Moody's Downgrades Spain To Aa1, As Goldman Rushes To Explain How It Was All Priced In

Moody's downgrades Spain from AAA to Aa1, a rating which pretty much everyone knew would not last, with the kneejerk reaction nonetheless being to spike bunds. However, as Goldman immediately reminded everyone who cares, this was (supposed to be) "completely priced in." As Erik Nielsen reminds us: "Moody's has just announced that they have downgraded the Spanish government to Aa1 with "stable outlook".   This is not really a surprise since they had given themselves until the end of September to consider this rating, and – as I discussed in my Sunday email – there is a good degree of “catch-up” in these ratings.  The good news, if that’s the way of putting it, is the “stable” outlook.  It appears that Moody’s is getting somewhat impressed with the reform agenda in Spain (as they should be)."

And here is Moody's on Spain:

Moody's downgrades Spain's rating to Aa1, outlook stable

Moody's also downgrades the ratings of Fondo de Reestructuración Ordenada Bancaria (FROB) to Aa1/stable

London, 30 September 2010 -- Moody's Investors Service has today downgraded Spain's local and foreign currency government bond ratings by one notch to Aa1 from Aaa. The outlook on the ratings is stable. Today's rating action concludes Moody's review for possible downgrade of Spain's sovereign ratings, as initiated on 30 June 2010.


The main drivers of Moody's decision to downgrade Spain are as follows:

(1) The country's weak economic growth prospects, also relative to Aaa-rated sovereigns, as the process of rebalancing the economy away from the construction and real-estate sectors will likely take several years;

(2) The considerable deterioration of the Spanish government's financial strength, as reflected in a more pronounced fiscal deterioration compared to Aaa-rated sovereigns; and

(3) Worsening debt affordability (i.e. interest payments as a share of revenues) and significant borrowing requirements, implying that the government remains vulnerable to further episodes of market volatility.

At the same time, Moody's has today affirmed Spain's short-term issuer rating of Prime-1 with a stable outlook. Spain falls under the Eurozone's Aaa regional ceilings for bonds and bank deposits, which are unaffected by today's downgrade.

Moody's has also downgraded to Aa1/stable outlook from Aaa/review for possible downgrade the rating of Spain's Fondo de Reestructuración Ordenada Bancaria (FROB), whose debt is fully and unconditionally guaranteed by the government of Spain.


"One of the key drivers for Moody's decision to downgrade Spain's rating to Aa1 is its weak growth prospects and the challenge that this presents for fiscal consolidation," says Kathrin Muehlbronner, a Moody's Vice President--Senior Analyst and lead analyst for Spain. "Over the next few years, the Spanish economy is likely to grow only by about 1% annually on average. Growth rates in the rest of the EU are likely to be higher but also sluggish. Moody's expects growth to average around 2% for the UK, 1½%-2% for Germany and around 1½% for France in the coming years."

According to Moody's, raising Spain's low productivity levels and improving international competitiveness will be among the country's key challenges. The rating agency considers the recently introduced labour market reforms and the broad wage restraint in both private and public sectors to be important steps in the right direction. However, dismissal costs will remain above the EU average and wage flexibility more limited than in many Aaa-rated peers. Spain's external imbalances as evidenced by high external debt and a persistent current account deficit are gradually being corrected but still remain larger than they are for most highly-rated peers. Meanwhile, Spain's traditionally high import elasticity will limit the positive contribution of net trade to growth. Moody's also notes that growth will remain moderate due to the ongoing deleveraging of the private sector and the adjustment in the real estate sector where a significant overhang of unsold houses persists and price adjustments have been more limited than elsewhere.

Moody's acknowledges that the process to refocus the economy away from the construction and real-estate sectors is under way. The results of the banking sector stress tests in July have confirmed that the Spanish authorities are well advanced in their efforts to strengthen the savings banks' sector. Moody's own analysis suggests that the banking system's capital adequacy can be held to a high standard with little need for additional financial assistance and that it lies fully within the capacity of the sovereign at its new rating level of Aa1.

The second driver for the downgrade to Aa1 is the significant fiscal deterioration that Spain experienced and the challenges that the government will face in reducing the budget deficit in an environment of only moderate economic growth. In its decision, Moody's has taken into account the recently-published 2011 draft budget, which targets a reduction in the general government deficit to 6% of GDP next year, and anticipates measures contemplated in today's budget submission. Although Moody's expects the government to broadly achieve its fiscal targets both this year and next, a further reduction in the deficit beyond 2011 is likely to require more fundamental spending reforms than the government has so far tabled.

"The government's determination to reduce its very large fiscal deficit in the near term is an important factor in Moody's decision to limit the downgrade to just one rating notch and to assign a stable outlook," says Ms. Muehlbronner. "Another positive factor that has emerged since Moody's initiation of the rating review in June is the central government's tightened control over the budgets of the regional governments." Nonetheless, Moody's expects Spain's budget deficits to be reduced at a slower pace than envisaged by the government over the medium term. Under such a scenario, Ms. Muehlbronner says that the public debt ratio would only stabilize in 2014 at around 80% of GDP.

The third driver for the downgrade is that Spain's debt affordability metrics such as interest payments as a share of revenues have deteriorated more than those of Aaa-rated sovereigns and are likely to take longer to stabilize and even longer to reverse. Given that the government faces sizeable gross borrowing requirements of around EUR 150-170 billion (including Treasury Bills) for 2011 and 2012 (with the net borrowing requirement amounting to around EUR 45 billion in 2011) and is sensitive to interest rate shocks, Spain's public finances remain vulnerable to further episodes of market stress.


Moody's notes that Spain's new rating of Aa1 is the second-highest level on its 21-notch rating scale. According to Moody's rating definitions "obligations rated Aa are judged to be of high quality and are subject to very low credit risk."

A positive outlook could be triggered by:

(1) The presentation and implementation of a credible medium-term fiscal consolidation plan by the government;

(2) Stabilisation of the debt ratio earlier than currently anticipated and ideally, reversal of the debt trajectory; and/or

(3) Signs of stronger and sustained economic expansion than assumed in Moody's baseline scenario, with clear indications that the necessary rebalancing of the economy is progressing at a significantly faster pace than assumed.

The following developments would likely trigger a negative outlook:

(1) Indications that the government's commitment towards fiscal consolidation and the introduction of pension reforms is fading;

(2) Indications that the central government's control over the regions' budget execution is weaker than expected or that signs of fiscal stress at the sub-sovereign level lead the government to loosen its fiscal targets;'

(3) Indication that economic growth is below Moody's already low projections; and/or

(4) Indications that debt affordability deteriorates more rapidly than is currently anticipated by our projections.

For a more detailed analysis of today's rating action, please refer to Moody's Special Comment entitled "Key Drivers of Spain's Downgrade to Aa1," which is available on


Moody's last rating action on Spain's sovereign rating was implemented on 30 June 2010, when the rating agency placed Spain's Aaa government bond ratings on review for possible downgrade.

Moody's last rating action affecting FROB was implemented on 13 July 2010, when the rating agency placed the FROB's Aaa rating on review for possible downgrade. This action followed the earlier rating action on the government of Spain, which provides a full guarantee on the senior unsecured debt issued by FROB.


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