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Fitch Reiterates Possibility Of Downgrade If Debt Ceiling Isn't Soon Raised

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NEW YORK (Daniel Bases and Caryn Trokie) - Fitch Ratings on Monday reiterated its view that if the U.S. debt ceiling is not raised prior to August 2, the agency will place the U.S. AAA rating on what it terms "ratings watch negative," meaning it could downgrade it within three to six-months.

Fitch prefaced its statement by saying it still believes an agreement on the debt ceiling will met before the deadline set by the U.S. Treasury.

"Agreement on a credible fiscal consolidation strategy will secure the U.S. 'AAA' status; failure to do so will inevitably weaken the sovereign credit profile and may result in a sovereign rating downgrade," Fitch said.

The U.S. Treasury Department has said if the debt ceiling is not raised by August 2, it will have to start prioritizing payments.

The only time Fitch put the U.S. sovereign on "ratings watch negative," or RWN, was November 13, 1995. It was removed on April 1, 1996. This was the period when Republicans in Congress refused to fund some federal agencies, resulting in parts of the government running out of money and shutting down.

A ratings downgrade would have a negative impact on government sponsored entities such as Fannie Mae and Freddie Mac, other GSEs such as the Federal Home Loan Banks and the Federal Deposit Insurance Corp guaranteed debt issued by U.S. banks.

"For each category above, in the event the U.S. debt ceiling was not raised and the U.S. sovereign rating was placed on RWN, Fitch would immediately place all of the AAA issuer and issue ratings listed on RWN," Fitch said in its report.

Fannie and Freddie, both of which were taken over by the U.S. government when the financial crisis hit a crescendo in September 2008, are considered the most vulnerable to a downgrade or a default because they are both regular issuers of debt used to finance the U.S. housing industry.

The placement of an RWN or RD (restricted default) moniker "may create challenges for Fannie or Freddie to issue debt in the capital markets," Fitch said.

In June, Fitch laid out a roadmap for its actions, saying if the debt limit is not increased and the U.S. cannot meet its immediate obligations for a debt payment on August 4, it would place that specific security at a B-plus rating, down from AAA.

"If the default persisted and additional payments due on Treasury securities were missed, the U.S. sovereign rating would be lowered to 'RD' and all outstanding Treasury securities rated by Fitch would be lowered to 'B+'," Monday's report said.

After a default is "cured," a future rating -- whether in the AA range or back to the highest level of AAA -- will be determined by Fitch's "assessment of the credit-worthiness of the U.S. government," it said.

INTERNATIONAL IMPLICATIONS

If the U.S. sovereign is downgraded, there may be negative ratings implications for multilateral development banks in which the United States is a key shareholder, such as the Inter-American Development Bank and the International Bank for Reconstruction and Development.

Israel has $4.4 billion worth of bonds issued with a U.S. government guarantee, Fitch noted. The ratings on these bonds would "move in line with that of the U.S., though the sovereign rating of Israel (A/stable outlook) provides a rating floor."

Given the U.S. dollar's status as a global reserve currency and widespread holdings of U.S. Treasury securities, the impact of a downgrade could have an impact on dollarized economies such as Panama, Ecuador and El Salvador. In addition, various countries that peg their currencies to the dollar or hold U.S. Treasuries as part of their reserves could feel an impact too.

However, Fitch said the firms' and countries' exposure to the United States varies and that none have levels at which their own ratings would be impacted.

On the U.S. corporate side, Fitch said there would be no impact on the two U.S. non-financial corporate issuers holding its AAA rating: Exxon Mobil Corp. and Johnson & Johnson.

(Editing by James Dalgleish and Dan Grebler)

Copyright 2011 Thomson Reuters. Click for Restrictions.

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