Moody's on Wednesday warned it may downgrade some Aaa-rated U.S. states and municipalities if the country loses its top-notch rating or if federal funding falls significantly as part of a plan to reduce the nation's deficit.
Most states and some municipalities rely on federal funding for operational purposes. The most susceptible to federal budget cuts would be those with greater economic volatility and that rely more heavily on capital markets to refinance their debt, Moody's senior analyst Anne Van Praagh told Reuters in an interview.
To the extent that Treasuries markets are volatile (in the case of a U.S. default and downgrade), then that could pass through in the form of additional interest costs for states or local governments, she said.
Moody's said earlier this month it may cut U.S. ratings in August if the government misses debt payments because of a failure by Congress to raise the nation's debt ceiling.
Negotiations between Republicans and Democrats to raise the debt limit fell apart earlier this week over disagreements on taxes and the size of budget cuts.
Van Praagh said Moody's will analyze the impact of a federal deficit reduction plan on state and local governments to decide about possible downgrades.
We have 15 Aaa-rated states and we think that, generally, many of them will be resilient. We're looking closely at those which are vulnerable and we'll put out some more specific research in the next few weeks with details, she said.
In its report issued on Wednesday, Moody's also said ratings directly linked to the U.S. government, including those of Fannie Mae, Freddie Mac, the Federal Home Loan Banks and Federal Farm Credit Banks, would move in lock-step with any sovereign rating action.
The ratings on municipal supported transactions, pre-refunded municipal bonds, and structured securities that hold government-linked debt as their primary collateral would also move in lock-step with the sovereign rating, it added.
However, the credit-worthiness of U.S. corporates and financial institutions with Aaa stand-alone credit ratings that lack any direct credit linkage to the sovereign would generally be resilient to a one- or a two-notch downgrade of the U.S. government, Moody's said.
(Editing by Andrew Hay and Carol Bishopric)