FROB's Aa1 rating also downgraded to Aa2 with negative outlook
London, 10 March 2011 -- Moody's Investors Service has today downgraded Spain's government
bond ratings by one notch to Aa2 from Aa1. The outlook on the Aa2
ratings is negative. Today's rating action concludes the
review for possible downgrade, which Moody's initiated on
15 December 2010.
The main triggers for the downgrade are:
(1) Moody's expectation that the eventual cost of bank restructuring
will exceed the government's current assumptions, leading
to a further increase in the public debt ratio.
(2) Moody's continued concerns over the ability of the Spanish government
to achieve the required sustainable and structural improvement in general
government finances, given the limits of central government control
over the regional governments' finances as well as the background
of only moderate economic growth in the short to medium term.
The decision to assign a negative outlook to the rating reflects Moody's
view that the risks to Spain's government finances remain skewed
to the downside. Spain's vulnerability to market disruption
remains elevated given the high funding requirements, not only for
the sovereign but also for the regional governments and the banks.
Moody's has today also downgraded the rating of Spain's Fondo de
Reestructuración Ordenada Bancaria (FROB) to Aa2 from Aa1 with
a negative outlook as the FROB's debt is fully and unconditionally
guaranteed by the government of Spain.
Spain's country ceilings for bonds and bank deposits are unaffected
by today's rating action and remain at Aaa (in line with the Eurozone's
rating). Spain's P-1 short-term rating is unaffected
by today's rating action.
RATINGS RATIONALE
The considerations that drove Moody's to place the ratings of the
Kingdom of Spain under review on 15 December 2010 continue to be the rating
agency's main concerns and have triggered today's rating action.
Firstly, Moody's continues to have concerns over the ultimate
cost of recapitalizing the saving banks ("cajas").
Although Moody's acknowledges that the government's recently
announced acceleration of efforts to restructure the cajas is likely to
strengthen the country's banking landscape, the rating agency
believes there is a meaningful risk that the eventual cost of the recapitalization
effort could considerably exceed the government's current projections
-- and Moody's own earlier estimates from December 2010 (which
were calculated using a minimum tier-1 capital ratio of 8%
for all entities). Specifically, the government estimates
the cost to be a maximum of €20 billion (less than 2% of GDP),
which is based on the capital requirements as percentage of risk-weighted
assets as of 31st December 2010. However, Moody's believes
the overall cost is likely to be nearer to €40-50 billion,
reflecting more than twice Moody's earlier estimates of recapitalization
needs of €17 billion because (1) the definition of eligible capital
instruments has been tightened, and (2) capital requirements have
been raised to a core capital ratio of 10% for those institutions
with a limited private investor base and high dependence on wholesale
funding. Indeed, Moody's believes that, in a
more stressed scenario, recapitalization needs could increase to
approximately €110-120 billion.
Secondly, the recently published budget execution data for 2010
revealed that the path to fiscal consolidation remains unclear for some
of Spain's regional governments. Last year, 9 out of
17 autonomous communities breached the budget deficit target of 2.4%
of GDP, some by a wide margin. This casts doubts over the
ability of the central government to exercise sufficient control over
the regions to ensure compliance with deficit targets. This year's
budget deficit target of 1.3% is significantly more ambitious
than that of last year, and the effort required to implement it
would be quite unprecedented for many regions. Moody's expects
that the regions will manage to reduce their deficits this year,
but observes that most of the improvement will likely come from cuts to
capital spending plus reduced personnel expenses due to the freeze in
public-sector wages -neither of which are sustainable policies.
Moreover, there are no new policy initiatives to reduce the regions'
structural spending pressures in the areas of healthcare and education,
beyond last year's reduction in pharmaceutical costs and the replacement
of only 10% of retiring public-sector workers. In
addition to the regional government finances, the social security
-- which has traditionally recorded a surplus in Spain -- also
recorded a deficit for the first time since 1998, mainly driven
by high outlays for unemployment benefits. This is unlikely to
change this year given the outlook for the labour market. Under
Moody's base case assumptions, GDP growth will accelerate
only moderately this year (to 0.8% from -0.1%
in 2010) and the unemployment rate is expected to remain close to current
levels.
