Spain financial crisis

Spain: the storm clouds gather

From Moody’s early on Wednesday morning: Moody’s puts Spain’s Aa1 ratings on review for possible downgradeShort-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 are: (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 governments’ finances. Moody’s has also placed the Aa1 rating of Spain’s Fondo de Reestructuracin 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 rating action. “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. (statement continued below) Now, Moody’s last downgraded Spain on September 28, and the negative watch issued today merely brings it in line with S&P, which already has Spain on negative watch for a downgrade. But the timing could have been better notes Gary Jenkins of Evolution Securities (emphasis ours): Moody’s has placed the Aa1 rating of Spain on review for downgrade. As it is already rated AA with a negative outlook by S&P this might not be a surprise, but coming the day after a difficult auction and with the 10 year hitting a multiyear yield high of 5.43% and indeed with more longer dated issuance coming tomorrow it is likely to lead to even more spread widening. Moody’s stated that the triggers for the rating review include the high refinancing needs in 2011 (have they only just noticed?) and the potential increase in the public debt ratio should the cost of bank recapitalisation prove to be higher than expected. Yep, Thursday’s bond auction takes on increased significance now. Also noteworth is the fact that the Fund for Orderly Bank Restructuring (FROB), an entity set up by the Spanish government to help the hard hit saving banks, or Cajas, has also been put on review for a possible downgrade. Related links:Spanish debt watch, the exploding yield edition - FT AlphavilleThe corroding core – FT AlphavilleSpain is all about the banks – FT AlphavilleSwelling Spanish bond yields - FT Alphaville ——————– The rest of the Moody’s statement on Spain: 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. Having provided ample arithmetical evidence of the inevitability of a default of restructuring of the debt of it is now time to turn to Spain. Spain is unique among the aforementioned group in that the amount of capital necessary to bail out this country is likely beyond the ken of the EU/IMF, and will likely assure a contagion effect. While it is true that Spain is not as indebted as the smaller periphery countries from a proportionate perspective, it is likely that it is not on a sustainable path and the efforts to make said path sustainable will may require restructuring/default, particularly if the smaller periphery states default. Of course, Spain doesn’t necessarily see it his way, at least according to the mainstream media. From CNBC: Spain Not Next in Line for EU Bailout: Finance Minister Spain will not be next in line for a rescue package from Europe but a common economic policy is needed to support a single currency, Spanish Economy Minister Elena Salgado told BBC Radio on Friday. This is a current snapshot of Spain as it stands now (excerpted from our subscription report Spain public finances projections_033010 and the online restructuring model - The Spain Sovereign Debt Haircut Analysis for Professional Subscribers):

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