More S&P Downgrades Expected - WJS Blog

By Damian Paletta

After it took the dramatic step of downgrading U.S. debt Friday, ratings firm Standard & Poor’s said it would “issue separate releases concerning affected ratings in the funds, government-related entities, financial institutions, insurance, public finance, and structured finance sectors” on Monday.

Those decisions could have big implications. On July 22, S & P signaled the other companies or debt that could see a downgrade once they pushed U.S. debt from AAA to AA+.

Here’s what S & P said two weeks ago:

“Hypothetical Scenario 2–Agreement To Raise The Debt Ceiling But No Credible Agreement To Reduce Debt From a creditworthiness perspective, we believe that failure to formulate a fiscal consolidation plan, even if the president and Congress were to agree to raise the debt ceiling in time to avert a potential default, would be materially less optimal than hypothetical scenario 1. Such a partial solution would essentially put before American voters in the 2012 presidential and congressional election the spending vs. revenue debate. Meanwhile, debt would continue to mount and the results of the election might not, in any event, resolve the issue.

Under this scenario, we might lower the U.S. sovereign rating to ‘AA+/A-1+’ with a negative outlook within three months and potentially as soon as early August. We expect that the U.S. transfer and convertibility assessment would likely remain ‘AAA’. We assume that under this scenario we would see a moderate rise in long-term interest rates (25-50 basis points), despite an accommodative Fed, due to an ebbing of market confidence, as well as some slowing of economic growth (25-50 basis points on GDP growth) amid an increase in consumer and business caution.

Agreement on raising the debt ceiling without making any tough budget decisions would not be shocking, in our view, given the number of times Congress has done so in the past. And while such a move might modestly raise borrowing costs for the federal government, we view it as relatively benign for public finance issuers. Maintaining the status quo on federal outlays–for the year, anyway–would help alleviate some fiscal stress in the public finance sector, and reduce the prospect of widespread downgrades until and unless a larger solution was reached that cut federal outlays significantly.

While banks and broker-dealers wouldn’t likely suffer any immediate ratings downgrades, we would downgrade the debt of Fannie Mae, Freddie Mac, the ‘AAA’ rated Federal Home Loan Banks, and the ‘AAA’ rated Federal Farm Credit System Banks to correspond with the U.S. sovereign rating. We would also lower the ratings on ‘AAA’ rated U.S. insurance groups, as per our criteria that correlates insurers’ and sovereigns’ ratings.

A scenario that leads to a downgrade of the U.S. government to the ‘AA+’ level wouldn’t affect the ratings of the four U.S.-based corporate borrowers rated ‘AAA’. However, we would lower the ratings on three government-related entities–the Army & Air Force Exchange Service, the Marine Corps Community Services, and the Navy Exchange Service Command–in keeping with our criteria.

For structured financing transactions, we would assess the degree of each deal’s exposure to U.S. government obligations or guarantees as part of our analysis of whether to affirm or lower the ratings. We think that any potential modest rise in interest rates would not generally affect the ratings of structured finance transactions. We expect that our ratings on non-affected structured finance transactions generally would not be affected by a change in the sovereign rating. Our approach to rating new structured finance transactions, denominated in U.S. dollars, up to ‘AAA’, would also not generally be affected. However, we might see adjustments in the way proposed new structures address potential changes in interest rate and foreign exchange scenarios. We also believe that new issuance activity may slow moderately under this hypothetical scenario due to market reaction.”