| Gilt-Edge Tube Debt |
31 March 2003
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Tube Bonds Get Highest Credit Rating
London's Underground is in need of funds, and the debt deal to make that happen is likely to close this week. What has surprised a few is the AAA credit rating has not been accepted by everyone in the market. The consortium that is borrowing the money hasn't got AAA-rated members, but they have arranged for monoline insurance that boosts the rating. However, some market pros doubt that the monoline insurers deserve their AAA. This would all be a tempest in a City teapot except that this could be the thin end of the wedge, leading eventually to higher prices for borrowing for everyone.
Monoline insurers, e.g. Ambac, MBIA, FSA, get a premium from the borrower to insure the debt. In other words, the debtor pays this fee to lower the amount of interest due on the debt. The higher the credit rating the lower the interest rate. So by paying a pound to one of these insurers, the borrower may be saving five pounds in interest. It spreads the debt risk more broadly, thereby reducing the extent of loss suffered by each creditor should the debt become a problem.
However, in the default swap market, monoline insurers trade at more expensive levels than other AAA rated credits -- that extra is a risk premium required because the traders believe they aren't as safe. Apparently, some AAA debts are more AAA than others.
What does this mean to Joe Consumer? Simply, if the market decides that the monolines aren't as safe, demand for Tube bonds will not be as great. To sell off the entire billion quid of debt, higher interest rates may be needed. This may result in higher fares later as the debt needs to be retired. Also, the supply of higher-risk debt rises, and as that cycles through the economy, mortgage and car-note rates rise. Wall Street and Main Street (or perhaps, Threadneedle Street and the High Street) are connected, after all.