Corporates more likely to feel US default impact long-term; some opportunistic corporations could benefit.
While Republicans and Democrats debate raising the debt ceiling at the edge of the abyss, most everyone else is forced to just stare into it. All wonder what will happen if debt-ceiling deadline passes and the US is downgraded. For corporations, there likely won’t be any immediate impact of a downgrade, but over the long term, they could feel the ripple effects.
To be sure, most agree that a downgrade will be the worst that will happen. The US likely won’t default per se, as it generates hundreds of billions of tax revenue a month. It can pay its bills. “There is absolutely no chance that the United States will ‘default’ on its debt,” wrote economist Brian Wesbury in a note to clients. “Every dime of interest will get paid and every penny of principal will be rolled over. The markets understand this and that’s why the government can still borrow money at 3% or less for 10 years. The US is not Greece, it is not even close.”
Initial de-risking
But experts also agree that there will be a chaotic de-risking reaction from the markets if the US misses the deadline and there is a downgrade. One of the big concerns is money markets funds, which have charters that allow them to hold only high-quality debt; as such they hold a lot of US Treasuries. If they suddenly are forced to dump their Treasury holdings due to a downgrade, this would create knee-jerk chaos – even another “break the buck” scenario (see related story here). However, according to the Investment Company Institute, “unless the major credit rating agencies also downgrade short-term debt issued by Treasury and other federal agencies, money market funds would not be affected by any change in the AAA/Aaa rating.”
Whatever chaos does occur, it may not last long as markets come to their senses. “In a one notch downgrade scenario for the USA sovereign (to ‘Aa1’/‘AA+’), we would not expect widespread forced selling of corporate securities including bonds issued by US banks and which benefit from the systemic support of the US government,” according to a note to clients from Deutsche Bank’s credit sales and trading team (they note this is its own opinion and not the official position of the bank). “That said, we would expect to see renewed interest to reduce exposure over time to those US banks that benefit from systemic government support and are rated at the lower end of the ratings scale.”
This of course would come around to hit US non-financial corporations eventually in the form of tighter lending or higher borrowing costs or both. In the meantime, those non-financial firms could actually benefit, as the demand for high quality debt increases. Last year around this time, as the US was supposedly coming out of crisis mode, several companies, including IBM, McDonald’s and Wal-Mart, issued debt that was not only well received but was more attractive than comparable US government debt – and this was of course way before the debt ceiling debate (see related story here).
Today of course a different story. Says DB, “Following the initial shock of a downgrade of the US government and its knee jerk de-risking, we’d expect to see very high quality non-financial corporate credit spreads actually tighten relative to US government securities as more buyers look to diversify their treasury holdings into alternative highly rated securities.”
Downgrade anyway?
As the US moves closer to the debt ceiling deadline (and Republicans and Democrats move farther away from each other in terms of acceptible plans), many market watchers are of the opinion that the US will be downgrade anyway. According to the Wall Street Journal, S&P has said it could move even if a debt-reduction deal is met. The rating agency wants $4tn in debt reduction “as a figure that would be appropriate for keeping the triple-A rating.” Indeed, small rater Egan Jones has already downgrade US debt.
So how should corporates prepare? Be ready to not depend on banks for borrowing. And if the company is considered high grade and is planning on issuing debt, then all indications point to going full steam ahead. Be ready to de-risk and keep a sharp eye MMFs.