Commentary:
Responding to S&P Downgrade of US Treasuries
What happened?
Standard & Poor’s (S&P) downgraded the long-
term rating for US Treasury debt one level from
AAA to AA+ on Friday August 5, 2011.
What about the other rating agencies?
S&P was the only rating agency to take this action.
Fitch Ratings and Moody’s Investors Services
affirmed their AAA rating for US Treasury debt on
August 2, 2011.
Why did this happen?
In the report, S&P stated, “the downgrade reflects
our view that the effectiveness, stability, and
predictability of American policymaking and
political institutions have weakened at a time of
ongoing fiscal and economic challenges to a
degree more than we envisioned when we
assigned a negative outlook to the rating on April
18, 2011.”
What does that mean?
The official report states, “We lowered our long-
term rating on the U.S. because we believe that
the prolonged controversy over raising the
statutory debt ceiling and the related fiscal policy
debate indicate that further near-term progress
containing the growth in public spending,
especially on entitlements, or on reaching an
agreement on raising revenues is less likely than
we previously assumed and will remain a
contentious and fitful process. We also believe that
the fiscal consolidation plan that Congress and the
Administration agreed to this week falls short of the
amount that we believe is necessary to stabilize
the general government debt burden by the middle
of the decade.”
In a nutshell, in S&P's opinion, the budget
agreement was not enough to show progress
August 7, 2011
toward sustainable deficit reduction.
You mentioned ‘long-term rating’. Is there a
short-term rating?
The US has 2 ratings. While the long-term rating
was reduced by one level, S&P affirmed the short-
term rating of A-1+ which is the rating for all US T-
Bills and the highest rating available.
US Banks are large holders of US Treasuries.
Could this pose any problems for US Banks?
This should not be a problem, as the Federal
Reserve has already announced there will
currently be no changes for banks from a capital
perspective.
US insurance companies are also large holders
of US Treasuries are there any issues for
them?
This news should not impact US insurance
companies. US insurance companies adhere to
NAIC ratings (NAIC stands for the National
Association of Insurance Commissioners). The
NAIC has established various bands that indicate
the capital requirement for each investment, with
the highest band (least risk) named the Class 1
band. The NAIC Class 1 band is quite wide
(including securities rated from AAA to A-), as a
result US Treasuries will remain in the Class 1
band.
How might this affect AAA corporations who
issue in US dollars?
The impact is expected to be limited as there are
very few corporations with AAA ratings since the
credit crisis. Of the 3,872 bonds in the Barclays
Aggregate Corporate Bond Index as of July 31,
2011, 46 of those bonds have AAA ratings.
Currently, these bonds represent 1.2% of the
Corporate Bond Index and 0.24% of the Barclays
US Aggregate Bond Index. Of the 11 issuers,
there are 5 corporations, 1 medical institute and 5
higher education institutions;
AAA Corporations
Johnson & Johnson (16 bonds)
Microsoft (10 bonds)
Rabobank (4 bonds)
SeaRiver Martime – a division of ExxonMobil (1
bond)
XTO Energy – a division of ExxonMobil (5 bonds)
AAA Medical Institute
Howard Hughes Medical Institute (1 bond)
AAA Higher Education Institutions
Massachusetts Institute of Technology (1 bond)
Harvard University (2 bonds)
Princeton University (2 bonds)
Stanford University (3 bonds)
Yale University (1 bond)
In addition, there is precedent in some emerging
market countries where corporations have had
higher credit ratings than the government.
How might this impact US Treasury yields?
As we state in our research article “When ‘Risk-
Free’ Isn’t Risk Free: The Impact of a US Treasury
Downgrade”, “We researched the potential market
impact by studying previous downgrades of
sovereign debt. We found that US Treasuries are
not likely to see a large increase in yields simply
due to a ratings downgrade.” The article goes on
to observe that a significant change in yield occurs
when the rating declines to BBB+.
Does this impact the investment guidelines of
any AllianceBernstein Fixed Income portfolios?
No.
For AllianceBernstein institutional separately
managed accounts, we typically apply the ‘higher
of ‘ when applying a credit rating. Since Moody’s
and Fitch affirmed their AAA rating for US
Treasuries, they will continue to be viewed as
AAA. A letter was distributed for clients that might
August 7, 2011
be impacted by a downgrade last week.
For AllianceBernstein mutual funds, we do have
some mutual funds that apply the ‘lower of’ when
applying a credit rating. However, most of our
guideline tests relate to investment grade and
limits on below investment grade securities. Since
US Treasuries are still investment grade this will
not impact any of the portfolios.
For Barclays Capital Indices, it is important to note
the methodology applied by Barclays Capital, the
benchmark chosen by many of our fixed income
clients. Barclays Capital applies the middle rating
from Moody’s, S&P and Fitch after dropping the
highest and lowest ratings available. Since
Moody’s and Fitch continue to rate US Treasuries
AAA, they will continue to be classified as AAA by
the Barclays Capital Indices.
Does this announcement change the portfolio
strategy for our Fixed Income portfolios?
No. This announcement does not change our
views in the portfolio. As mentioned in the note
"Responding to a Volatile Market" distributed on
Friday August 5, 2011 we noted, “Over the past
several quarters, we have gradually been reducing
risk in our fixed-income portfolios as compensation
for risk (as measured by credit spreads) has
declined and uncertainty has risen.” Please refer
to that report for additional information.
Does AllianceBernstein think large central
banks, such as China, will be compelled to sell
US Treasuries on this news?
No. While there have been some comments by
China recently with regard to the US deficit, we do
not believe the downgrade will result in significant
short term sales of US Treasuries by China. China
has been diversifying its investments for some time
and will continue to do so. We expect this
diversification will likely continue through the
investment of newly accumulated foreign
exchange reserves rather than selling US
Treasuries to purchase securities in other
government bond markets.
2
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