Fitch Ratings just cut Spain’s long-term issuer rating to BBB from A.That’s a three notch downgrade, leaving Spain just two notches above junk.
Further, it maintains a negative outlook for the creditworthiness of Spanish debt.
The ratings agency cites five reasons for the downgrade:
- The estimated €60-€100 billion cost of recapitalizing the banking sector.
- Upward revisions to the country’s debt-to-GDP ratio to 95 per cent of GDP in 2015.
- Recession forecast through 2013.
- Contagion from Greece.
- Increasing financing concerns for the Spanish government that will restrict it from taking strong action to assuage banking concerns.
This development comes amid rumours that European countries will soon lend support to prop up the Spanish banking system, with hopes to circumvent the IMF and its regulations.
It is likely to prove difficult for the country to bail out its banks without drawing investor concerns about the stability of the Spanish government.
The Spanish economy is steadily contracting after a housing bubble wreaked havoc on its banking system. Bankia, a conglomeration of seven regional savings banks formed in the wake of the crisis, recently asked the government for €19 billion in funds to stay afloat.
NOW: Here Are 14 Reasons Spain Is Turning Into A Disaster >
Here’s the full release from Fitch:
Fitch Downgrades Spain to ‘BBB’; Outlook Negative
2012-06-07 16:41:42.164 GMT
FITCH DOWNGRADES SPAIN TO ‘BBB’; OUTLOOK NEGATIVE
Fitch Ratings-London-07 June 2012: Fitch Ratings has downgraded Spain’s
Long-term foreign and local currency Issuer Default Ratings (IDR) to ‘BBB’ from
‘A’. The Short-term IDR has also been downgraded to ‘F2’ from ‘F1’. The Outlook
on the Long-term IDRs is Negative. Fitch has simultaneously affirmed the common
Euro Area Country Ceiling for Spain at ‘AAA’.
The downgrade of Spain’s sovereign ratings by three notches reflects the
— The likely fiscal cost of restructuring and recapitalising the Spanish
banking sector is now estimated by Fitch to be around EUR60bn (6% of GDP) and as
high as EUR100bn (9% of GDP) in a more severe stress scenario compared to
Fitch’s previous baseline estimate of around EUR30bn (3% of GDP);
— Gross general government debt (GGGD) is projected by Fitch to peak at 95% of
GDP in 2015 assuming a EUR60bn bank recapitalisation, compared to Fitch’s
forecast at the beginning of the year of 82% by the end of 2013;
— Spain is forecast to remain in recession through the remainder of this year
and 2013 compared to Fitch’s previous expectation that the economy would benefit
from a mild recovery in 2013;
–Spain’s high level of foreign indebtedness has rendered it especially
vulnerable to contagion from the ongoing crisis in Greece; and
— The much reduced financing flexibility of the Spanish government is
constraining its ability to intervene decisively in the restructuring of the
banking sector and has increased the likelihood of external financial support.
The downgrade follows a series of recent steps taken by Fitch:
— The potential fiscal costs of the restructuring and recapitalisation of
Spanish banks initiated in May (see ‘Fitch: Spanish Banking Reform Will Require
State Assistance’ at www.fitchratings.com);
— Prospects for the Spanish economy in light of the latest episode of the
systemic eurozone crisis triggered by the inconclusive 6 May Greek general
— The credit and funding profile of regional governments (see ‘Fitch Downgrades
8 Spanish Autonomous Communities; Negative Outlook’ dated 31 May at
— The overall outlook for public finances following the announcement on 18 May
of a second upward revision in the general government budget deficit in 2011 to
8.9% of GDP, compared to 8% estimated by Fitch in its last review of Spain in
The dramatic erosion of Spain’s sovereign credit profile and ratings over the
last year in part reflects policy missteps at the European level that in Fitch’s
opinion have aggravated the economic and financial challenges facing Spain as it
seeks to rebalance and restructure the economy. The intensification of the
eurozone crisis in the latter half of last year pushed the region and Spain back
into recession, exacerbating concerns over sovereign and bank solvency. The
absence of a credible vision of a reformed EMU and financial ‘firewall’ has
rendered Spain and other so-called peripheral nations vulnerable to capital
flight and undercut their access to affordable fiscal funding. Spain has been
especially vulnerable to a worsening of the eurozone crisis because of the high
level of net foreign indebtedness (around 90% of GDP) and fragile confidence in
its capacity to implement fiscal consolidation and bank restructuring in a
Spain’s investment grade status remains supported by a relatively high
value-added and diverse economy as well as political and social stability
despite very high unemployment. Competitiveness and export performance are
improving and the trade balance on goods and services is expected to post a
surplus this year. The rating is also supported by the Spanish government’s
commitment to wide-ranging structural reform to improve the efficiency of public
services and strengthen the budgetary and fiscal framework; enhance the
flexibility of the labour market; and foster competitiveness and the growth
potential of the economy. Moreover, securing public debt sustainability is
within reach if the government is successful in reducing its budget deficit to
3% of GDP by 2014 and in light of the economy’s long-run growth potential of
between 1.5% and 2% or higher if the structural reform agenda continues to be
Spain’s investment grade rating is premised on EMU remaining intact and Fitch’s
judgment that the ECB, EFSF/ESM, and IMF, will, in extremis, provide financial
support to prevent a fiscal funding crisis. Moreover, Spain’s ‘BBB’ rating
incorporates Fitch’s expectation that Spain will secure financial support from
its European partners for the restructuring and recapitalisation of the Spanish
banking sector, though not necessarily a full-fledged policy-conditional
external funding programme.
