Credit ratings agencies face examination: Local Government Chronicle

Nigh on one billion pounds buys an awful lot of bucks, even at current exchange rates. And there is a hell a lot of buck-passing going on when it comes to accepting responsibility for the £920m of investments and deposits in Icelandic banks potentially lost by local authorities.


Councils say they relied on credit ratings agencies’ assessments when they placed their money with the banks. The agencies respond they merely provide information – the users must accept responsibility for how it is applied. Investment advisers, meanwhile, say they just assist local authorities to develop the systems by which risks are assessed and investment decisions are made. The crisis is, apparently, no one’s fault.


Nonetheless, the Local Government Association has called for an investigation into the role of credit ratings agencies in the decisions that led to vast funds being placed with the failed Icelandic banks – Landsbanki and its Heritable division, Glitnir and Kaupthing. It is the Audit Commission that has to weigh-up the conflicting versions of recent history and reach conclusions – arguably compromised by the fact that the arbiters of good local government financial housekeeping themselves had £10m on deposit with two Icelandic banks, Landsbanki Islands and Heritable, which were placed in April this year.


Amidst all the financial carnage, some interest facts and notably different patterns of behaviour emerge. Take, for instance, the way various local authorities responded when the credit ratings agencies did start questioning the viability of the Icelandic banks – in, it has to be said, their own coded language.


It was in February this year that the two credit ratings agencies mostly used by councils cast doubt on any of the Icelandic banks. While Fitch all retained long-term ratings for Glitnir, Kaupthing and Landsbanki at A (a high credit quality) and short-term ratings at F1 (the strongest rating), Moody’s reduced its long-term rating for Landsbanki from Aa3 (high quality, but with a long-term risk) to A2 (upper medium grade, but susceptible long-term). The other banks retained their high ratings with Moody’s.


In April the first proper warning bells were issued, when Fitch announced that the three Icelandic banks were being put on negative rating watch, warning that long and short-term ratings could be reduced. Subsequently, there were downgradings in May, September and October.


Two of the largest potential losers, Kent County Council and Norfolk County Council, stress that they made no further investments after Fitch put the banks on negative ratings watch. Their losses relate to long-term investments that had punitive penalties attached to early withdrawal. A spokesman for Kent County Council says: “The credit rating was of the highest importance – which is why when these banks were placed ‘on watch’ back around April time, we decided to be as risk adverse as possible and not invest further from this point in time.”


Similarly, Norfolk County Council ceased making any investments or deposits with Icelandic banks since sentiment turned negative. Its spokesman, Steve Reilly, says: “As soon as we were aware they had gone onto watch we did not invest after that. The last investment was in March.”


But the situation is noticeably different with Nottingham City Council, which made its last investment on September 19th this year. By this time, there had been speculation in the press about the continued viability of the Icelandic economy and its banks. However, Landsbanki’s long-term ratings with Fitch were still A (high credit quality) and its short-term ratings remained F1. The deposits – which were on long-term, fixed interest terms, with punitive penalty clauses – were made in accordance with the council’s policy of only investing with institutions whose short-term ratings were F1 and long-term ratings were at least A-.


But many observers have criticised councils for still making deposits with any of the Icelandic banks by the autumn. Warning signs were clear, for instance, when on 21st July this year the cost of insuring Iceland’s banks against default rose to 10% of debt levels, against a mere 0.3% a year before. While careful readers of the Financial Times would have been aware of this fact, it did not provoke either Fitch or Moody’s to amend their ratings of the banks.


LGA spokesman, Nick Mann, says it is unhappy that this and other events in the spring and summer failed to spark warnings from the ratings agencies. “We have called for an independent inquiry into how these banks got these very sound credit ratings until 30th September, just a matter of days before these banks went into receivership,” he says. “Obviously local authorities are incredibly reliant on these ratings when making decisions on where to put their money. Councils still have tens of millions of pounds invested in other banks. Councils need to have confidence in those banks’ credit ratings.”


Fitch’s Ratings dismissed the suggestion that it had not been sufficiently watchful. A spokesman responds: “Fitch first warned of systemic risk in the Icelandic banking sector in March 2006. The agency has expressed similar concerns in frequent market commentary and rating actions since then. Ratings do not constitute recommendations to buy, sell, or hold any security, nor do they comment on the suitability of any security for a particular investor. Fitch does not provide any advice.”


The other main credit ratings agency used by councils, Moody’s said that no one was available to discuss criticisms of the agency.


Standard’s & Poor’s, the third big agency avoided LGA criticism – because it did not monitor Landsbanki or Kaupthing. A spokesman for S&P says: “Moody’s and Fitch rated more of the [Icelandic] banks than we did. We only rated one of the Icelandic banks, Glitnir. We have steadily downgraded it since March. It was never rated more highly than A- [the seventh of ten investment grade ratings]. We cut it to BBB+ [the eighth grade] in April, with a negative outlook. This was the lowest rating at the time of any major European bank. We have been consistently warning about the growing risks of the Icelandic banks for several months.”


