TEXT-Fitch pubs rationale for Spanish regions' investment-grade ratings
(The following statement was released by the rating agency)
Feb 27 - Fitch Ratings has introduced a temporary investment grade rating floor of 'BBB-' for Spanish regions whose standalone credit metrics, in an international context, are weaker than their ratings would indicate.
The structurally negative current balances (current revenues less current expenditure) reported in the past few years, as well as the unlikelihood that these fiscal results will turn positive in the near future is not indicative of an investment grade rating. It also means that a number of Spanish regions would find it difficult, without support from the central government, to meet their financial obligations. Moreover, to fund existing deficits and commercial liabilities debt levels have increased sharply in all Spanish regions.
Regions which presently have a weaker standalone financial profile than their rating level include Catalonia, Castile-La Mancha and Murcia. Fitch is of the opinion that support from the central government would be forthcoming and timely given potential negative market reactions to a default by a region and also because the regions provide essential public services, particularly in the area of health care and education.
Fitch's rationale for maintaining an investment grade rating floor on Spanish regions ('BBB-') is, therefore, based on a number of supporting factors that we believe would help liquidity and also reduce the likelihood of default by a region:
- The recent budgetary stability law gives the central government much wider powers to intervene in the finances of a region that does not comply with deficit targets and therefore instil greater fiscal discipline. As a result, Fitch believes that most regions will make greater efforts to meet the budgetary targets and will be given strategic, operational and, if necessary, directions and financial assistance to do so.
- Debt servicing is given priority by law before payment of salaries as per article 135 of the Spanish Constitution.
- Existence of the Regional Liquidity Fund (Fondo de Liquidez Autonomica; FLA). The fund was established specifically to provide funding for regions, some of which are no longer able to access sources of funding previously available to them at a reasonable cost. Although in 2012 the FLA did not cover the refinancing of maturing loans from Spanish banks, Fitch understands that in 2013 it may do so, which would enable some regions to tap this source of funding for their entire financing needs. For 2013 the FLA is endowed with EUR23bn (2012: EUR18bn) but the sum can be increased if necessary.
- The fact that the negative tax settlement which should have been repaid to the state in 2010 and 2011, will now be repaid over a 10-year period thereby easing the liquidity situation of the regions.
Fitch considers that these features are supportive of a rating floor for Spanish regions. There are various considerations, however, that would lead Fitch to review its position including:
- The hypothetical downgrade of the Spanish sovereign by one notch (presently rated 'BBB'/Negative) would mean that Fitch would be likely to withdraw the rating floor at 'BBB-' and probably a number of regions would be downgraded to the 'BB' category as Fitch will not maintain a rating floor at the same level as the sovereign.
- The inability of regions to turnaround their fiscal situations in the medium-term which would mean that access to the FLA becomes structural rather than an alternative or provisional financing option. Fitch expects Spanish regions to be able to report a positive current balance within a three to four year time horizon and to be able to tap sources of funding other than the FLA. If this is not the case, then Fitch would review its position and may withdraw the floor. In Fitch's view the FLA should only provide a temporary liquidity mechanism to compensate for the inability of many Spanish regions to presently fund themselves at reasonable prices in the market and not exist as a permanent financing mechanism. Indefinite borrowing to cover operational deficits is not consistent with an investment grade rating.
- Any action by the sovereign that would cause Fitch to doubt the willingness and timeliness of support.
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