16 October 2012

Moody's confirms Spain's government bond rating at Baa3/(P)P-3, assigns negative outlook

Moody's Investors Service confirmed the Kingdom of Spain's Baa3 government bond rating and assigned a negative outlook to the rating. In addition, Moody's has confirmed Spain's short-term rating at (P)Prime-3.

The decision to confirm the Kingdom of Spain's sovereign ratings reflects the following positive developments since June:

1) Moody's assessment that the risk of the Spanish sovereign losing market access has been materially reduced by the willingness of the European Central Bank (ECB) to undertake outright purchases of Spanish government bonds to contain their price volatility. The rating agency believes that Spain will likely apply for a precautionary credit line from the European Stability Mechanism (ESM). This should in turn help sustain demand for Spanish government bonds by allowing the ECB to activate its Outright Monetary Transactions (OMT) programme of secondary market purchases. Entry into an ESM precautionary programme would not in itself lead to a downgrade, as long as the rating agency believes that the government is likely to retain access to private capital markets.

2) Evidence of the Spanish government's continued commitment to implement the fiscal and structural reform measures that are needed to stabilise its debt trajectory, as indicated by the package of fiscal measures announced in July, the changes to the institutional framework for regional government finances and, more recently, the announcement of further structural reforms to be implemented in the coming months. In this respect, Moody's considers the external monitoring of the Spanish government's implementation of its plans that would accompany an ESM precautionary credit line to be a positive factor. The rating agency's base case assumes that the Spanish government will be successful in gradually reducing its large budget deficit and arresting the rise in its debt burden.

3) The ongoing progress towards restructuring the Spanish banking sector and enhancing the solvency of the affected banks, which should help to restore market confidence in Spain's banking system as a whole.

In summary, Moody's believes that the combination of euro area and ECB support and the Spanish government's own efforts should allow the government to maintain capital market access at reasonable rates, providing it with the time it needs to stabilise public debt over the next few years. In Moody's view, the maintenance of market access is critical because the risk that some form of burden-sharing will be imposed on bondholders is material for those countries that rely entirely or to a very large extent on official sector funding for an extended period of time.

The negative rating outlook reflects Moody's assessment that the risks to its baseline scenario are high and skewed to the downside. In particular, Spain's credit standing would be negatively affected by a lack of progress in placing the country's public finances on a sustainable footing. Shocks at the euro area level could also have negative repercussions on Spain's rating, for example in the absence of concrete progress in reforming the euro area's fiscal, economic and regulatory institutions. The possibility of Greece exiting the euro area continues to constitute a major event risk for all the weaker euro area Member States. Should any such factors lead the rating agency to conclude that the Spanish government had either lost, or was very likely to lose, access to private markets, then Moody's would most likely implement a downgrade, potentially of multiple notches.

In addition to the confirmation of Spain's sovereign ratings, the rating agency has today also confirmed the Baa3/Prime-3 ratings of the Fund for Orderly Bank Restructuring (Fondo de Reestructuración Ordenada Bancaria or FROB) and assigned a negative outlook. Spain's local and foreign currency bond and deposit ceilings remain unchanged at A3.

Full press release

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