How Would a Downgrade of the U.S.'s Debt Impact Defeased Muni Bonds?

Approximately $457 billion of municipal securities have been prerefunded or are currently pending refunding, according to Bloomberg data (this includes the accreted maturity value of zero coupon bonds). Bonds are defeased by collateralizing the debt with a portfolio government securities (such as direct obligations of the U.S. government, obligations guaranteed by the U.S. government, or securities backed by U.S. government obligations as collateral) that are essentially risk-free (meaning credit risk) as to the amount, timing, and collection of interest and principal. With Moody's, S&P, and Fitch all putting the U.S. on a negative watch, what would a downgrade mean to these "risk-free" securities and the municipal securities that have been legally and financially defeased? Will they no longer be legally defeased? Will issuers be required to add the debt back into their balance sheets?

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Moody's Special Comment "Implications of a U.S. Rating Action for other Aaa Issuers" notes that the ratings on pre-refunded municipal bonds that are defeased and secured by escrows funded with U.S. Treasuries or other directly linked credits would move in lock-step with the sovereign rating. http://su.pr/22DeSh

 

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