Madrid, October 19, 2011 — Moody’s Investors Service has downgraded the long-term ratings of nine Spanish regions, two Basque provinces and five government-related ratings by one or two notches. The outlook on the ratings is negative. At the same time, the rating of Castilla–La Mancha was downgraded by five notches to Ba2 from A3 and remains on review for downgrade.
The rating actions conclude the review for possible downgrade initiated for eight ratings on 29 July 2011.
A full list of affected ratings actions can be found at the end of this press release.
The downgrades of Spanish sub-sovereigns were prompted by:
(i) Moody’s downgrade of the government of Spain to A1 from Aa2 with a negative outlook on 18 October 2011. For full details, please see Moody’s press release ‘Moody’s downgrades Spain’s government bond rating to A1, negative outlook’.
(ii) Growing liquidity pressures. Large financing needs alongside constrained access to long-term funding sources have forced regions to deplete their cash reserves, extensively use short-term credit lines, and expand their commercial debt obligations.
(iii) Persistent fiscal imbalances due to the regions’ difficulty in reining in their cost bases significantly. Spanish regions, on average, recorded a deficit-to-GDP ratio of 1.2% in H1 2011, against the deficit target of 1.3% for the full-year. Moreover, poor national economic prospects for 2012-13 will limit regional tax proceeds — about three-quarters of their budgets — and complicate fiscal consolidation plans.
- ENTITIES RATED ABOVE THE SOVEREIGN
The downgrades of the Basque entities’ ratings (Basque Country, Diputacion Foral de Guipuzcoa and Diputacion Foral de Bizkaia) by two notches to Aa3 with negative outlook from Aa1 reflect the same economic pressures that prompted the sovereign rating downgrade. However, the Basque entities’ unique and constitutionally protected tax regime currently allows them to retain enough credit strength to maintain their ratings one-notch above that of the sovereign. In addition, their limited borrowing needs this year and next limit the impact of difficult market conditions on their financial performances.
- ENTITIES RATED AT THE SOVEREIGN LEVEL
The downgrades of Extremadura, Galicia and Madrid’s ratings by two notches to A1 with negative outlook — in line with the sovereign — from Aa2 reflect Moody’s opinion that these regions do not have the required fiscal manoeuvrability nor the institutional strength to maintain a rating above the sovereign. Comparable rating levels with the sovereign reflect the financial and operational linkages between these regions and the central government as well as similarly constrained economic and financing environments weighing on their credit profiles.
- ENTITIES RATED BELOW THE SOVEREIGN
The downgrade by one notch of Catalunya’s ratings to Baa2 with negative outlook from Baa1 reflects its significant liquidity pressures, as the region’s extensive financing needs come in the context of an increasingly difficult market environment and constrained access to long-term funding sources. However, Moody’s notes that Catalunya, unlike some of its peers, has taken measures to rein in costs and sees its fiscal trajectory as progressively stabilising, as illustrated by its deficit of 1.0% of its GDP at end-H1 2011 (vs. 1.2% in H1 2010). The continuation of this trend would bring Catalunya’s deficit closer to the target set by the central government in the next few years.
The two-notch downgrade of the ratings of Andalucia and Castilla y León (to A2 negative from Aa3), Murcia (to Baa1 negative from A2), and Generalitat de Valencia (to Baa2 negative from A3) reflects the pressures on their fiscal positions and the ordinal ranking of their credit quality relative to the sovereign. The relative ranking continues to reflect differing financial, economic and institutional strengths, which ultimately translate into diverse capabilities to withstand a deteriorating operating environment and successfully implement austerity measures.
The downgrade of Castilla-La Mancha by five notches to Ba2 from A3 reflects recently disclosed features which Moody’s considers incompatible with an investment-grade rating. In particular, they refer to the structural and substantial weakening in the region’s financial fundamentals, largely as the result of the emergence of unexpectedly large deficits and commercial liabilities following a recent audit of its accounts. This adds significant liquidity pressure and exacerbates the continued deterioration in the region’s fiscal and debt metrics, which are amplified by its very high dependence on credit line facilities — a negative credit feature in the current funding environment.