But credit ratings agencies have been under fire internationally for more than a year for their failure to warn investors about the doubtful value of complex financial instruments – particularly, packages of sub-prime mortgage debt. French president Nicholas Sarkozy and German chancellor Angela Merkel have led the criticisms, joined recently by the US Congress. All are unhappy that the agencies are paid not by investors, but by the companies they rate – producing, it is alleged, a conflct of interest. This is not, though, one of the complaints made by the LGA.


It is noticeable that many of the councils that lost most heavily from investments in Icelandic banks were advised by Butlers – the Butler Group, a division of ICAP brokers. Butler’s argues this merely reflects its dominance in the market place, in which it advises 144 local authorities.


Butlers is a segregated and independently managed division of an ICAP company, which provides a service to local authorities in relation to the structure and organisation of their treasury operations,” says Mike Sheards, director of corporate affairs at ICAP. “Butlers also provides information on any changes to credit ratings which are received from S&P, Moody’s and Fitch, within parameters set by the relevant local authority, for which Butlers charges an annual fee. Butlers does not provide advice on what deposits the local authorities should make with which banks. The Bank of England Non-Investment Products Code (NIPS), which applies to cash deposits, requires each individual local authority to make its own decision as to where to deposit money.”


The other leading investor advisory firm is Sector Treasury Services – which claims to advise 250 councils – and makes a similar point. Antoinette Huka, spokeswoman for its owners Capita, says: “Sector does not assess the suitability of countries such as Iceland for investment, nor does it independently assess the suitability of individual banking institutions. Sector passes on information from independent credit rating agencies to assist councils to comply with the Government’s guidance on local government investment. That guidance requires councils to base their investment decisions on the ratings from the following credit rating agencies: Standard and Poor’s, Moody’s Investors Service Ltd and Fitch Ratings Ltd.”


Westminster City Council explains how it makes its investment decisions. “The key factor is whether the bank or financial institution appears on our approved ‘counterparty list’,” says spokesman Oliver Finegold. “This list is ‘flagged’ by our investment advisors, Sector Treasury Services, to indicate their support for continuing short term or/and long term investment with each institution. Other factors taken into consideration include the internally agreed investment limits, the duration of the investment and the rate of return. The director of finance and his treasury team will also have regard to the ‘sentiment’ in the wider financial markets.” Finegold adds that the council “also uses Sector Treasury Services to give strategic treasury management advice and advice/guidance on credit ratings information provided by Fitch and Moody’s. All investments are made in line with the council’s treasury management strategy.”


Local authorities that have lost substantially have made strong defences of their actions. A spokesman for Kent County Council, which had the largest investments, said: “Until the end of September the advice from the rating agencies was that these banks were a safe option. None of these Icelandic institutions had any exposure to the US sub-prime market and the rates offered by Icelandic banks were competitive but not excessive – we were not chasing the highest rates available in the market….. Kent County Council made these deposits based on the assessments of three ratings agencies and our professional advisers, Butlers. We have quarterly meetings with Butlers and talk to them in between. They help us form a view on where we should deposit our funds.”


A spokesman for Nottingham City Council says: “We are reviewing our investment strategy to see what lessons can be learned from these unprecedented international circumstances and we are currently not investing in any foreign banks – only UK and Irish banks, where we believe risks are low.” A similar response is recommended by the LGA for councils that made the most recent investments and has been adopted by several affected councils.


But it should be remembered that with 116 councils admitting to having placed deposits with Icelandic banks, that implies around 300 authorities in England and Wales alone did not invest with them. One of these is Leicester City Council, which reduced its risk exposure as the global financial crisis worsened. Leader Ross Willmott explains: “We have been very cautious about where to put our money. Our treasury management people are very good and did a lot of work on credit ratings. And that is why we did not have any money in the Icelandic banks. I had weekly discussions with the chief finance officer and had strongly supported going for low risk. We took a decision to accept a lower interest rate and lower risk. That was a strategic approach.” And it is one which over a hundred councils probably wish, in retrospect, they had taken too.




Council deposits with Icelandic banks


Date of most recent Advisor Audit Commission

deposit Use of resources rating (2007)


Kent £50m March 2008 Butler 4


Nottingham £42m September 2008 Butler 3


Haringey £37m September 2008 Sector Treasury 3


Norfolk £33m March 2008 Butler 3


Dorset £28m August 2008 Butler 3


Hertfordshire £28m September 2008 Butler 3


Barnet £27m September 2007 Butler 3


Somerset £25m April 2008 No retained advisor 3


Northumberland £23m September 2008 Sector Treasury 3


Hillingdon £20m [details not supplied] * 2


Surrey £20m [details not supplied] ** 3


Reigate & Banstead £16m August 2008 Several 3


Westminster £16m August 2008 Sector Treasury 4


  • * The London Borough of Hillingdon declined to provide information.

  • ** Surrey County Council did not respond to requests for information.

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