Tuesday, October 23, 2012

Moody's downgrade of Spanish regions should be a signal for Rajoy to request aid

Spanish regional downgrades should not have been a surprise. After all, regional credits are generally tied to the national rating in most rating agencies' methodologies. As the central government bonds got downgraded, regional debt was sure to follow - this was discussed in some detail here.
Moody's: - The ratings of the following five regions have been downgraded:

- Junta de Extremadura: long-term issuer rating downgraded by one notch to Ba1 from Baa3; negative outlook;

- Junta de Andalucia: long-term issuer and debt ratings downgraded by two notches to Ba2 from Baa3; negative outlook;

- Comunidad Autonoma de Murcia: long-term issuer and debt ratings downgraded by two notches to Ba3 from Ba1; negative outlook;

- Castilla-La Mancha: long-term issuer and debt ratings downgraded by one notch to Ba3 from Ba2; negative outlook;

- Catalunya: long-term issuer and debt ratings downgraded by two notches to Ba3 from Ba1; negative outlook;
Note that none of these bonds are now investment grade based on Moody's, which may ultimately impact their eligibility for the ECB collateral. What's troubling is that Moody's is basically looking beyond the internal rescue fund (called the FLA) set up by Spain to bail out the regions (see discussion).
Moody's: - Moody's decision to downgrade the ratings of the four Spanish regions of Andalucia (to Ba2 from Baa3), Castilla-La Mancha (to Ba3 from Ba2), Catalunya (to Ba3 from Ba1) and Murcia (to Ba3 from Ba1) was driven by the deterioration in their liquidity positions, as evidenced by their very limited cash reserves as of September 2012 and their significant reliance on short-term credit lines to fund operating needs.

In addition, Catalunya, Andalucia and Murcia face large debt redemptions in Q4 2012 when retail bonds issued in 2011 are due to mature. In this context, five regions -- namely, Catalunya, Andalucia, Murcia, Valencia and Castilla La Mancha -- have already requested liquidity support from the Fondo de Liquidez Autonomico (FLA) to cover their financing needs in the second half of 2012.

While the FLA greatly reduces the risk of a region's liquidity driven default in the short term, it does not address their fundamental economic and financial weaknesses, namely: (1) the significant uncertainty regarding viable long-term funding alternatives, and the resulting considerable reliance on government funding; and (2) the regions' significant difficulties in controlling their deficit and debt trajectories in an economic environment in which the implementation of cost-cutting measures to redress the regions' structural deficits will likely take longer than expected.
As discussed before (see this post), Spain's government is waiting for the market to force its hand before the officials finally request a bailout package from the ECB/EC. But Spain should use this downgrade as an opportunity to ask for help, since it may give politicians some cover. If Mariano Rajoy waits much longer, he may end up asking for aid under duress.


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