The region’s stock of commercial liabilities is forecasted to reach around EUR3.1 billion at YE2011 or 59% of the region’s operating revenue. Poor accountability and inadequate checks and balances have fostered inefficiencies within the administration, which itself has been unable to provide adequate estimates of its fiscal performances over the past year. Moreover, the region’s stock of commercial debt is likely to take several years to absorb. As Castilla-La Mancha is unlikely to record a budget surplus for some time, repaying its commercial obligations will require it to incur more costly financial debt or may even require financial support from the central government.
- RATIONALE FOR THE REVIEW FOR DOWNGRADE OF CASTILLA-LA MANCHA
The Ba2 rating of Castilla-La Mancha is on review for downgrade. While acknowledging that the new regional government elected in May has drafted ambitious saving measures — notably the reduction of operating expenses by approximately 20% by the end of 2012 — the review will examine the feasibility of the proposed measures. In addition, the rating agency will focus on the region’s plans to finance its large commercial obligations, including outstanding payments to two shadow toll road projects.
RATIONALE FOR THE NEGATIVE OUTLOOK
The outlook is negative for all other rated Spanish sub-sovereigns, reflecting (i) Spain’s weak economic growth prospects, which will likely continue to adversely affect the regional tax base; and (ii) uncertainty associated with the regions’ ability to meet its forthcoming borrowing requirements at an affordable cost in the context of constrained market conditions.
WHAT COULD CHANGE THE RATINGS UP/DOWN
Stabilisation of the outlooks or an upgrade to the ratings would require (i) the stabilisation or upgrade of the sovereign rating; and (ii) detailed plans from the regional administrations to restore their fiscal performances and reverse debt ratios.
Further deterioration of the operating environment in Spain that would put pressure on the sovereign rating would also negatively affect the ratings of the Spanish sub-sovereigns. Additionally, failure of any individual sub-sovereign to progress towards fiscal consolidation targets would add pressure to that specific rating.
The following regional and local governments are affected by today’s rating action:
- Basque Country: long-term issuer and debt ratings downgraded to Aa3 from Aa1; outlook negative
- Diputacion Foral de Guipuzcoa: long-term issuer rating downgraded to Aa3 from Aa1; outlook negative
- Diputacion Foral de Bizkaia: long-term issuer rating downgraded to Aa3 from Aa1; outlook negative
- Comunidad Autónoma de Galicia: long-term issuer rating downgraded to A1 from Aa2; outlook negative
- Comunidad Autónoma de Madrid: long-term issuer rating downgraded to A1 from Aa2; outlook negative
- Junta de Extremadura: long-term issuer rating downgraded to A1 from Aa2; outlook negative
- Junta de Andalucia: long-term issuer and debt ratings downgraded to A2 from Aa3; outlook negative
- Junta de Castilla y Leon: long-term issuer and debt ratings downgraded to A2 from Aa3; outlook negative
- Comunidad Autonoma de Murcia: long-term issuer and debt ratings downgraded to Baa1 from A2; outlook negative
- Region of Valencia: debt ratings downgraded to Baa2 from A3; outlook negative; short-term rating downgraded to Prime-3 from Prime-2
- Castilla-La Mancha: long-term issuer and debt ratings downgraded to Ba2 from A3; under review for downgrade
- Catalunya: long-term issuer rating downgraded to Baa2 from Baa1; outlook negative; short-term rating downgraded to Prime-3 from Prime-2
The following government-related ratings are affected:
- Consorcio de Transportes de Bizkaia: long-term issuer rating downgraded to Aa3 from Aa1 in line with Basque Country ‘s downgrade; outlook negative.
- Instituto Valenciano de Finanzas: debt ratings downgraded to Baa2 from A3, in line with the Generalitat de Valencia’s downgrade; outlook negative.
- Notes of CACSA and Universities of Valencia (Universidad de Valencia, Universidad de Alicante, Universidad Jaume 1 de Castellón and Universidad Politécnica de Valencia): downgraded to Baa2 from A3, in line with the Generalitat de Valencia’s downgrade; outlook negative.
- Notes of Feria Valencia: underlying rating downgraded to Baa2 from A3 with a negative outlook (A and B Certificates); the rating of Feria Valencia’s notes remains at Aa3/negative, in line with the financial guarantee provided by Assured Guarantee (Europe) Ltd (formerly, Financial Security Assurance (UK) Ltd).
About Edward Harrison
Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.
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