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Rating Action:

Moody's downgrades Spain's government bond rating to Baa3 from A3, on review for further downgrade

 The document has been translated in other languages

Global Credit Research - 13 Jun 2012
NOTE: On June 22, 2012 the press release was revised as follows: Correct the sixth paragraph to add the following: "Short-term ratings were also placed on review for possible further downgrade." Revised release follows.

London, 13 June 2012 -- Moody's Investors Service has today downgraded Spain's government bond rating to Baa3 from A3, and has also placed it on review for possible further downgrade. Moody's expects to conclude the review within a maximum timeframe of three months.

The decision to downgrade the Kingdom of Spain's rating reflects the following key factors:

1. The Spanish government intends to borrow up to EUR100 billion from the European Financial Stability Facility (EFSF) or from its successor, the European Stability Mechanism (ESM), to recapitalise its banking system. This will further increase the country's debt burden, which has risen dramatically since the onset of the financial crisis.

2. The Spanish government has very limited financial market access, as evidenced both by its reliance on the EFSF or ESM for the recapitalisation funds and its growing dependence on its domestic banks as the primary purchasers of its new bond issues, who in turn obtain funding from the ECB.

3. The Spanish economy's continued weakness makes the government's weakening financial strength and its increased vulnerability to a sudden stop in funding a much more serious concern than would be the case if there was a reasonable expectation of vigorous economic growth within the next few years.

Moody's has today also downgraded the rating of Spain's Fondo de Reestructuración Ordenada Bancaria (FROB) to Baa3 from A3 and placed the rating on review for possible further downgrade, in line with the sovereign rating action. The FROB's debt is fully and unconditionally guaranteed by the government of Spain. Moreover, the provisional short-term rating of the Spanish government has today also been downgraded to (P)Prime-3 from (P)Prime-2. Similarly, FROB's short-term rating was lowered to P-3 from P-2.

The review for downgrade will focus on the outcome of the ongoing external audits of the Spanish banking system, the conditionality and details of the EFSF/ESM loan agreement, and the specific execution strategy developed for the banking system's recapitalisation. Moody's will also consider any further initiatives at the euro area level. In addition, Spain's rating -- as well as the ratings of other euro area countries -- could be adversely affected if the risk of a Greek exit from the euro area were to rise further. Short-term ratings were also placed on review for possible further downgrade.

RATINGS RATIONALE

The first key driver underlying Moody's three-notch downgrade of Spain's government bond rating is the government's decision to seek up to EUR100 billion of external funding from the EFSF or ESM. A formal request will be presented shortly, but the euro area finance ministers announced on 10 June their willingness to accede to that request. The sum of EUR100 billion is twice the size of Moody's previous base case estimate, and in line with the rating agency's adverse case estimate.

While the details of the support package have yet to be announced, it is clear that the responsibility for supporting Spanish banks rests with the Spanish government. EFSF funds will be lent to the government which will use them to recapitalise Spanish banks. This borrowing will materially worsen the government's debt position: Moody's now expects Spain's public debt ratio to rise to around 90% of GDP this year and to continue rising until the middle of the decade. Stabilising the ratio will be a key challenge for the Spanish authorities, requiring years of continued fiscal consolidation. As a consequence, the government's fiscal and debt position is no longer commensurate with a rating in the A range or even at the top of the Baa range.

The second driver of today's rating action is the Spanish government's very limited financial market access, as evidenced both by its reliance on the EFSF or ESM for the recapitalisation funds and its growing dependence on its domestic banks as the primary purchasers of its new bond issues, who in turn require funding from the ECB to purchase these bonds. In Moody's view, this is an unsustainable situation. In the absence of positive developments that shore up investor sentiment, such as a resumption of growth or rapid progress in achieving fiscal consolidation objectives, neither of which is likely in the current environment, the government is likely to become increasingly constrained with regard to the terms under which it is able to refinance maturing debt. If unchecked, Moody's believes that the risk of the government losing access to private debt markets on affordable terms and needing to seek direct support from the EFSF/ESM will continue to rise.

Given the experience with private-sector involvement (PSI) in Greece and the intentions expressed by euro area officials around the development of the ESM, Moody's believes that the debts of euro area sovereigns that are fully dependent upon official sources to fund their borrowing requirements represent speculative-grade risk. Support would, if needed for a sustained period, be likely to be made conditional on loss-sharing with private investors or in extremis withdrawn altogether.

Moody's action to place the government's rating one notch above speculative grade reflects the rating agency's view that Spain has moved much closer to needing to seek direct support from the EFSF/ESM, and therefore much closer to being positioned within speculative grade.

Moody's decision to leave the government's rating in investment grade reflects the underlying strength of the Spanish economy and the government's clear desire to reverse the debt trajectory through a strong fiscal consolidation programme. Moody's also acknowledges several factors that differentiate the current programme from the support packages extended to Ireland, Portugal and Greece. In particular, the size of the support package is significantly smaller than it is in the other cases. The maximum amount of EUR100 billion equates to around 10% of Spain's GDP, compared with more than 54% of GDP in the case of Ireland, 114% of GDP in Greece and 46% of GDP in Portugal. Moody's therefore also considers the issue of subordination of bondholders to the senior creditor EFSF/ESM to be less of a negative factor. Senior creditors account for 37% and 40% of total public debt in Ireland and Portugal, while the respective share in Spain is 11% (in case the maximum amount was drawn).

FOCUS OF THE RATING REVIEW

Moody's has today also placed Spain's Baa3 government bond rating on review for possible further downgrade in order to assess the implications of several factors on the Spanish government's ability to continue to fund its borrowing requirements in the private debt markets. These factors are as follows:

- The clarification of the remaining open questions regarding the size and terms of the banking support package.

- The ultimate size of the government's liability following the results of the independent valuations and audits of all the Spanish banks, which are expected on 31 July.

- Any further initiative at the euro-area level, in particular those relating to steps towards a fiscal and banking union.

- The impact of the banking support package on Spain's ability to restore market confidence in the banking sector and by extension in the government bond market.

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Sovereign Bond Ratings Methodology published in September 2008. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides relevant regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides relevant regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides relevant regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

The ratings have been disclosed to the rated entities or their designated agent(s) and issued with no amendment resulting from that disclosure.

Information sources used to prepare each of the ratings are the following: parties involved in the ratings, parties not involved in the ratings, public information, and confidential and proprietary Moody's Investors Service information.

Moody's considers the quality of information available on the rated entities, obligations or credits satisfactory for the purposes of issuing these ratings.

Moody's adopts all necessary measures so that the information it uses in assigning the ratings is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Moody's Investors Service may have provided Ancillary or Other Permissible Service(s) to the rated entities or their related third parties within the two years preceding the credit rating action. Please see the special report "Ancillary or other permissible services provided to entities rated by MIS's EU credit rating agencies" on the ratings disclosure page on our website www.moodys.com for further information.

Please see the ratings disclosure page on www.moodys.com for general disclosure on potential conflicts of interests.

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Please see Moody's Rating Symbols and Definitions on the Rating Process page on www.moodys.com for further information on the meaning of each rating category and the definition of default and recovery.

Please see ratings tab on the issuer/entity page on www.moodys.com for the last rating action and the rating history.

The date on which some ratings were first released goes back to a time before Moody's ratings were fully digitized and accurate data may not be available. Consequently, Moody's provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Kathrin Muehlbronner
Vice President - Senior Analyst
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Bart Oosterveld
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's downgrades Spain's government bond rating to Baa3 from A3, on review for further downgrade
No Related Data.
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