Moody’s: Debt derived from U.S. credit rating correlated to any action

This is obvious, so I’m chalking the release up as a friendly reminder to check your securities and understand how a U.S. credit rating adjustment can directly affect you, even if you aren’t holding U.S. debt directly.

New York, June 29, 2011 — Ratings that are directly linked to the U.S. government’s rating would move in lock-step with any U.S. sovereign rating action, says Moody’s Investors Service in a new report. Some Aaa ratings of state and local governments could be vulnerable to credit pressure where sovereign credit linkages are potentially strong. However, the creditworthiness of U.S. corporates and financial institutions with Aaa stand-alone credit ratings and Aaa (sf)-rated structured finance transactions that lack any direct credit linkage to the sovereign would generally be resilient to a one- or a two-notch downgrade of the U.S. government.

On June 2, Moody’s said it expected to place the U.S. government’s Aaa rating on review for possible downgrade, if there were no progress on increasing the statutory debt limit by mid-July. If a debt-ceiling related default were to occur, Moody’s would likely downgrade the U.S. sovereign rating. A rating in the Aa range would be the most likely outcome.

“There is a large amount of debt issued with strong credit linkages to the credit quality of the U.S. government,” says Moody’s. “Therefore, we are detailing the potential rating implications of a U.S. downgrade for other Aaa-rated U.S. credits, without commenting on the likelihood of a rating action on the U.S. sovereign.”

Ratings directly linked to the U.S. government would move in lock-step with the any sovereign rating action. These ratings include those on Aaa-rated bonds issued by banks and others guaranteed by the U.S. government. It also includes Fannie Mae, Freddie Mac, the Federal Home Loan Banks and Federal Farm Credit Banks whose own Aaa ratings are based on support from the U.S. government. The ratings on municipal supported transactions, pre-refunded municipal bonds, and structured securities that hold government linked debt as their primary collateral would also move in lock-step with the sovereign rating.

The Aaa ratings on U.S. companies, financial institutions, and the Aaa (sf) ratings on structured finance transactions not directly linked to the U.S. sovereign rating would generally be resilient to a one- or a two-notch sovereign downgrade because the credit linkages to the U.S. government are sufficiently weak. Some Aaa-rated states and local governments, however, may be more vulnerable to credit pressure under the circumstances that would lead to a sovereign downgrade and in turn more vulnerable to rating actions, says Moody’s. Moody’s will issue additional research providing more detail on the impact of a U.S. sovereign rating action on issuers in the U.S. municipal bond sector in the coming weeks.