In late breaking news Standard & Poor’s downgraded Spain to BBB- from BBB+ citing “mounting economic and political risks”. The Outlook is negative. This action comes a little more than two months after the rating agency affirmed Spain’s ratings. Key part of the rationale is that the ability of the ESM to recapitalize banks directly does not appear to apply to legacy situations.

spain flag

Recall that the agreement at the June 29, 2012 EU Summit initially suggested that Spain could bail out its banks by borrowing from the EFSF using the sovereign’s balance sheet – then later that burden could be lifted from the sovereign as the ESM would be in a situation
to recapitalize the banks directly.

More recent information, such as a Sep 25 statement from the finance ministers of Germany, the Netherlands and Finland, has suggsted that this scheme would apply to new – nut not legacy bailouts.

Note that this was not the rating action we were waiting for – i.e. Moody’s Corporation (NYSE:MCO) decision, now due this month, about whether to downgrade Spain below investment grade. Even if that happens, following today’s action by The McGraw-Hill Companies, Inc. (NYSE:MHP)’s S&P the country will still have two of three ratings in investment grade, although the cushion has declined.

Bank of America Merrill Lynch (BAML)  have revised their forecasts for Spain based on the recent economic and fiscal data, the new budget, and the latest announced structural reforms. They now expect a milder contraction, both this year and next. We forecast that GDP will contract by -1.5% in 2012 and -1.6% in 2013. We have also revised our deficit forecasts: they now expect Spain to have a budget deficit of 7.5% of GDP in 2012 and 6.2% in 2013.

Timing based on market pressure, conditionality, & politics

BAML analysts believe that expectations of more austerity if Spain asks for financial support, the country’s cash position and limited market pressure, political resistance to bringing forward European recommendations and pressure from core countries to delay making a request for financial aid are generating additional resistance to asking for financial support. In their view, without a significant increase in market pressure recent news flow and events could potentially further delay a decision and lead to a request by the end of this year or even the beginning of 2013.