Moody’s warns 5 AAA states of downgrade prospect if fed debt default occurs

July 21, 2011

Banking & Finance, Politics

The threat of the Congress and President Obama failing to reach a deal to raise the federal debt limit has led Moody’s to say it is placing five of the 15 states with triple-A ratings on review for possible downgrade.

The downgrade warning for Maryland, New Mexico, South Carolina, Tennessee and Virginia s based on the growing possibility of a downgrade in the U.S. sovereign. Moody’s said that if the U.S. sovereign rating were lowered, the ratings of those five stated could be lowered also.

Moody’s says it would not automatically lower ratings for the five states in the event of a U.S. debt downgrade, but would examine each on a “case-by-case basis,” looking at mitigating circumstances in each state “to determine if their financial position and governance are strong enough to negate the impact of a potential U.S. downgrade.”

Moody’s analysts say the five states for a variety of reasons, are more closely tied to federal spending levels than the other 10 AAA-rated states, and could be hurt by any federal significant cuts in federal spending.

The total amount of debt issued by those five states which could be affected by any downgrade is reportedly $24 billion, according to Banking Investment Consultants newsletter.

The newsletter reports that Moody’s analyst Bob Kurtter, in an interview with On Wall Street, said, “Globally, it is fairly rare for sub-sovereign governments to have ratings that are higher than the sovereign parent, only where there is independence and insularity. “So what we did was look at the AAA rated governments that were linked to the federal government to see which ones were relatively independent.”

All five states are particularly sensitive to the federal government rating because of either a high percentage of residents who are federal employees or a high dependence upon federal contracts or a high reliance upon government transfer payments, such as federal Medicaid funding.

Virginia and Maryland, for example, are both states with large numbers of federal employees, and would be heavily impacted by any major cutbacks in federal employment which might result from significant cutbacks in federal spending. New Mexico and South Carolina, meanwhile, are both states where the government spends a large amount on the military and on other government projects. Maryland, New Mexico and Tennessee are said to also have a higher than average percent of debt carrying variable interest, which could rise in the event of a federal debt downgrade. Finally, both South Carolina and Tennessee, with large numbers of low-income families, receive a disproportionate amount of federal funds for welfare and Medicaid programs, which could also be threatened by federal budget cutbacks.

Meanwhile, according to Moody’s, the other 10 AAA-rated states are not entirely immune from a federal debt downgrade. The ratings agency says that if the U.S. sovereign rating were to be lowered by “more than one notch,” then Moody’s would have to re-evaluate whether those states — Alaska, Delaware, Georgia, Indiana, Iowa, Missouri, North Carolina, Texas, Utah and Vermont — should be placed on review for downgrade as well.

Moody’s awarded Mississippi an Aa rating last October with an outlook of “stable.” The Aa denotes “very high quality” debt issuance. However, the Magnolia State is greatly dependent on federal spending, not only for military purposes but for federal funds for welfare and Medicaid programs.

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