Bangkok--9 Aug--Standard & Poor's
Standard & Poor's Ratings Services announced on Aug. 5 that it lowered its long-term sovereign credit rating on the United States of America to 'AA+' with a negative rating outlook (see "United States Of America Long-Term Rating Lowered To 'AA+'"). The sovereign downgrade will not affect the ratings or stable rating outlooks on the six U.S.-domiciled highest-rated nonfinancial corporate issuers: Automatic Data Processing Inc. (ADP; AAA/Stable/A-1+), ExxonMobil Corp. (AAA/Stable/A-1+), Johnson & Johnson (AAA/Stable/A-1+), Microsoft Corp. (AAA/Stable/A-1+), General Electric Co. (AA+/Stable/A-1+), and W.W. Grainger Inc. (AA+/Stable/A-1+).
WHY THERE IS NO IMPACT ON OUR TOP-RATED U.S. INDUSTRIALS
According to Standard & Poor's criteria, ratings on a nonfinancial corporate borrower may exceed those on the sovereign if we expect the borrower to continue to fulfill its financial obligations, even in a sovereign default scenario. Depending on the industry sector or individual company's financial strength, a company may be better or less able to withstand macroeconomic shocks or other country-related risks. In considering corporate ratings vis-?-vis the sovereign rating, we consider how exposed a company would be to a typical sovereign stress scenario, which, in the past, has included: sharp currency movements, credit shortages, a weakened banking sector, higher government taxes and fees, late or partial payments from the public sector, a more difficult regulatory environment, economic contraction, and rising inflation and interest rates.
Corporate entities that we would typically consider to be most exposed to country risk include firms with mainly domestic customers, highly cyclical companies or companies for which profitability is highly correlated with the general condition of the economy, and companies with high exposures to government sector customers. Corporate entities that typically are least exposed to country risk include globally diversified companies and export-oriented companies. Local economic conditions have less of an effect on such companies, and they generally benefit from currency depreciation.
Given the global and diverse business lines and significant financial strength of Exxon Mobil, Johnson & Johnson, Microsoft, and General Electric, the sovereign downgrade of the U.S. does not have an impact on our ratings and rating outlooks for these U.S. domiciled corporate issuers. They enjoy "excellent" business risk profiles (see "Business Risk/Financial Risk Matrix Expanded," published May 27, 2009), with end-market diversity, diversity of product and service lines, and a track record of solid profitability, along with "minimal" or "modest" financial risk, with significant cash flow from various businesses and substantial liquidity. In addition, the U.S.'s transfer and convertibility assessment remains 'AAA' following the sovereign downgrade. (See "Methodology: Criteria for Determining Transfer and Convertibility Assessments," May 18, 2009--"Ratings Above the Sovereign's" section. Also see "2008 Corporate Criteria: Analytical Methodology," April 15, 2008--"Country Risk" section.) Although there is no direct impact on our credit ratings on these companies from the U.S. sovereign rating action, a weakening macroeconomic scenario would negatively affect the U.S. segments of their businesses to some degree.
There is also no current impact on our ratings or rating outlooks for ADP and W.W. Grainger from the rating action on the U.S. Although most of these companies' revenues come from within the U.S. and they are less diversified by product line and geographical business mix than the previously mentioned companies, ADP and Grainger both enjoy high customer and end-market diversification and have revenue bases that held up well during the recent recession. In addition, they have minimal reliance on the public sector, with a set of products for which demand is relatively inelastic.
WE DID LOWER RATINGS ON THE GOVERNMENT-RELATED ENTITITES
In conjunction with the sovereign downgrade, we lowered our ratings on the three government-related entities (GREs): Army & Air Force Exchange Service (AAFES), Marine Corps Community Services (MCCS), and Navy Exchange Service Command (NESC) to 'AA-' from 'AA', in keeping with Standard & Poor's criteria on GREs. The rating outlook on AAFES is stable, while the outlooks on MCCS and NESC are negative. The stable outlook for AAFES reflects its better stand-alone credit profile than the other two GREs. The likelihood of extraordinary government support for these entities, in our assessment, would remain very high. (See Standard & Poor's individual research reports on these entities published earlier today.)
THE EFFECT ON CERTAIN DEBT INSTRUMENTS
The U.S. sovereign downgrade also had an effect on the credit ratings of certain specific debt instruments. Most common among the affected obligations were:
BONDS SUPPORTED BY THE FEW REMAINING 'AA+' RATED BOND INSURERS. We revised the rating outlooks on the 'AA+' bond insurers, which include Assured Guaranty (Europe) Ltd., Assured Guaranty (UK) Limited, Assured Guaranty Corp., Assured Guaranty Municipal Corp., and Berkshire Hathaway Assurance Corp., to negative from stable. In conjunction with this outlook change, we also revised the rating outlooks on the project finance bonds backed by these insurers to negative.
DEFEASED BONDS. These are bonds for which the borrower sets aside cash to pay them off. We lowered our ratings on defeased bonds backed by U.S. Treasury securities to 'AA+' from 'AAA'.
THE IMPACT ON DEFENSE CONTRACTORS AND MEDICARE PROVIDERS
The recently enacted bill that increases the federal debt limit includes a $350 billion reduction to previous planned "security spending" over the next 10 years. Given that the $350 billion is spread among a number of security sectors, including the Department of Defense, and is mainly back-end loaded, Standard & Poor's believes there will be only a modest impact on the credit quality of most defense contractors. A more significant impact on the credit quality of companies in the defense industry could occur if Congress does not specify additional cuts to the overall federal budget by the end of the year or pass a balanced budget amendment. In these cases, security spending could be cut by an additional $500 billion, possibly resulting in across-the-board cuts to weapons programs. In response to possible lower defense spending, military contractors have been reducing costs to preserve profitability and remain competitive, as well as attempting to increase foreign sales. (See "Planned Cuts To The U.S. Defense Budget Are Likely To Have A Modest Impact On Military Contractors' Credit Quality," Aug. 2, 2011)
Significant cuts to Medicare are likely, either as part of a special Congressional committee's $1.5 trillion in spending cuts or as part of the backup plan if the committee fails to come to an agreement. This would be in addition to cuts that the Affordable Care Act of 2010 already require, such as a $155 billion cut in Medicare payments to hospitals over 10 years. Medicare has more than doubled in cost over the past 10 years, to about $550 billion annually. We have long considered government efforts to rein in such expenditures as a key rating risk for health care providers. Still, surprising government actions, such as the recently announced 11% nursing home cuts, can lead to credit deterioration. We placed all six of our rated for-profit nursing home companies on CreditWatch with negative implications as a result of this announcement. Providers that have exposure to Medicare are likely to remain at risk of more sparing reimbursement, as long as budgetary pressures persist (see "The Deficit Remedy May Be Toxic for U.S. Health Care Companies," to be published shortly on RatingsDirect).
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