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Rating Action:

Moody's upgrades Spain's ratings to Baa1 from Baa2; the outlook remains stable

13 Apr 2018

London, 13 April 2018 -- Moody's Investors Service, ("Moody's") has today upgraded the Government of Spain's long-term issuer and senior unsecured ratings to Baa1 from Baa2 and the senior unsecured MTN program ratings to (P)Baa1 from (P)Baa2; the senior unsecured shelf rating to (P)Baa1 from (P)Baa2; the other short-term rating of (P)P-2 is affirmed. The outlook remains stable.

The key driver for today's rating action is Moody's view that improvements in Spain's credit profile that have emerged recently, in particular enhanced economic resiliency due to an increasingly balanced growth profile and improved banking sector fundamentals, now outweigh the drag from political/institutional factors.

Moody's has also upgraded the long-term issuer rating of the Fondo de Reestructuracion Ordenada Bancaria (FROB) to Baa1 from Baa2. The short-term issuer rating was affirmed at P-2. The outlook on the ratings remains stable.

The stable outlook on Spain's Baa1 ratings reflects Moody's view that further changes in the rating are unlikely over the medium term given that material structural macroeconomic and fiscal reforms are unlikely to materialise over the medium-term.

In a related move, Moody's raised Spain's long-term country ceilings to Aa1 from Aa2 for foreign and local currency bonds and bank deposits. Spain's short-term country ceilings are unchanged at P-1.

RATINGS RATIONALE

Recent years have seen gradual, but increasingly sustainable, improvements to Spain's credit profile. Much has been done to address the weaknesses in the banking sector that emerged during the financial crisis. It has also become increasingly clear that structural changes in the economy have changed the growth model to one that is broader-based and more sustainable than in past recoveries, though we do expect growth to decelerate from current above-potential rates.

However, those improvements have been counterbalanced by institutional weaknesses that have threatened to undermine the gains from reform and recovery. In 2016, Moody's changed the outlook in Spain's Baa2 rating from positive to stable to reflect concerns relating to the effectiveness of fiscal and economic policymaking, partly reflecting the absence of a settled government. More recently, the rising independence sentiment in Catalunya heightened uncertainty regarding the effectiveness of Spain's governing institutions.

Today's upgrade reflects Moody's conclusion that, while institutional weaknesses are likely to remain a constraining factor for some time, the improvements seen in recent years are sufficiently well-entrenched to move to a higher rating. The stable outlook reflects the view that, in part because of the uncertain impact of institutional and political dynamics on fiscal and economic policy, upside pressures are limited; the upgrade reflects a step improvement in Spain's credit profile rather than a clearly improving trajectory that we expect to continue.

RATIONALE FOR UPGRADING THE RATING TO Baa1

With that context, today's action reflects two key positive drivers.

FIRST DRIVER: A MORE BALANCED GROWTH PROFILE HAS IMPROVED SPAIN'S ECONOMIC RESILIENCY

Spain has experienced growth in excess of 3% per annum for the past three years. This cyclical upturn in growth rates in itself is not particularly credit relevant but it has revealed the degree to which the Spanish economy's structure has changed in ways that makes it more robust to shocks. This is evident in current account trends, demand-side growth drivers, and productivity improvements in tradeable sectors.

As the economic recovery has matured, the drivers of growth are much more balanced than they were during previous growth upswings and the economy is therefore more resilient. Growth continues to be driven by domestic demand, particularly private consumption and, more recently, investment activity. However, net external demand has also played an important role in driving growth. Initially, this shift was due to import compression, a natural result of Spain's deep recession. However, more structural changes to cost competitiveness, diversification of export markets, and lower import propensity due to import substitution have also occurred that should sustain external demand going forward.

For over 20 years, Spain ran -- sometimes large -- current account deficits (peaking at 9.6% of GDP in 2007), which in turn led to a material increase in external debt and a large negative net international investment position accumulated. When the financial crisis broke and the housing bubble burst, Spain's current account deficit shrank very quickly -- in part due to import compression -- and in 2013 the deficit turned to surplus. However, a sterner test came with the advent of the economic recovery, particularly the current period of growth rates in excess of 3%. We expect current account surpluses of 1.7-1.8% of GDP over the next few years, which marks a notable break from past trends where Spain has struggled to maintain current account surpluses in times of strong growth. While falling energy prices have clearly played an important role in driving this trend, the share of exports in GDP increased significantly during the crisis years, and export levels have broadly been maintained. While tourism remains an important source of services export revenue, it has not been the sole driver of growth in services income. Other services exports, such as professional services and IT-related services, have also been important sources of services growth.

SECOND DRIVER: THE ONGOING RECOVERY OF THE BANKING SECTOR HAS FURTHER REDUCED THE THREAT THAT IT POSES TO THE SOVEREIGN'S BALANCE SHEET

Spain's robust economic recovery has supported the authorities in their broader efforts to rebuild and restructure the financial sector and has helped its financial institutions to rebuild their credit fundamentals, notably through improved asset quality and stronger capital and funding positions. Although legacy issues remain and improvements are starting from a low base, we consider the Spanish banking sector to be less of a material event risk to the sovereign's balance sheet.

