Credit Analysis for Government Issuers | CFA Level I

Welcome to our exploration of credit analysis for government issuers, where we delve into the intricacies of sovereign and non-sovereign government debt. This lesson aims to equip you with a thorough understanding of the factors influencing the creditworthiness of government issuers.

Understanding Sovereign Debt

Sovereign debt, issued by national governments, hinges on two critical aspects: the government’s ability and willingness to pay. The ability largely stems from tax revenues and economic activities, while willingness is nuanced by sovereign immunity, which protects governments from lawsuits over debt.

An in-depth credit risk assessment of sovereign issuers involves analyzing qualitative and quantitative factors:

• Institutions and Policy: Examines political stability, legal protections, and economic policies.
• Fiscal Flexibility: The government’s capacity to adjust taxes and spending in response to debt obligations.
• Monetary Effectiveness: Evaluates the central bank’s control over inflation and currency stability.
• Economic Flexibility: Assesses the economy’s diversification and growth prospects.
• External Status: Considers the global standing of the country’s currency and geopolitical risks.

Quantitative Factors in Sovereign Credit Analysis

Quantitative measures provide a comparative basis for assessing sovereign credit quality:

• Fiscal Strength: Indicated by debt-to-GDP ratios, interest coverage, and fiscal discipline.
• Economic Growth and Stability: Measured by GDP growth rates and volatility.
• External Stability: Evaluated by foreign currency reserves and external debt levels.

Non-Sovereign Government Debt Analysis

Non-sovereign debt encompasses several types of issuers, each with unique credit considerations:

• Agency or Quasi-Government Bonds: Issued by entities for specific government purposes, often backed by the government.
• Government Sector Banks: Special-purpose financial institutions, like green bond issuers, with implied government support.
• Supranational Bonds: Issued by multilateral agencies, backed by member countries’ contributions.
• Regional Government Bonds: Issued by local governments for budgetary or project financing, with credit quality reflecting local economic health.

Special Considerations for Municipal Bonds

Non-sovereign governments and quasi-government entities also issue bonds, such as U.S. municipal bonds. Interest payments are often tax-exempt, and default rates are low.

Most municipal bonds are classified as:

• General obligation bonds: Unsecured bonds supported by the issuer’s taxing power.
• Revenue bonds: Issued to finance specific projects.

General Obligation Bonds: Assessing Local Economy

Municipal governments can’t print money to service debt, so credit analysts should focus on the local economy:

• Employment, income, and debt trends
• Tax base dimensions and demographics
• Ability to attract new jobs
• Revenue variability over economic cycles
• Long-term obligations (e.g., underfunded pensions)

Revenue Bonds: Project Analysis

Revenue bonds have higher credit risk since the project is the sole source of funds. Analyzing revenue bonds is similar to corporate bond analysis.