Moody's Put Spain's Aa1 Rating On Downgrade Review, EURUSD Meets Gravity

EURUSD kneejerk reaction on Moody's announcement shows a downward acceleration of 9.8 m/s2:

Moody's puts Spain's Aa1 ratings on review for possible downgrade

Short-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 Reestructuración 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."


"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.

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.


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.


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.

The principal methodology used in rating the government of Spain is Moody's "Sovereign Bond Methodology", published in 2008, which can be found at Other methodologies and factors that may have been considered in the process of rating this issuer can also be found on Moody's website.

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