The Spanish banking sector has been restructured, with higher capital ratios and more sound funding structures in place -- nevertheless, capital levels remain below those of other European banking systems such as Ireland's (A2 stable) or Slovenia's (Baa1 stable). Spanish banks' funding gap has narrowed materially in recent years, reducing their reliance on wholesale finance, thanks to a combination of customer deleveraging and stable deposits. The governance, regulatory and supervisory frameworks have also been overhauled, and the successful resolution of Spanish lender Banco Popular Espanol, S.A.'s (Banco Popular, long-term deposits at Baa3 positive, Adjusted BCA ba3) in June 2017 - with no significant impact on financial stability - marked the first use of the EU's Single Resolution Board (SRB) under the Bank Recovery and Resolution Directive.

Spanish banks' stock of nonperforming loans (NPLs) has been falling gradually since peaking in late-2013. The overall NPL share in total loans, according to Moody's calculations, has fallen to 7.38% as of the end of 2017, from 12.9% four years before. Banks will continue to reduce their stocks of problematic assets, with the decline being accelerated by the continued cyclical recovery and large real estate portfolio sales, like those announced in 2017 by Banco Santander S.A. (Spain) (long-term deposits at A3 stable, BCA baa1) and Banco Bilbao Vizcaya Argentaria, S.A. (BBVA, long-term senior debt at Baa1/long-term deposits at A3 stable, BCA baa2). Spanish banks also hold a sizeable stock of real-estate assets repossessed from troubled borrowers -- either through foreclosures or payments in kind - which, after rising in the years following the crisis, has started declining since 2016.

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook reflects Moody's view that, while downside pressures emanating from the political sphere are manageable, upside pressures are similarly weak.

The political crisis in Catalunya has abated somewhat and it appears to have not caused any deterioration in Spain's macroeconomic or fiscal performance to date. While we expect political tensions between the central government and pro-independence forces in Catalunya to remain elevated for the foreseeable future, our baseline is still that Catalunya will remain part of Spain. And while the crisis is, in part, responsible for the government's difficulties -- for the second year running -- in passing a budget, we do not think that the government's current challenges, or the prospect of regional and potentially national elections, will bring about a marked credit negative policy shift over the coming years. Cyclically high growth will abate slowly towards its medium-term potential level of 1.5%-2%, but in the meantime will provide further policy space to buffer credit negative political shocks.

Nevertheless, we do not expect material structural fiscal or macroeconomic measures to be legislated in the coming years; rather, the authorities' medium-term challenge will be to resist pressures to roll back reforms that were pursued during the crisis. Spain is highly indebted and is likely to remain so for many years: while nominal deficits have fallen and are likely to continue to do so while the cyclical recovery lasts, its structural fiscal position has weakened and, according to European Commission estimates, is back to 2012 levels. We do not expect any material changes in the debt burden; the debt-to-GDP ratio is likely to remain over 90% for some years. The impact on the effectiveness of fiscal policy of changes being negotiated to the relationship between central and regional/local governments remains unclear -- as indeed are the changes themselves given the Catalan situation -- but the negotiations could conceivably result in some of the credit positive changes introduced during the crisis being unwound.

WHAT WOULD CHANGE THE RATING UP/DOWN

A positive outlook or upgrade in Spain's rating will likely be driven by a combination of factors, but the critical consideration will be the strength of the government's commitment to the further fiscal and economic changes commonly identified as pre-requisites for a material and sustainable fall in the country's debt burden. Such a commitment is likely to be evidenced by robust implementation of fiscal and macroeconomic reforms, and improvements in the structural deficit. We would ultimately expect such a positive scenario to be reflected in sustained and meaningful reductions in Spain's debt burden. A further abatement of the political tensions over Catalunya would also be credit positive, but would not be sufficient on its own to move either the outlook or the rating.

We would consider a negative outlook or a downgrade were there to be fiscal slippage against Stability Program targets, leading to a later stabilisation of Spain's public debt ratio at a higher level. A reversal of reforms -- in particular pension or labour market reforms -- that have been legislated in recent years would also place downward pressure on Spain's rating. A re-emergence of elevated financial and debt market stress, while unlikely, would also be highly credit negative. Although extremely unlikely at this point in time, an increasing probability that Catalunya would secede from Spain would also be negative for the Spanish sovereign rating given the size and economic importance of the region for Spain overall.

GDP per capita (PPP basis, US$): 36,347 (2016 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 3.3% (2016 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 1.6% (2016 Actual)

Gen. Gov. Financial Balance/GDP: -4.5% (2016 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 1.9% (2016 Actual) (also known as External Balance)

External debt/GDP: [not available]

Level of economic development: High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 10 April 2018, a rating committee was called to discuss the rating of the Spain, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have materially increased. The issuer's institutional strength/ framework, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer has become less susceptible to event risks.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2016. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain 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 certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain 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.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

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.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Sarah Carlson
Senior Vice President
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

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

No Related Data.
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