Financial Regulatory Forum

Recent corporate disclosures reflect unease over U.S. debt ceiling impasse

By Guest Contributor
July 29, 2011

By Thomson Reuters Accelus – Staff

NEW YORK, July 29 (Business Law Currents) The U.S. debt ceiling debate may be a lot of noise to some of  the public, but for companies and investment funds, the governmental standoff has real consequences. The ripple effect through the markets should the government of the United States default on its obligations can’t be fully appreciated. The inevitable credit ratings hit will drive up the already high cost of borrowing for taxpayers. For many companies, who are starting to discuss the debt-ceiling debate in their regulatory filings, it is not only credit markets that will be affected. Independent government contractors may also get stiffed, not to mention lose future business.

For filers with names like T. Rowe Price U.S. Treasury Funds, the impact of the debt ceiling is easily enough grasped:

U.S. Treasury securities were generally flat over the last six months as investors turned away from the safe haven of U.S. government debt and sought higher yields in riskier securities. However, in somewhat of a repeat of events in 2010, risk aversion spiked late in the period as evidence mounted that the economic recovery was faltering amid uneven consumer demand; festering problems in the housing market; and unease about raising the federal debt ceiling, which requires congressional approval.

Blackrock Inc. has found its investors “increasingly concerned” due to the debt ceiling impasse, along with the European sovereign debt crisis. “The adverse shift in investor sentiment,” notes Blackrock, “caused greater volatility in index and iShares flows and a slowdown in retail industry-wide, particularly in equities.”

Arch Capital Group Ltd. of Bermuda, like many filers, cites a general “effect on the value of securities in [its] investment portfolio as well as the uncertainty in the market generally.”

For Seattle Genetics Inc., the ramifications on its portfolio could be particularly acute. “Uncertainty surrounding U.S. congressional approval of increases to the federal similarly could impact the trading market for U.S. government securities. These factors,” cautions the company, “could impact the liquidity or valuation of our available-for-sale securities, 97% of which were invested in U.S. treasury securities as of March 31, 2011.”

Lockheed Martin merely cites the debt ceiling as one of a number of potential risks that it categorizes as “changes in government and customer priorities and requirements.” In addition to the “debt ceiling implications,” these risks include: “the potential deferral of awards, terminations or reduction of expenditures, changes to respond to the priorities of Congress and the Administration, budgetary constraints…and cost-cutting initiatives.”

Kratos Defense & Security offers a more concrete breakdown of how the debt ceiling, wrapped up as it is with both spending cuts and appropriations, might directly impact the company.

The failure of the Federal Government to pass a new appropriations bill, extend the Continuing Resolution or increase the nation’s debt ceiling could result in a shut down of the government for all nonessential Federal Government services … [causing] the government, government agencies or prime contractors that use Kratos as a subcontractor, to reduce their purchases under existing contracts, to exercise their rights to terminate contracts at-will, to abstain from exercising options to renew contracts, to delay or refrain from making new contract awards, or to delay the payment of Kratos’ invoices, any of which could have an adverse effect on Kratos’ business, financial condition and results of operations.

Alion Science & Technology Corp., likewise worries that “if the federal budget process were to result in a prolonged federal government shutdown, it could result in [the company] incurring substantial unreimbursed labor or other costs, or delay or cancel key programs, which could materially adversely affect [its] cash flows and operating results.”

For St. Louis-based Centene Corp., the debt ceiling’s impact on Medicaidfunding could be cause a serious cash crunch. “If legislation increasing the debt ceiling is not enacted and the debt ceiling is reached, the federal government may stop or delay making payments on its obligations, including funding for Medicaid. A failure by the federal government to fund or a material delay in the funding for Medicaid could have a material adverse effect on our cash flows.”

Integrated Freight Corp., an over-the-counter traded company headquartered in Sarasota, has roughly 1,000 trucks on the road. The ultimate impact of a debt ceiling-related shut down could mean more than merely increased borrowing costs to keep its fleet operational.

Such a move, it said, could also occasion “a decline in gross domestic product, which would involve a reduction in freight shipments. If the U.S. debt ceiling is not raised in time to avoid default on U.S. government obligations, we believe we will experience higher interest rates and lease payment levels, increased difficulty in obtaining financing for both equipment and acquisitions and a decline in demand for freight transportation.”

Not all filers believe the sky is falling. Legg Mason Capital Management Value Trust Inc. looks back several months to put the whole debt ceiling/default issue into context.

During April, the “it” event that spooked investors came mid-month when credit rating agency Standard & Poor’s (“S&P”) ratcheted down the United States’ credit outlook to “negative.” In a statement, S&P noted the obvious — the U.S. has large annual budget deficits, $14 trillion in federal debt and a politically polarized budget process which makes difficult choices even thornier. Although changing the outlook from “stable” to “negative” does not reduce the U.S.’s vaunted triple-A (“AAA”) rating, it sparked investors’ lingering post-traumatic stress from 2008 and early 2009. Commentators chimed in with dire predictions about how the Chinese would stop buying U.S. debt, Congress would fail to raise the debt ceiling thereby triggering a default, and nothing would get done to fix any of this before the 2012 election.

Unlike many handwringers, Legg Mason discounts the impact of the debt ceiling and ratings hoopla:

…absent major new developments, we do not believe that the U.S.’s credit rating, the debt ceiling or budget negotiations are likely to undermine the market. Contrary to popular perception, the market manages to look through well-understood events. The reason is simple. Markets rapidly discount current information and expectations for the future.

But Legg Mason appears to be in the minority. Even Deutsche Bank wrapped up as it must be in the multi-front assault on the Euro, cautions, “an agreement on raising the statutory debt ceiling and consolidating public finances in the U.S. is of utmost importance.”

“Utmost importance” is an understatement. Notwithstanding questions about what the mechanics of a failure to raise the debt ceiling would mean (e.g., Would that formally trigger a default? does a spending or revenue cushion inherent in the budget exist that would push the actual date further out?), the consequences of this process have already been set in motion. Many (rightly) believe that political machinations are driving the debate; the party trying to obtain a tax increase right at election time in 2012, will likely find little favor among voters. The fates of the debate’s winners and losers may already be settled.

Beyond the political fallout, however, a potential default is a symptom rather than a cause of the nation’s fiscal emergency. Unless Uncle Sam has a wealthy relative, at some point the bailouts must stop. Rather than a font of political credit for providing government largesse, momentum may be shifting in an ultimately healthy way to rewarding the clear-cutting of an impenetrable thicket of earmarks, entitlements and discretionary spending. A default will most definitely bring about a credit crisis; politicians able to cut government spending may actually see a silver lining in this very dark cloud.

(This article was first published by ThomsonReuters’ Business Law Currents, a leading provider of legal analysis and news on governance, transactions and legal risk. Visit Business Law Currents online at http://currents.westlawbusiness.com.)

 

 

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