What the UK downgrade means for new infrastructure

Not a lot, basically. But that doesn’t make it irrelevant.

In the next few days, having downgraded the UK’s sovereign debt by one notch, Moody’s is likely to embark on a rash of downgrades of sub-sovereign entities that are also able to borrow, such as Transport for London and local authorities.  They will also look at utility companies, banks (other than the Bank of England, already downgraded) and, importantly for this blog, project companies set up to build infrastructure on a ‘project finance’ basis which hold debt for that purpose. The reason is this.

It’s a general principle at Moody’s and other agencies that sovereign issuers sit at the pinnacle of a pyramid of borrowers in a given sovereign state, and nobody’s debt in it can have a higher rating than that of the sovereign. Plus, a lot of infrastructure projects and companies rely on sovereign states to underpin their financial structure, either because they actually provide the revenue directly (in the case of, say, a PFI school or waste project) or because they off some form of revenue subsidy, offtake agreement or guarantee (such as a wind farm). So when a country does get downgraded, that carries with it the risk of other, non-sovereign downgrades that would raise the price of private as well as public sector debt.

However, in this case, there’s unlikely to be a big effect. Firstly, the UK’s creditworthiness is not really disputed; the idea that the Treasury wouldn’t pay its bills seems far-fetched. Where ratings have an impact is where they directly govern whether you can raise debt and at what price. The UK is still very much investment-grade (it would have to be downgraded nine times more to lose that) and while it stays where it is, new infrastructure projects within it will not see their debt margins rise comparatively – not due to the downgrade, anyway. France was downgraded below triple A in 2012, and, as my ex-colleague Tom Bowker, a former Moody’s infrastructure writer tells me, there wasn’t a great effect on debt margins for infrastructure projects. France is still procuring projects with private finance at pace.

On the other hand, Spanish projects, utilities and banks are struggling to attract finance – but that’s because Spain’s banking system is broken, unemployment is high and its government is massively on the hook for the debt run up by the regions. In other words it has macroeconomic conditions we don’t have.

Credit ratings aren’t always directly relevant when borrowing; a debt instrument only gets rated under certain circumstances. Publicly issued bonds always do, because, well, they’re publicly issued, unlike loans which are a private matter between a borrower and their banks. However, most infrastructure bonds, while they are investment grade, aren’t quite triple-A anyway; they hover around A or triple-B. So new bond issuances (which HM Government wants there to be more of, because bank finance is drying up)  wouldn’t necessarily fail to get an investment-grade rating.

The downgrade might possibly make private finance more attractive by thinning the margin gap between public and private debt. Although, according to the commentators out there, it’s unlikely our gilt margins will rise anytime soon. So not much to shout about, in spite of all the discussion about this issue.

Update: France was downgraded below triple A, not triple B. Also, Mr Bowker was a writer, not an analyst, he tells me. I have amended.


About René Lavanchy

You can contact me at rene dot lavanchy at googlemail dot com.
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