Moody's downgrades Spain's rating over fears about state of finances

Moody's Investors Service on Thursday lowered Spain's sovereign ratings by a notch, arguing that the recapitalization of the banking sector would require more than double the amount calculated by the government.

Spain's rating was downgraded to Aa2 from Aa1, with the negative outlook attached by Moody's indicating the possibility of further cuts. Spain's risk premium widened to over 230 basis points after the release of the Moody's report before easing later. The stock market also fell sharply.

The downgrade took place just hours before the Bank of Spain was due to release the needs of the country's banks to meet the tighter solvency requirements being imposed, prompting government officials to say the ratings agency had jumped the gun.

"We are surprised Moody's has taken this decision before knowing about the report"

"It's right that we have to make a bigger effort to get the deficit down, particularly the regions"

Moody's said the recapitalization of the banking sector is likely to cost between 40 and 50 billion euros, up from an earlier estimate of only 17 billion eurosand the government's figure of 20 billion euros, most of which is expected to come from the private sector. In a "more stressed scenario," the funding requirement could jump to as much as 110-120 billion euros, Moody's said.

As it turned out, the Bank of Spain said later in the day that the sector's total capital needs to meet the new requirements amounted to 15.151 billion euros, in line with its earlier estimate. Most of that — 14.077 billion euros— is needed by the country's savings banks. Bankia, the brand name for the lender emerging from the merge of Caja Madrid and six other savings banks, requires 5.775 billion euros.

The Galician savings bank Novacaixagalicia needs to almost double its current capital to meet the minimum. Twelve lenders require more capital, including eight savings banks.

Bankinter, one of the commercial banks short of the minimum, earlier this week announced it was launching a convertible bond issue to comply with the requirements.

Rival ratings agency Fitch yesterday estimated the banks' capital needs under a base scenario at 38 billion eurosand at 96.7 billion eurosunder a situation of "stress."

The government has raised the minimum core capital ratio for banks to 8 percent from 6 percent and to 10 percent in the case of non-listed lenders and those heavily reliant on wholesale funding and with a limited private investor base.

Moody's said it increased its estimate for the banks' funding needs because of the 10-percent requirement and the fact that the definition of what could be called core capital had been tightened.

The ratings agency said the downgrade reflects "Moody's expectation that the eventual cost of bank restructuring will exceed the government's current assumptions, leading to a further increase in the public debt ratio."

It said the decision to assign a negative outlook to the new rating is due to "Moody's view that the risks to Spain's government finances remain skewed to the downside."

Moody's also questioned the regions' ability to meet the deficit-reduction targets set by the central government. It pointed to the fact that nine out of Spain's 17 regions failed to meet the budget deficit goal for last year of 2.4 percent of GDP. It noted the target for this year is a much stiffer 1.3 percent of GDP, particularly in light of the fact there are no new policy initiatives to reduce the regions' structural spending pressures in the areas of healthcare and education.

"This casts doubts over the ability of the central government to exercise sufficient control over the regions to ensure compliance with deficit targets," the ratings agency said. However, Moody's said it continues to believe that "Spain's debt sustainability is not under threat" and that it does not expect the government to have to seek assistance from the European Financial Stability Facility (EFSF) set up in the wake of the Greek debt crisis in May of last year.

Moody's decision sparked a vexed response by the government. "We are surprised by the fact that Moody's has taken this decision before knowing the report today [Thursday] of the only institution [the Bank of Spain] that has all the data on the recapitalization issue," the director general of the Spanish Treasury, Soldedad Núñez, said in a telephone interview with Reuters.

Núñez said Moody's had also failed to recognize the government's commitment to reining in its public deficit and the recent reform of its state pension system.

In remarks to Spanish newswire EFE, the author of the Moody's report, Karin Muehlbronner, said there was little room for the ratings agency to delay the downgrade as Spain was due to hold two government-debt tenders next week.

In a similar vein to Nuñez, Economy Minister Elena Salgado said: "I am at odds [with Moody's] over the funds the banking sector will need to recapitalize because I believe that any doubts would have been resolved simply by waiting until this evening when the Bank of Spain will reveal the amounts required," she said. "On that basis, whoever says a different amount is needed, will have to say in which institution this amount is needed."

The minister, however, acknowledged the validity of the ratings agency's concerns about the regions' finances. "It's right that we have to make a bigger effort to get the deficit down, and for the regions particularly to do so, with us controlling it," Salgado said.

Fitch put Spain's AA+ rating on review for possible downgrade two weeks ago, while Standard and Poor's rating for Spain is AA, equivalent to Moody's Aa2.

Salgado was speaking ahead of a trip to the United States where she is due to meet with officials from the Federal Reserve, a trip that was organized some time previously, the minister said.

Salgado will be accompanied by the governor of the Bank of Spain, Miguel Ángel Fernández Ordóñez. The two officials are also due to meet with leading investors in the United States to explain the merits of the reforms being carried out in the Spanish banking sector.