Saturday, July 30, 2011

The Debt Ceiling Debate in Washington

Below is an email we sent out to our clients earlier in the week:

We have had a few questions recently about the debt ceiling debate in Washington. The most frequently asked question concerns what impact the failure to raise the debt limit might have on portfolios we manage. Our expectation is that it would have a minor impact on the investments we hold. We should emphasize that we expect a debt ceiling deal to be made and a delay of a week or so past the August 2 “deadline” does not equate to a default. A delay could lead to a partial government shutdown as outgoing payments must equal the $200 billion the government collects in monthly tax revenues, rather than the approximately $280 billion the federal government spends per month now.

Turning to the investments, the stocks we own either directly or through mutual funds are almost exclusively high quality companies with strong balance sheets. We would expect that they would ride out this period with relatively limited impact on their operations. Some of the companies do a substantial amount of work with the federal government and so might see a short-term revenue hit. We believe that even these companies have the financial wherewithal to manage through that period and ultimately would collect any money owed to them. It is also worth noting, we have had a number of stocks we own directly, hit our target sale prices so we have been selling and allowing cash to build up in our portfolios. This gives us flexibility going forward.

As far as fixed income goes, we primarily own high quality corporate bonds of similarly well managed, conservatively financed companies. We expect no issues in collecting our interest and principal payments from them. Another area of the fixed income market we have invested in, more as a cash management tool, has been callable agency bonds. Again, we think ultimate collection of interest and principal due is not at risk. Our worst case scenario would be, in an effort to conserve cash, these agencies of the federal government might not call their securities (meaning buy back their bonds prior to the maturity date) even though it would make financial sense. This would lead to a modest increase in the average maturity of our bond portfolios.

While the future is unknowable, we believe we are well positioned to ride out this period. Overall, we have cash available for opportunities that a market dislocation might provide and we feel good about what we own.