Change in tone of US debt talks could prompt rating action before default – Moody’s

By Davide Barbuscia

NEW YORK (Reuters) – Ratings agency Moody’s expects the U.S. government to continue paying its debt on time, but public statements from lawmakers during debt ceiling negotiations could prompt a change in its assessments of the U.S. credit outlook ahead of a possible default. said a senior analyst.

Investors use credit ratings as one of the metrics to create risk profiles for governments and companies.

In general, the lower the borrower’s rating, the higher his financing costs. This means that a possible downgrade of the US government’s rating could affect the pricing of trillions of dollars of Treasury debt securities.

Investors need to grapple with this risk before the June 1 deadline indicated by the US Treasury to raise the government’s debt ceiling of $31.4, as Democrats and Republicans remain deeply divided over how to rein in the federal deficit.

Moody’s has the US government’s “Aaa” rating with a stable outlook – the highest creditworthiness rating that Moody’s gives to borrowers.

Fitch Ratings also assigned the US government’s (A. S&P Global) rating of “AA-plus”, its second-highest rating.

Standard & Poor’s stripped the US of its coveted top rating during a debt ceiling showdown in Washington in 2011, just days after an agreement the agency said at the time did not stabilize “medium-term debt dynamics”.

Moody’s expects that lawmakers will eventually reach an agreement on raising the borrowing cap this time around. But William Foster, senior vice president at Moody’s, told Reuters it was preparing for lengthy negotiations and possible interim solutions.

The US government will be deemed default if it defaults on debt payments, which will result in a downgrade of the rating agency’s rating by one notch to “Aa1”.

But Foster said Moody’s could take action before a default by changing its view of the US government to negative from stable if lawmakers indicate that a default is expected. Any change in outlook reflects a material increase in the downgrade potential.

“Circumstances like these can be if public messaging from both sides or from the lead negotiators indicates that they are seriously considering default, and are comfortable that this is a viable option,” Foster said.

“If we approach X-date and there appears to be a change in tone that seems significant and material and changes the overall probability analysis, … that is the only basis for potential change before the missed payment,” he said.

Date X is when the government can no longer pay all of its bills. US Treasury Secretary Janet Yellen said on Sunday that June 1 remains a “tough deadline” for raising the federal debt limit.

Moody’s put the US’s Aaa rating under review for a possible downgrade in 2011 just weeks before a debt limit agreement was reached.

Because of the tight timeframe, Foster said he continued to expect a debt ceiling agreement in the summer or at the end of the US fiscal year in September, with lawmakers likely to agree to a short-term suspension in the meantime.

Should the government reach Date X without an agreement, Moody’s expects that principal payments of outstanding debt will not be at risk as the Treasury can bid on new debt to redeem old liabilities while staying under the existing debt limit.

However, interest payments must be prioritized to avoid default. “If that’s the scenario, we expect that to happen,” Foster said.

In the event of a non-payment, Moody’s will downgrade the government’s rating by one notch, even if it defaults briefly.

“The circumstances of that will depend on something that could have been avoided, that was expected, but happened anyway because of politics,” he said.

(This story has been paraphrased to specify that change in ratings refers to US Credit Expectations in Paragraph 1)

(Reporting by Davide Barbuscia; Editing by Megan Davies and Leslie Adler)

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