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S&P Downgrades Spanish Region Of Valencia From AA- To A+ "Because Of Growth In Debt Burden"

Submitted by Tyler Durden on 06/10/2010 10:30 -0400

Overview

Like Spain as a whole, Valencia is suffering from a deep recession, which is hitting employment hard.
The region's recent budgetary results and our expectations for the future indicate sizable growth in its debt burden.
We are lowering our ratings on Valencia to 'A+/A-1' from 'AA-/A-1+'.
The negative outlook reflects our expectation that Valencia will continue posting deficits after capital expenditures at least until 2013.

Rating Action

On June 10, 2010, Standard & Poor's Ratings Services lowered its long- and short-term issuer credit ratings on Spain's Autonomous Community of Valencia to 'A+/A-1' from 'AA-/A-1+'. The outlook is negative.

In a related action, we have lowered the long-term ratings to 'A+' from 'AA-' on secured debt of four universities belonging to the region: Universidad de Valencia, Universidad Politécnica de Valencia, Universidad de Alicante, and
Universidad de Castellón. We equalize these ratings with those on the region.

Rationale

The downgrade reflects the region's sharp budgetary deterioration in the last two years. As a result, we presume that the region's tax-supported debt, which includes public sector debt, will reach about 170% of operating revenues at year-end 2010, well above the 'AA-' median of comparable European peers.

The downgrade is also due to the recessionary economic environment, which has been more acute than for most of its Spanish and, particularly, European peers.

The ratings on Valencia continue to reflect Standard & Poor's Ratings Services' view of Spain's supportive intergovernmental system, through which the central government has historically provided additional funds when Spanish regions have experienced budgetary pressures. Also, the ratings on Valencia are supported by the region's satisfactory liquidity, underpinned by a historically fluid access to the markets and large credit lines. However, the existence a noticeable negative fund balance is a negative aspect for the region's short-term liquidity position. Despite the launch of a new guarantee program for highly rated securitized assets, contingent liabilities remain low
by international standards.

Constraining factors include the region's historically high and increasing debt burden, the structural pressure from fast-growing and rigid social expenditures that are hard to cut, and the negative economic climate.

Valencia's budgetary performance in 2009 was very weak, with a negative operating balance (after interests) and a high deficit after capital expenditures (around 15% of total revenues).

We believe that Valencia's performance for fiscal year 2010 will further weaken because of a double-digit percentage decline in tax revenues and equalization fund. This will not be offset by the additional €1.1 billion the region is to gradually receive this year from the central government following the implementation of the new regional financing system.

Despite ambitious cuts in operating spending, thanks to stringent measures that the national and regional governments have already approved--5% cut in personnel wages, no replacement of retired civil servants, a 25% reduction in the number of public entities, sizable cuts in pharmaceutical margins--Valencia has budgeted record high investments. Therefore, the regional deficit after capital expenditures will remain, in our view, about 20% of total revenues.

Looking ahead, we expect that tax revenues will grow around 3% annually in 2011 and 2012, in line with our estimates of anemic growth for Spain and the region. Our base scenario assumes that the region will keep a tight rein on operating expenditures and suffer from much less demographic pressure. The population grew by only 0.1% in 2009, the lowest figure in more than a decade.

Considering both factors, we believe the region could post an almost nil operating balance during the next two years.

Combined with still large investments (though lower than in recent years), we expect the region's weak operating performance to result in deficits after capital expenditures of about 10% of total revenues in 2011 and 2012, roughly in line with the fiscal targets set out by the central government.

Accordingly, in our base scenario, we expect tax-supported debt to further accumulate, reaching up to 185% of consolidated operating revenues by year-end 2012.

Like Spain as a whole, Valencia is experiencing a deep recession. Regional GDP dropped by 4.3% in 2009, which is the second-highest decline nationwide according to preliminary data from the INE national statistics agency, hitting
employment particularly hard. Valencia's jobless rate reached 23% in the first quarter of 2010 and was the fifth-highest rate in Spain. Standard & Poor's growth expectations for the region are similar to those for Spain, including
two years of recession and very slow growth of below 1% on average for 2011 and 2012.

Liquidity

Valencia's short-term liquidity position is satisfactory. According to the latest available data on April 30, 2010, the region had €3.3 billion in committed credit facilities--of which €1 billion were to the regional companies--which is about €1.4 billion higher than the 2009 figure. These lines are committed until at least 2013. About 38% of the total credit lines were disbursed. The unused credit lines of €2.05 billion, together with average cash in first-quarter 2010, accounted for 1x of 2010 debt service.

The negative fund balance, however, deteriorated slightly in 2009, and accounted for almost 12% of operating revenues, basically due to payables accumulation.

The region tapped the bond markets to raise €935 million in the first six months of the years, for about one-fourth of its annual financing needs.

Outlook

The negative outlook reflects our expectation that Valencia will continue posting deficits after capital expenditures at least until 2013. This is in line with the assumption under the Spanish Stability Program that the aggregated regional deficit will reach 1.1% of the regional GDP that year. The negative outlook also reflects our concerns about the national and regional economic climate, which we believe will continue to result in sluggish tax revenue growth.

We could downgrade Valencia if we anticipate that persistently high deficits lift tax-supported debt to about 190%-200% of consolidated operating revenues by 2012, and, more importantly, we do not see this ratio stabilizing after 2012.

Conversely, we could revise the outlook back to stable if we believe that the recently adopted measures to contain expenditures are leading to a gradual improvement in Valencia's operating performance and a gradual return to
balanced budgets, enabling stabilization of the region's debt burden by 2012 to about the level in our base scenario. The decision will also depend on our assessment of the regional government's willingness to continue to reduce debt
after 2012.