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15 Dec 2010
Short-term ratings are affirmed at P-1; FROB's Aa1 rating also placed on review for possible downgrade
London, 15 December 2010 -- Moody's Investors Service has today placed Spain's Aa1 local and
foreign currency government bond ratings on review for possible downgrade.
The main triggers for placing the rating on review for possible downgrade
(1) Spain's vulnerability to funding stress given its high refinancing
needs in 2011. This vulnerability has recently been amplified by
fragile market confidence.
(2) A potential further increase in the public debt ratio should the cost
of bank recapitalisation prove to be higher than expected so far,
whether to meet higher-than-expected asset impairments or
simply to retain the confidence of the wholesale markets.
(3) Increased 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
Moody's has also placed the Aa1 rating of Spain's Fondo de Reestructuración
Ordenada Bancaria (FROB) on review for possible downgrade as the FROB's
debt is fully and unconditionally guaranteed by the government of Spain.
No further ratings or outlooks have been changed as part of today's
"Moody's believes that the above-mentioned downside
risks warrant putting Spain's rating under review for downgrade",
says Ms Muehlbronner, Moody's Vice President and lead analyst
for Spain. "However, Moody's also wants to stress
that it continues to view Spain as a much stronger credit than other stressed
Euro zone countries. This is reflected in the significantly higher
rating for the Spanish sovereign. Moody's review will therefore
most likely conclude that Spain's rating will remain in the Aa range."
RATIONALE FOR REVIEW FOR DOWNGRADE
"Moody's does not believe that Spain's solvency is under
threat, and in its base case assumptions does not expect the Spanish
government to have to ask for EFSF liquidity support. However,
Spain's substantial funding requirements, not only for the
sovereign but also for the regional governments and the banks, make
the country susceptible to further episodes of funding stress.
This is one of the drivers behind the review for possible downgrade,"
says Kathrin Muehlbronner.
The Spanish government will need to raise approximately EUR170 billion
(including Treasury Bill roll-over requirements) in 2011,
even after taking into account the potential revenues from the recently
announced privatizations. In addition, regional governments
have refinancing needs of around EUR 30 billion next year. Moreover,
the Spanish banks, whose own funding capacity partly depends on
the fortunes of the Spanish sovereign, have around EUR90 billion
worth of term debt to refinance in 2011.
Moody's notes that these needs are now rendered more challenging
by the fragile confidence of international capital markets. Over
the past few years, foreign investors have typically funded around
50% of Spain's overall funding requirements. However,
they may be less willing to do so in the immediate future given recent
speculation about the treatment of bondholders should Spain be pushed
to seek support from the EU/IMF. In a base case scenario,
Moody's expects the sovereign to be able to raise the necessary
financing. However, ongoing higher funding costs would strain
Spain's debt affordability further beyond current expectations and
could also negatively impact the availability and cost of credit to the
wider economy, which remains vulnerable.
Secondly, Moody's is also in the process of reassessing its
assumptions regarding the potential cost to the government of recapitalizing
the country's savings banks. Under base case assumptions,
the rating agency continues to expect relatively moderate recapitalization
needs of around EUR25 billion if the banks are to retain Tier 1 capital
ratios of 8%, which the FROB has already provided EUR10.5
billion. However, in a more stressed scenario, recapitalization
needs could increase to at least EUR80 billion. If a higher capital
standard -- of as much as 12% Tier 1 capital -- for banks
wishing to raise term funding is applied, even under base case assumptions
regarding future loan losses, Moody's believes that such a
requirement would necessitate an additional EUR90 billion of capital.
Thirdly, Moody's remains concerned about the ability of the
Spanish government to engineer the necessary structural improvement in
general government finances over the next 3-4 years. These
concerns mainly relate to the commitment of the regional governments to
control their spending and the central government's ability to enforce
fiscal discipline at the regional level. Moody's believes
that the recent, rather timid, steps to improve transparency
will not address the fundamental problem of a lack of fiscal discipline.
Several regional governments appear likely to miss even the relatively
unchallenging budget targets posed for this year, and most are expected
to achieve next year's targets by severely cutting their capital
expenditure programs, which Moody's does not consider to be
a sustainable policy. There are no policy initiatives to reduce
their structural spending pressures in the areas of healthcare and education.
In addition, the central government lacks effective powers to restrict
the regions' debt issuance in case of non-compliance,
and two regions are accumulating commercial debts which are not subject
to the debt authorization rule. Moody's also notes the repeated
delays to table important structural reforms like pension reforms and
changes to the collective bargaining system. These delays have
raised doubts about the commitment and ability of the Spanish government
to implement the far-reaching structural reforms that are needed
to return the economy to a stronger and sustainable growth path.
FACTORS TO BE CONSIDERED IN THE REVIEW
Moody's review of Spain's sovereign rating will focus on the
central government's ongoing commitment to address the key structural
challenges of the Spanish economy, in particular whether the government
will indeed pursue the implementation of announced and planned structural
reforms like the pension and collective bargaining reforms. The
review will also assess the likelihood of the regional governments achieving
structural and lasting fiscal improvements as well as the commitment of
the central government to increasing the transparency and oversight of
the regional government accounts. Moreover, Moody's
will again review the potential for the costs of recapitalizing Spain's
banking sector to be larger than currently expected, whether to
meet higher-than-expected asset impairments or simply to
retain the confidence of the wholesale markets. Moody's will
also assess its ratings on the Spanish banks in the coming days in response
to today's rating action on the sovereign.
In addition, any broader developments in the Eurozone, in
particular with regard to the design of the envisaged permanent crisis
mechanism, could also be important determinants of the outcome of
Moody's rating review. Moody's will focus in particular
on the likely effect on market access and the cost of funding for the
Spanish government and other issuers in the country, as well as
the impact this may have on the government's debt metrics.
PREVIOUS RATING ACTION AND METHODOLOGY
Moody's last rating action affecting Spain was implemented on 30
September 2010, when the rating agency downgraded Spain's
Aaa government bond ratings to Aa1 with a stable outlook. The rating
action prior to that was taken on 30 June 2010, when the rating
agency placed Spain's Aaa ratings on review for possible downgrade.
Moody's last rating action affecting FROB was implemented on 30 September
2010, when the rating agency downgraded the FROB's rating
to Aa1/stable from Aaa/review for possible downgrade. This action
followed the same rating action on the government of Spain, which
provides a full guarantee on the senior unsecured debt issued by FROB.
The principal methodology used in rating the government of Spain is Moody's
"Sovereign Bond Methodology", published in 2008,
which can be found at www.moodys.com. Other methodologies
and factors that may have been considered in the process of rating this
issuer can also be found on Moody's website.
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Vice President - Senior Analyst
Financial Institutions Group
Moody's Investors Service Ltd.
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MD - Sovereign Risk
Financial Institutions Group
Moody's Investors Service
Moody's Investors Service Ltd.
Moody's puts Spain's Aa1 ratings on review for possible downgrade
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