’s tolls or fees. Maturity usually matches the expected life of the project’s cash flows, so they are longer-dated. Because only that project’s cash flows repay them, revenue bonds carry more credit risk than a GO bond from the same issuer.

	GO bond	Revenue bond
Purpose	general public services	one project
Repaid from	tax revenue	project fees or tolls
Credit risk	rests on the whole tax base	rests on one project’s income
Typical maturity	varies	matches the project’s life

What are supranational organizations?

supranational organizations such as the World Bank, the International Monetary Fund and regional development banks are created and supported by several sovereign governments in pursuit of a shared goal, such as economic cooperation, trade or financing for developing economies. Member states share control and give explicit and implicit financial support. That gives them the highest credit quality among government-linked issuers and market access across maturities.

They target investors in major currencies through global bond markets. Sometimes they sell notes whose amounts are fixed in an emerging currency but paid in US dollars. The investor then still bears the emerging currency risk.

Supranationals and sovereigns also partner to create quasi-government agencies, which can borrow more cheaply than the emerging market government alone. An infrastructure finance company owned by a government and backed by development banks is an example.

Go deeper Why agency debt usually yields slightly more than the sovereign

The agency’s credit is close to the sovereign’s because of the state backing, but its bonds are smaller, less often traded and less demanded by banks and central banks that must hold government securities. Investors want a little extra yield for that lower liquidity. The gap is a liquidity effect and not a sign of a weak credit.

Go deeper Why revenue bond maturities track the project life

Bondholders are repaid from what the project earns, so the debt should be paid off while the project is still earning. A 30-year toll tunnel can carry a 30-year revenue bond; a short-lived asset cannot. Matching maturity to the cash flows also keeps the project from facing a refinancing it may not be able to meet.

Go deeper Government-guaranteed mortgage securities

Some agencies guarantee pools of mortgage loans and issue securities backed by them. The guarantee comes from the government, so the securities are treated as a form of government-backed debt. Their cash flows depend on how borrowers prepay, which is covered in the mortgage-backed securities module.

Exam tip Ask one question about any government-linked bond: what money repays it? Taxes, project fees, operations or member states.