Moody's Investors Service warned Tuesday that it probably will lower the credit rating on five states if it downgrades the U.S. government's credit rating.
The credit rating agency said it has placed on review for possible downgrade the triple-A bond ratings of Maryland, New Mexico, South Carolina, Tennessee and Virginia.
A triple-A rating is the highest for debt and tells investors an institutional borrower presents a minimal credit risk.
Last week, Moody's placed the U.S. government's triple-A credit rating under review for a possible downgrade as Congress and the White House wrestle over raising the nation's $14.3 trillion borrowing limit. Moody's said there is a small but rising risk the government will default on its debt.
The government reached its borrowing limit in May. Treasury says the government will default on its debt if the limit is not raised by Aug. 2.
Any action on the states' ratings would come within 10 days of a U.S. rating downgrade, the firm said.
A downgrade would raise interest rates on U.S. treasury bonds, increasing the interest that taxpayers pay those who buy the bonds. It would also push up rates for mortgages, car loans and other debts, which are linked to Treasury rates.
It would have a ripple effect on states, particularly those that depend most on federal revenues and those with more federal government workers, contracts and Medicaid expenditures, among other factors.
"One of the factors that goes into a rating for a state is the health of their economy, so if the federal government is cutting back on activity within that state, that could weaken the economy," said Naomi Richman, Moody's managing director.
Another factor is the state's financial condition. If the federal government cuts back on programs that benefit a state, such as Medicaid, that also could affect the state's budget and finances, Richman added.
States could also be susceptible to any fallout in the capital markets, depending on what's happening at the federal level.
In addition, lower credit ratings can affect a state's ability to issue debt, by making it more expensive to do so.
Moody's examined the 15 states that have a triple-A credit rating to determine which might be most vulnerable to the fallout from a downgrade in the U.S. government's rating. The firm concluded that Maryland, New Mexico, South Carolina, Tennessee and Virginia would be most at risk.
The firm's review affects some $24 billion in obligations and related debt for the five states combined.
Should Moody's lower the U.S. government's rating due to a default following a failure by the government to raise the nation's debt ceiling, the firm said it will conduct another review of the five states to gauge if their financial position and governance are strong enough to overcome the impact of a U.S. downgrade.
Moody's said the other 10 states with a triple-A rating are resilient enough to withstand a one-notch downgrade in the U.S. government's rating.
Those states are: Alaska, Delaware, Georgia, Indiana, Iowa, Missouri, North Carolina, Texas, Utah and Vermont.
Should the firm end up lowering the nation's rating by more than one notch, the status of those 10 states could change.
The remaining 35 states and the District of Columbia have lower credit ratings.