Rating Implications of U.S. Debt Ceiling Crisis

   LONDON - (BUSINESS WIRE) -10/12/2013 - Fitch Ratings spokespersons said they continue believe that an agreement will be reached to end the current political impasse and raise the U.S. debt ceiling. Nonetheless, the U.S. Treasury has said that extraordinary measures could be exhausted as soon as October 17, leaving a cash balance of just $30 billion.
   The treasury would still have limited capacity to make payments after that date but would be exposed to volatile revenue and expenditure flows. As in the debt-ceiling crisis in the summer of 2011, it is useful to outline how Fitch may react to a failure to raise the debt ceiling, and to the potential consequences, including a default on U.S. Treasury securities.
   As we said when the U.S. government shut down on Oct. 1, a formal review of the U.S. sovereign 'AAA'/Negative Issuer Default Rating (IDR) with potentially negative implications would be triggered if the U.S. government has not raised the federal debt ceiling in a timely manner before the treasury exhausts extraordinary measures and cash reserves. In such a scenario, Fitch would consider placing the U.S. sovereign IDR on Rating Watch Negative (RWN), reflecting the increasing risk of a near-term default event. If the U.S. sovereign IDR were placed on RWN, all outstanding U.S. sovereign debt securities would also be placed on RWN.
   A widespread and prolonged delay of payments to suppliers of goods and services to the federal government, including salary payments to federal employees, would not in itself constitute an event of default from Fitch's rating perspective. It would, however, damage perceptions of U.S. sovereign creditworthiness and, if payment delays were extensive on non-prioritized obligations, signal that the U.S. government was in financial distress, with negative rating implications. It would also have a detrimental effect on the economy.
   Fitch would only recognize a sovereign default event if the government failed to honor interest and/or principal payments on the due date of U.S. Treasury securities. In this scenario, Fitch would lower the U.S. sovereign IDR to 'Restricted Default (RD)' until the default event was cured. We would also lower the rating of the affected issue(s) from 'AAA' to 'B+', the highest rating for securities in default in expectation of full or near-full recovery. Debt approaching maturity would be vulnerable to a downgrade.
   Once cured, the U.S. sovereign IDR would be raised to a level reflecting Fitch's assessment of the creditworthiness of the U.S. sovereign. This would reflect the scale and duration of the default, the perceived risk of a similar episode occurring in the future, the likely impact on the U.S. sovereign's cost of funding and cost of capital for the economy as a whole, and the implications for long-term growth.
   Willingness to pay, as reflected in the sovereign debt service record, is an important component of all sovereign credit analysis. Even a short-lived default that did not impair the long-term capacity of the U.S. government to service its obligations would call into question the effectiveness of the country's political institutions in ensuring that sovereign debt obligations are honored in a timely manner. This means that if the U.S. sovereign IDR were lowered to 'RD', it would be unlikely to return to 'AAA' in the short to medium term.
   If the U.S. sovereign IDR were downgraded to 'RD', there would be negative rating consequences for those entities whose issuer and issue ratings are underpinned by U.S. sovereign support, such as the government sponsored entities (GSEs). Any rating impact on those entities would be influenced by the potential path of the U.S. sovereign rating as well as the stand-alone credit profiles of the affected issuers.
   The ratings of U.S. states and municipalities would not be directly affected, reflecting their autonomy and discrete powers and taxing authority, although a limited number of U.S. municipal obligations with direct links with the U.S. rating would be. These include pre-refunded and other municipal bonds secured by AAA rated U.S. government and agency obligations held in escrow and U.S.-guaranteed debt obligations, such as debt guaranteed by the Department of Energy under its renewable energy programs. If Fitch downgrades the U.S. sovereign to 'RD' - following the placement on RWN - that would not necessarily lead to an immediate downgrade of these linked ratings. These ratings would remain on RWN and would not be adjusted until the sovereign rating is ultimately resolved.

Photo by Steve Rensberry (c) 2014