S&P special report examines potential effects of US debt debate

Thu Jul 21, 2011 4:21pm EDT

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(The following statement was released by the rating agency)

July 21 - Following the placement of the United States rating on CreditWatch with negative implications on July 14, Standard & Poor's Ratings Services analysts have examined the potential effects of three hypothetical outcomes of the current debate over the U.S.'s fiscal stance and the government debt ceiling on the corporate, financial institutions, public finance, and structured finance sectors. As a result, we published the following articles:

-- "The U.S. Debt Ceiling Standoff Could Reverberate Around The Globe--With Or Without A Deal,"

-- "Most Corporate Borrowers Remain Unaffected By The U.S. Debt Debate--For Now,"

-- "The Implications Of The U.S. Debt Ceiling Standoff For Global Financial Institutions,"

-- "Where U.S. Public Finance Ratings Could Head In The Wake Of The Federal Fiscal Crisis," and

-- "What If Analysis: The Potential Impact To Structured Finance Securities Of The U.S. Debt Ceiling Standoff."

The projections by sector build on the points explained in Standard & Poor's July 14 research update on the United States. Financial institutions would see the greatest impact under one of the hypothetical scenarios, in which The White House and Congress cannot agree to raise the debt ceiling by their Aug. 2 deadline, and the Treasury begins to sharply reduce spending to preserve cash for debt service. Such measures could conclude, if the standoff persisted for just a short while, with the Treasury missing an interest payment or failing to pay off maturing debt--i.e., a default.

We still believe that the risk of a payment default is small, though increasing, but such a scenario would see financial institutions experience the largest number of ratings changes among the sectors reviewed in these articles. This is not only because we could revise the U.S. rating to 'SD', but also because we could expect a systemic and global macroeconomic disruption. "This hypothetical scenario could look similar to the fall of 2008, when a loss of investor confidence and a flight to quality brought the global funding markets to a temporary standstill," said Standard & Poor's Senior Director Damien Magarelli.

"The U.S. financial sectors that would be at the greatest risk would be those with business models that depend at least partially on short-term funding. These include banks, funds, finance companies, exchanges and clearinghouses, broker-dealers, and life insurers."

Depending on how these issues are resolved, the current impasse could potentially--though not inevitably--cause widespread negative rating actions among U.S. public finance issuers in all sectors: states, local governments, affordable housing finance entities, not-for-profit health care entities, public utilities, obligations secured by federal lease payments, and higher education and other not-for-profit entities that rely on significant federal funding.

"The impact under the various scenarios will vary from sector to sector: what happens to the states won't be the same as what happens, say, to not-for-profit health care providers," said Standard & Poor's Managing Director Steven Murphy. "We believe that for public finance issuers, the least disruptive situation would be characterized by raising the debt ceiling, combined with a lack of drastic changes in federal spending.

While the sovereign rating is lowered in that scenario, the credit profiles of public finance issuers would remain relatively unaffected because there would be no dramatic changes in federal outlays." Generally, a change in the credit rating or outlook on a sovereign issuer doesn't necessarily lead to a change in ratings or outlooks on similarly rated nonfinancial corporate borrowers in that country. However, the ratings assigned to corporate borrowers may be affected by the U.S. debt debate depending upon the depth and length of the standoff.

"We would generally expect a more pronounced effect in a scenario involving a failure to raise the debt ceiling--especially if a delay persists long enough that the Treasury defaults on any of its obligations," said Standard & Poor's Managing Director John Bilardello. "Nor do we believe the consequences would be limited to the U.S. Rather, we would expect the reverberations to be deep and wide."

Given the likelihood, in our view, that a selective default, were it to occur, would persist for only a short time, we expect that ratings actions on structured finance securities would be limited to those with payments due in the near term and those that fail to make payments within any grace period, in accordance with our criteria.

"In that situation, we would likely lower our ratings on these to 'D (sf)' until the relevant payment defaults were cured," said Standard & Poor's Senior Director Robert Chiriani. "If a government default persisted, we would also use that same approach in rating transactions exposed to maturing U.S. obligations such as defeased securities, for example."

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