Since Fitch’s last formal review of Spain’s sovereign ratings in January, the
2011 outturn for the general government budget deficit has twice been revised
upwards to 8.9% from 8% of GDP. Local and regional governments accounted for
around two-thirds of the overshoot relative to the 2011 budget deficit target of
6% and remain a source of fiscal risk. Fitch recently downgraded eight regional
governments in light of the expected increase in regional indebtedness and
worsening economic and financing environment.
The settlement of outstanding payment arrears incurred by sub-national
administrations and other ‘one-off’ operations will increase GGGD by 5.5% of GDP
in 2012. Fitch expects that bank recapitalisation will add a further 6% of GDP
to government debt during 2012 and 2013. Combined with a worsened outlook for
the economy and higher interest payments, GGGD/GDP is projected by Fitch to peak
at 95% in 2015 compared to the agency’s previous projection of a peak of 82% in
2013 (the latter broadly corresponds to the government’s current forecasts).
Under a scenario whereby the recession is more severe than forecast (-2.7% and
-1.5% contraction in real GDP in 2012 and 2013 respectively compared to -1.9%
and -0.5% assumed in Fitch’s baseline projections), deficit reduction less rapid
(3% primary budget deficit in 2013 compared to 1.4% assumed in the baseline) and
bank recap costs are higher (9% of GDP rather than 6%), government debt would
peak above 100% of GDP by 2014. Nonetheless, even under this negative scenario,
government debt would stabilise reflecting Fitch’s analysis and judgment that
public debt sustainability is within reach, albeit at a high level of
indebtedness that offers very limited fiscal space to absorb further negative
The Spanish government is expected to retain access to market financing for
fiscal purposes, albeit at an elevated cost. Resolution of the banking crisis,
progress on deficit-reduction and on-going structural reform combined with steps
at the European policy level towards resolution of the eurozone systemic crisis
would support a normalisation of funding costs and enhance confidence in the
sustainability of public debt.
FISCAL COSTS OF BANK RESTRUCTURING
Fitch initiated a review in May of its previous assessment that the
recapitalisation of Spanish banks would incur a fiscal cost of around EUR30bn
(3% of GDP). On 25 May, it was announced that Bankia/BFA faces a EUR19bn capital
shortfall. Fitch now expects the fiscal cost of bank restructuring and
recapitalisation to be in the range of EUR50bn to EUR60bn and in a negative
stress scenario, the cost could rise to EUR90bn- EUR100bn. A detailed
description of Fitch’s analysis of the potential capital requirements of the
Spanish banking system is set out in an accompanying comment, “Fitch: New Base
Case Indicates Spanish Banks Need EUR50bn to EUR60bn Capital”.
Fitch expects Spain to secure external financial support for the
recapitalisation of medium-sized banks and savings banks which would help
restore confidence in the banking sector as a whole. The core of the system –
Santander, BBVA and La Caixa – will not require assistance in meeting more
stringent provisioning and capital requirements and underpin Fitch’s confidence
that the fiscal costs of restructuring the banking sector remain manageable from
a sovereign credit and rating perspective.
Recourse to external funding for bank recapitalisation underscores the
constrained financing flexibility of the sovereign to respond to adverse shocks.
Nevertheless, securing low cost and long duration funding from European partners
to assist in the restructuring of the Spanish banking sector is consistent with
Spain’s current sovereign rating. If effective in restoring confidence in the
banking sector and easing the fiscal burden of restructuring, such support would
be credit positive.
The Outlook on Spain’s sovereign ratings remains Negative, indicating a
heightened risk of further downgrades. The Negative Outlook primarily reflects
the risks associated with a further worsening of the eurozone crisis, notably
contagion from the ongoing Greek crisis (see ‘Fitch: Re-Run Elections Would Be
Critical for Greece, Eurozone’, dated 11 May at www.fitchratings.com). Spain’s
sovereign ratings at ‘BBB’ are robust to some further deterioration in the
economic and fiscal outlook and somewhat greater than expected fiscal cost of
bank restructuring, as well as to receipt of temporary external financial
support for bank recapitalisation. However, Spain’s high level of foreign
indebtedness and prolonged economic weakness as it deleverages and rebalances
does render it vulnerable to negative economic and financial shocks. A loss of
market access for budgetary funding and consequent reliance on external
policy-conditional financial support would prompt a further review of Spain’s
Agreement on eurozone reforms that would strengthen confidence in the monetary
union’s long-term viability and measures to ease the severe financial and
economic strains currently evident across the region would be supportive of a
stabilisation of Spain’s sovereign ratings. Along with the successful adjustment
of the Spanish economy, supported by ongoing structural reform that enhances
competitiveness and its growth potential, upward pressure on Spain’s sovereign
ratings could emerge over the medium term.
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