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Rating Action:

Moody's downgrades five Portuguese regional and local governments

14 Jul 2010

Madrid, July 14, 2010 -- Moody's Investors Service has today downgraded to A1 from Aa2 the ratings of the Portuguese municipalities of Cascais, and Sintra. Moody's has also downgraded to A2 from Aa3 the ratings of the municipality of Lisbon as well as those of the Autonomous Regions of the Azores and Madeira. The outlook for all of these regional and local governments (RLGs) is negative. The rating actions conclude the review of Portuguese RLGs for possible downgrade initiated on 5 May 2010.

Today's downgrades of Portugal's RLGs were prompted by Moody's downgrade of Portugal's sovereign ratings to A1 from Aa2 occurred on 13 July 2010. The downgrade of the sovereign ratings reflects the fact that (i) the Portuguese government's financial strength will continue to weaken over the medium term; and (ii) the Portuguese economy's growth prospects are likely to remain relatively weak unless recent structural reforms bear fruit over the medium to longer term.

RATIONALE FOR DOWNGRADE

"The two-notch downgrade of Portugal's government bond ratings has implications for the ratings of regional and local governments within the country," explains Sebastien Hay, a Vice President and Senior Credit Officer in Moody's Sub-Sovereign Group. "Although Portuguese RLGs have substantial autonomy over their financial management, the national government has overall control of the sector via legislation and can impose strict limits on tax rates and debt levels," continues Mr. Hay. Moreover, Moody's recognises that Portuguese RLGs are reliant on transfers from the central government to fund both their operations and capital investments, which emphasises the close operational and financial linkages between the central government and RLGs.

With regard to Portuguese rated municipalities, Moody's points to a weakening in their revenue flexibility over the past few years given slowing tax revenue growth (especially in property transfer tax). Moreover, an expected fall in some operating revenue in 2010 is unlikely to be fully compensated by central government transfers, which are likely to stabilise or even decline in 2010 and 2011 as detailed in the central government's fiscal consolidation measures.

"In the context of uncertain levels of future government transfers, Moody's believes that rated Portuguese municipalities are unlikely to have a sufficient financial margin to permit their credit quality to be stronger than that of the sovereign itself," continues Mr. Hay. Moody's has therefore downgraded the ratings of Sintra and Cascais to A1 from Aa2, in line with the ratings of the sovereign.

The City of Lisbon was downgraded to A2 from Aa3, reflecting the economic and governmental factors noted above. Lisbon entered the economic downturn already with a negative outlook, due to high debt levels and a challenging budget plan with little margin for manoeuvre. The downturn and the uncertainties of governmental reform complicate these weaknesses, contributing to the City's continuing negative outlook.

The downgrade of the Autonomous Regions of the Azores and Madeira to A2 from Aa3 reflects their increasing levels of direct and indirect debt, especially in light of the likely difficulty the regions will encounter in stabilising or reducing this burden in the foreseeable future. These concerns are exacerbated by an anticipated fall in tax revenue and the regions' lack of flexibility over operating expenditure (given that healthcare and personnel costs account for a major part of their total expenses and are rigid by nature), which will impact operating balances going forward.

RATIONALE FOR THE NEGATIVE OUTLOOKS

The outlook for all Portuguese RLGs is negative, reflecting primarily the weak prospects for growth in the Portuguese economy, which will likely impact tax revenue going forward. Moreover, potential uncertainties associated with wider governmental reform leads to ambiguity in the timing and amounts of subsidies in the future. These uncertainties coincide with RLGs' relatively limited capabilities in cutting costs rapidly, given the large share of essential services and personnel costs in their budgets. Consequently, pressure on the finances of RLGs is likely to be sustained over the next two to three years.

The previous rating actions on the above-mentioned Portuguese RLGS were implemented on 5 May 2010, when their ratings were placed on review for possible downgrade.

The principal methodologies used in rating Portuguese Regional and Local Governments were Moody's "Regional and Local Governments Outside the US" and "The Application of Joint-Default Analysis to Regional and Local Governments", published in May and December 2008, respectively, and available on www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating these issuers can also be found in the Rating Methodologies sub-directory on Moody's website.

Madrid
Sebastien Hay
VP - Senior Credit Officer
Sub-Sovereign group
Moody's Investors Service Espana, S.A.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Milan
Mauro Crisafulli
Senior Vice President
Sub-Sovereign group
Moody's Investors Service
Telephone:+39-02-9148-1100

Moody's downgrades five Portuguese regional and local governments
No Related Data.
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