Moody's downgrades Spain's rating to Aa2 with a negative outlook
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
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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.
Issuer's rating:
Moody's Investors Service Aa2/Negative Int. Scale (foreign curr) 10.03.2011
Standard & Poor's AA/Negative Int. Scale (foreign curr.) 28.04.2010
Fitch Ratings AA+/Stable Int. Scale (foreign curr.) 28.05.2010
Come al solito tutto studiato nei minimi dettagli vero Moody's