Moody's recognizes the government's resolve in addressing
the country's key weaknesses, which is a key reason for limiting
the downgrade to one notch. The government is accelerating the
process of bank recapitalization and has just agreed a pension reform
with the trade unions and employers' association. An important
reform to the system of collective bargaining is on the agenda for the
end of March at the latest. This should be an important step towards
gradually making the labour market more flexible. Moody's
also acknowledges that the government achieved the target set for the
general government budget deficit in 2010 (9.24% of GDP
versus target of 9.3%) and reduced its own central government
deficit by a full percentage point of GDP more than the target (5.66%
of GDP versus target of 6.7% in cash terms). At around
60% of GDP in 2010, Spain's public debt ratio is lower
than that of several important peers, including Germany, France,
the UK, Belgium and Italy. Even including the higher estimates
for bank recapitalization, Spain's debt ratio would remain
lower than those of Italy (Aa2, stable) and Belgium (Aa1,
stable).
Moody's continues to believe that Spain's debt sustainability
is not under threat, and its baseline assumptions do not anticipate
a need for the Spanish government to ask for EFSF liquidity support.
However, Spain's substantial funding requirements --
not only those of the sovereign, but also those of the regional
governments and the banks -- make the country susceptible to further
episodes of funding stress.
WHAT COULD CHANGE THE RATING DOWN
Moody's would downgrade the ratings further if there are indications
that Spain's fiscal targets will be missed and if the public debt
ratio increases more rapidly than currently expected. Moody's
concerns relate less to the actual level of public debt than to the very
rapid increase in debt recorded since 2008 (doubling between 2007 and
2012) and the fact that, under current assumptions, a stabilization
of the debt ratio is unlikely to occur before the middle of the decade.
The ratings could also face further downward pressure if the recapitalisation
needs for the banking sector increase further beyond Moody's current
expectations, as this would result in a further rise in government
debt and increasing pressure on debt affordability. A need to access
the EFSF, although unlikely in Moody's view, would probably
lead to a downgrade to below the Aa range.
WHAT COULD CHANGE THE RATING UP
Moody's would return the outlook to stable and upgrade the ratings
if the rebalancing of the Spanish economy proceeded much faster than currently
expected. The rating agency expects a modest acceleration in GDP
growth in 2011 to an average rate of 0.8%. Our forecast
for the future years incorporate a moderate further acceleration.
On average, real GDP growth is expected at around 1.5%
for the period 2012-2014. A sustained rebalancing towards
a more export-driven economic model would also contribute to a
reduction in the still elevated external vulnerability of the Spanish
economy.
The implementation of effective policies to address the structural spending
pressures at the regional government level, combined with stricter
control by central government, would also be positive for Spain's
creditworthiness.
For further information, please see Moody's Special Comment "Key
Drivers Behind Moody's Decision to Downgrade Spain's Rating"
which will be published today on www.moodys.com.
PREVIOUS RATING ACTION AND METHODOLOGY
The principal methodology used in this rating was Sovereign Bond Ratings
published in September 2008.
Moody's last rating action affecting Spain was implemented on 15
December 2010, when the rating agency placed Spain's Aa1 government
bond ratings on review for possible downgrade. The rating action
prior to that was taken on 30 September 2010, when the rating agency
downgraded Spain's Aaa ratings to Aa1 with a stable outlook.
Moody's last rating action affecting FROB was implemented on 15 December
2010, when the rating agency placed the FROB's Aa1 rating
on review for possible downgrade. This action followed the parallel
rating action on the government of Spain, which provides a full
guarantee on the senior unsecured debt issued by FROB.
REGULATORY DISCLOSURES
Information sources used to prepare the credit rating are the following:
parties involved in the ratings, parties not involved in the ratings,
and public information.
Moody's Investors Service considers the quality of information available
on the issuer or obligation satisfactory for the purposes of maintaining
a credit rating.
The rating has been disclosed to the rated entity or its designated agents
and issued with no amendment resulting from that disclosure.
Moody's Investors Service may have provided Ancillary or Other Permissible
Service(s) to the rated entity or its related third parties within the
three years preceding the Credit Rating Action. Please see the
ratings disclosure page www.moodys.com/disclosures on our
website for further information.
Moody's adopts all necessary measures so that the information it uses
in assigning a credit rating 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.
Please see ratings tab on the issuer/entity page on Moodys.com
for the last rating action and the rating history.
The date on which some Credit Ratings were first released goes back to
a time before Moody's Investors Service's Credit Ratings were fully digitized
and accurate data may not be available. Consequently, Moody's
Investors Service 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 the Credit Policy page on Moodys.com for the methodologies
used in determining ratings, further information on the meaning
of each rating category and the definition of default and recovery.
London
Kathrin Muehlbronner
Vice President - Senior Analyst
Financial Institutions Group
Moody's Investors Service Ltd.
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New York
Bart Oosterveld
MD-CCO Pub, Proj and Infra Fin
Financial Institutions Group
Moody's Investors Service
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Moody's downgrades Spain's rating to Aa2 with a negative outlook
