The rating agency Moody’s this week announced that it is placing five of the 15 states with triple-A ratings on review for possible downgrade because of the growing possibility of a downgrade in the U.S. sovereign AAA rating.

Moody’s said that if the U.S. sovereign rating were lowered, the ratings of those five stated could be lowered also.

According to Moody’s analysts, the five states -- Maryland, New Mexico, South Carolina, Tennessee and Virginia -- for a variety of reasons, are more closely tied to federal spending levels than the other 10 AAA-rated states, and could be hurt by any federal significant cuts in federal spending.

The total amount of debt issued by those five states which could be affected by any downgrade is reportedly $24 billion.

Explaining the reason for the concern about the five states facing possible downgrade review, Moody’s analyst Bob Kurtter, in an interview with On Wall Street, said, “Globally, it is fairly rare for sub-sovereign governments to have ratings that are higher than the sovereign parent, only where there is independence and insularity. So what we did was look at the AAA rated governments that were linked to the federal government to see which ones were relatively independent.”

Nicholas Samuels, a vice president in Moody’s State Ratings Team, said, "While all states are indirectly linked to the U.S. government to some degree,” these five states are “particularly sensitive”, for reasons relating to either a high percentage of residents who are federal employees, to a high dependence upon federal contracts or a high reliance upon government transfer payments, such as federal Medicaid funding.

Virginia and Maryland, for example, are both states with large numbers of federal employees, and would be heavily impacted by any major cutbacks in federal employment which might result from significant cutbacks in federal spending.  New Mexico and South Carolina, meanwhile, are both states where the government spends a large amount on the military and on other government projects.  Maryland, New Mexico and Tennessee are said to also have a higher than average percent of debt carrying variable interest, which could rise in the event of a federal debt downgrade. Finally, both South Carolina and Tennessee, with large numbers of low-income families, receive a disproportionate amount of federal funds for welfare and Medicaid programs, which could also be threatened by federal budget cutbacks.

Moody’s says it would not automatically lower ratings for the five states in the event of a U.S. debt downgrade, but would examine each on a “case-by-case basis,” looking at mitigating circumstances in each state “to determine if their financial position and governance are strong enough to negate the impact of a potential U.S. downgrade.”

Meanwhile, according to Moody’s, the other 10  AAA-rated states are not entirely immune from a federal debt downgrade. The ratings agency says that if the U.S. sovereign rating were to be lowered by “more than one notch,”  then Moody’s would have to re-evaluate whether those states -- Alaska, Delaware, Georgia, Indiana, Iowa, Missouri, North Carolina, Texas, Utah and Vermont  -- should be placed on review for downgrade as well.







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