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A moderate downgrade of U.S. sovereign debt would increase borrowing costs and cause "unrealized losses" for holders of U.S. Treasuries, but the results wouldn't be catastrophic, says Guardian finance chief Robert Broatch.
Vincent Ryan, CFO.com | US
July 29, 2011
As the owner of a large bond portfolio and holder of a AA+ credit rating, The Guardian Life Insurance Company of America could get hit on both sides of the balance sheet if U.S. sovereign debt is downgraded. But the looming deadline on raising the U.S. debt ceiling is not causing a lot of hand-wringing for Guardian CFO Robert Broatch.
Broatch says Guardian is not taking any drastic action with its investment portfolio or any other parts of its business. "We think we are going to come through this just fine," he says. "There is going to be a little hiccup here as markets adjust, but we have not felt it appropriate to take dramatic moves."
The most likely effect of the United States losing its AAA rating is a widening of bond spreads, since they are all tied to U.S. Treasury rates, says Broatch. "Borrowing would be more costly and you would have some unrealized losses," he notes. But rebalancing Guardian's bond portfolio — including its holdings of U.S. Treasuries — at this time would be "speculative" and "could be dramatically wrong," he says.
Fitch Ratings intimated on Wednesday that the prices of Treasuries are not likely to fall dramatically in a moderate downgrade scenario. The immediate aftermath of a U.S. downgrade would "spark volatility" in Treasuries and broader financial markets, but Fitch says "U.S. Treasuries would likely retain their standing as the benchmark security that anchors global fixed-income markets." Treasuries have "unparalleled liquidity," and there is a lack of viable alternatives for a global benchmark, notes Fitch.
The $9.3 trillion in marketable U.S. Treasury securities is roughly five times the size of the French ($1.9 trillion), U.K. ($1.8 trillion), and German ($1.6 trillion) government bond markets, according to Fitch. Fitch also cites Treasury notes' "unparalleled" market liquidity. Daily trading volumes of Treasuries ($580 billion) are almost 10 times higher than that of U.K. gilts and German bunds combined. "This deep market liquidity enables holders to convert Treasury securities into dollars with negligible transaction costs, irrespective of market conditions," Fitch says.
As to Guardian's own credit rating, Standard & Poor's has said it could downgrade some AAA-rated insurance companies, such as Northwestern Mutual Life, based on economic volatility from a downgrade or federal default, a devaluation of the U.S. dollar, and a deterioration of their large holdings in U.S. Treasuries.
But if the United States loses its AAA rating by only one notch, Broatch says AA+ Guardian won't be affected, according to conversations he's had with the credit-rating agencies. In a less-likely scenario — a two-notch downgrade of U.S. debt — "the rating agencies might put our credit under review but not take action," says Broatch. A weakening U.S. credit rating or a technical default by the United States does not mean Guardian's credit is weaker or the company is any less able to fulfill its obligations, he points out.
Broatch thinks the European debt crisis is more problematic than the U.S. situation, because there are fundamental economic problems in the eurozone countries that could result in real economic loss for many people. "I don't want to minimize [the possibility of a U.S. downgrade]," says the CFO. "It's embarrassing to think where we are with this political system and that we could be having this kind of conversation."
As the result of a threat of a downgrade to U.S. sovereign debt, Standard & Poor's has already placed some categories of financial instruments on negative CreditWatch. They include 125 FDIC-insured AAA-rated debt obligations issued by 30 financial institutions under the Temporary Liquidity Guarantee Program and 604 structured finance transactions with a total original issuance value of $374 billion.