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July 19 (Bloomberg) -- Five of the 15 states with top bond ratings from Moody’s Investors Service may be downgraded because their dependence on federal revenue makes them vulnerable to a U.S. credit cut should talks to raise the debt limit fail.
Maryland, South Carolina, New Mexico, Tennessee and Virginia are under review, Moody’s said today. The action affects $24 billion of general-obligation and related debt, it said. The states are rated Aaa, Moody’s top municipal grade.
The credit evaluator said on July 13 it may cut the federal government’s Aaa rating as congressional Republicans and President Barack Obama’s administration failed to agree on raising the U.S. debt limit. Moody’s said the next day it would scrutinize top-rated states, municipalities, housing programs and other debt issuers.
“Should the U.S. government’s rating be downgraded to Aa1 or lower, these five states’ ratings would likely be downgraded as well,” New York-based Moody’s said today. Aa1 is Moody’s second-highest rank. Any change in the state ratings would be announced seven to 10 days after action on the U.S., it said.
Democrats and Republicans have yet to agree on raising the government’s debt limit with an Aug. 2 deadline looming. Without the ability to borrow, the Treasury would have to cut about $134 billion of spending during August, according to a report by the Washington-based Bipartisan Policy Center.
Such cuts could imperil money states receive for programs such as Medicaid, which is the health-care program for the poor, public-works projects and education. An impasse could also rattle financial markets and push up interest rates for states, whose bonds track Treasury securities.
The deadline hasn’t upset financial markets, where Treasuries have gained as investors bought U.S. bonds on speculation Greece’s struggle with its debt will spread in Europe.
Municipal-bond yields have also declined as issuers cutting budgets curtailed borrowing. The Bond Buyer 20 Index, a measure of yields on general-obligation bonds due in 20 years, dropped to 4.51 percent last week, down from 4.65 a week earlier and as much as 5.4 percent in January.
A bond sold by one of the states, South Carolina, to fund infrastructure projects traded for a yield of 4.5 percent today, unchanged from before the Moody’s announcement, according to Municipal Securities Rulemaking Board data.
“Most participants are assuming there will not be a default and there will not be an event that would create a downgrade,” said Alan Schankel, head of fixed-income research for Janney Montgomery Scott LLC in Philadelphia. “It’s kind of a long shot.”
Today, President Obama backed a $3.7 trillion debt-cutting plan by a bipartisan group of senators that would both increase taxes and cut spending while raising the government’s ability to borrow, spurring optimism that Congress will resolve the deadlock of the debt limit.
Moody’s said it chose the five states because they are more vulnerable to economic fluctuations and depend more than the others on the federal government for employment and revenue.
Maryland, Virginia and New Mexico have relatively high proportions of federal employees and contracts, the ratings company said. New Mexico, South Carolina and Tennessee rely more on Medicaid money than the national average, Moody’s said. Maryland, Tennessee and Virginia are more sensitive to national economic trends than most, according to the Moody’s report.
A spokeswoman for Maryland Governor Martin O’Malley, Raquel Guillory, said the Moody’s announcement isn’t surprising, given the state’s economic ties to the federal government. She said the state has the ability to respond to financial problems emanating from Washington.
“We’re positioned very well right now,” she said.
The 10 top-rated states that Moody’s said are less vulnerable to downgrades are Alaska, Delaware, Georgia, Indiana, Iowa, Missouri, North Carolina, Texas, Utah and Vermont. They would be cut only in the event that the federal rating is dropped by more than one level, Moody’s said.
--Editors: Jerry Hart, Stephen Merelman, Mark Tannenbaum
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