Our other option is to hold the lower-rated bonds until they mature. The bonds’ issuers will continue to make interest payments despite the downgrade. The county will continue to earn interest; and when the bonds mature, we would invest the money in appropriately rated investments.
Our Defense against a Potential Default
If the federal government defaults on its debt, this means the government is unable to pay interest to bond holders. However, default only affects one type of investment: US Treasury Bonds.
A default would not affect the principal, the amount of money we purchased, of the bond. It means the government would not pay the interest. Once the White House and Congress find a solution to the deficit impasse, we expect that interest payments would resume.
If the government “called” the bond, meaning it purchased back the bond, rather than resume interest payments, the county would receive its initial investment minus future interest payments.
We have $10.3-million worth of US Treasury Bonds, or 3.5-percent, in our portfolio as of July 22, 2011.
How a US Downgrade Affects Will County’s Credit Rating
According to the world’s largest and most prominent asset manager, BlackRock, a downgrading of US debt will cause several unintended consequences. The most important to Will County (and other local government) is a concept in finance called the “sovereign ceiling rule.”
The sovereign ceiling rule says that, with few exceptions, the private sector cannot have a higher credit rating than the government. This follows the fact that the S&P said they would downgrade other AAA- rated companies such as Fannie Mae and US insurance agencies.
The sovereign ceiling rule also can apply to municipal bonds issuers, such as Will County.
In April 2010, Standard and Poor’s rating service affirmed its “AA+” rating to Will County’s outstanding debt. This means the county’s finances are very strong, and it is one rating level below the highest “AAA” rating. If the S&P were to apply the sovereign ceiling rule to municipalities, Will County could see a downgrade in its credit rating through no fault of our own. A downgrade to “AA” or “A” would make it more expensive for the county to borrow money in the future, but not affect the interest rate we pay on our debt today.
Conclusion and Recommendation for Local Government
Even if you do not believe the government will default on its debt, or that the S&P will cut ratings, our office must prepare in the event either actually occur.
It is our opinion that Will County’s investment portfolio will be secure in the event of a default or a credit downgrade. We say this because over half of our investments are in bank CDs or cash. As a