On Friday August 5th Standard & Poor’s downgraded the credit rating on U.S. Debt from AAA to AA+, while issuing a negative outlook for the future, indicating future downgrades might be possible. While the initial reaction has largely been negative and fear has taken hold of many investors and the markets, in the long run the downgrade’s effects are not that severe. For one, both Moody’s and Fitch, the two other prominent rating agencies, both reaffirmed their credit ratings on U.S. Debt at AAA over the weekend. The fact only one rating agency has downgraded U.S. debt will minimize the financial impact. Secondly, the downgrade by Standard & Poor’s to an extent calls into question the grading system as a whole. U.S. currency is still considered the strongest currency, so some analysts are arguing that the downgrade by Standard & Poor’s to AA+ in essence means that the highest standard has just fallen slightly, but the U.S. is still the highest standard.
As it specifically relates to commercial lending and commercial loans, the effect should be minimal. The larger issue for bank’s was the debt ceiling, because the failure of the government to increase the debt ceiling could have negatively impacted many banks’ liquidity as those banks would have been incapable of borrowing from the Fed. However, with the debt ceiling increase the banks are fine. Although borrowing costs in the United States could go up slightly due to the credit rating downgrade, which would likely impact banks, because only Standard & Poor’s made the downgrade it is unlikely interest costs would go up much, limiting the impact to commercial loan borrowers who would likely see that cost passed onto them.
We continue to contend that the larger term impact to commercial loan and commercial lending is going to come from other factors such as the slowing economy, additional job cuts related to federal spending cuts and the longer-term outlook on unemployment, and the possibility of future tax increases, which typically negatively impact business and spending. If unemployment spikes back up and / or spending continues to fall, it is likely defaults on business and consumer loans would spike again, causing another pull back in commercial lending, and could cause some additional bank failures for those banks struggling and without the capital to support additional losses. However, such negative economic news would likely keep interest rates low, benefiting strong commercial loan borrowers. Like the economy as a whole, the commercial lending market is in unchartered waters, and it will take time for commercial loan managers to sort through all of the economic news and chart the best course of action. Certainly we are far from a full recovery in commercial lending, and until that happens, commercial loans will continue to be challenging to get.