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Fitch: DOD Budget/QDR Should Strengthen Defense Credit Quality.

NEW YORK -- The releases of the Department of Defense (DOD) fiscal year (FY) 2007 budget request and the Quadrennial Defense Review (QDR) have lessened near-term uncertainty in the defense sector and provide support for improvement in the sector's debt ratings. Although requested spending in FY2007 is modestly lower than the DOD projected in last year's budget, the request is higher than Fitch expected and preliminary projections for FY2008 through FY2011 appear to grow more than anticipated, with growth rates in the mid-single digits. The QDR reflects the DOD's existing transformation strategy, and no major program changes were announced. If the budget request is approved by Congress, the budget could support positive ratings actions in Fitch's defense coverage, barring significant cash deployment for acquisitions or share repurchases.

Excluding supplemental budgets, the budget request includes $439.3 billion for total DOD spending in FY2007 and $157.4 billion for modernization spending (procurement and R&D), both up 6.9% versus FY2006 but slightly below the levels projected in last year's budget request. Office of Management and Budget (OMB) projections of total DOD spending through 2011 are slightly ahead of last year's budget projections, showing a compound annual growth rate of 4.2%. Preliminary projections for modernization spending through 2011, the most important numbers for the defense contractors, are higher than last year's projections, particularly for R&D. The modernization compound annual growth rate is 5.0%. The speculated 'cuts' to the budget growth rates did not materialize, and growth rates are better than the low-single digit growth rates incorporated into most of Fitch's defense ratings.

The high levels of supplemental DOD budgets used to fund operations in the war on terror continue to support defense sector financial performance. A $70 billion supplemental request will likely be submitted to support operations in FY2006, and a $50 billion supplemental is planned to support FY2007 operations. Fitch estimates that supplemental budgets approximating $260 billion have gone to the DOD since Sept. 11, 2001. While most of the supplemental funds do not directly benefit the defense contractors, an increasing percentage has gone to modernization spending.

The QDR includes most of the themes that have been in place in the DOD since 9/11, and all major programs remain intact. However, the QDR is not fully reflected in the FY2008-FY2011 DOD budget projections. Fitch believes there are still risks within the budget to some legacy programs, although uncertainty about overall DOD spending levels has declined.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.
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Publication:Business Wire
Date:Feb 7, 2006
Words:471
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