On March 24 Moody’s Investors Services downgraded the senior debt and deposit ratings of the 30 Spanish banks below the big three (Banco Santander, BBVA, and La Caixa). This followed an earlier downgrading of Spanish sovereign debt by Moody's on March 10 and was, in a sense, a logical corollary of that earlier downgrading. Since the Spanish government has been acting as the lender of last resort propping up the Spanish banking system, if its covenant is judged to be weaker, the banks have to be correspondingly weaker as well – as if they weren’t in enough trouble on their own behalf.
In fact Moody’s makes the connection explicit in the reasons it gives for the 30 bank debt downgrade. Moody’s cites the combination of heightened financial pressures on the Spanish government, the sheer number of weak Spanish banks, their declining systemic importance thanks to consolidation plays (which suggests that those not yet consolidated could more safely be allowed to crash and burn, as non-systemic players) and, last, but not least, a general weakening in what the ratings agency terms “the future support environment” for European banks generally.
The downgrades were fairly swingeing, with 15 of the banks having their debt downgraded by two notches and five by three or four notches. The remaining ten banks suffered a one notch downgrade. What this means is that any debt that needs to be rolled over will be more expensive; in some cases, much more expensive, unless the Spanish government steps in again to underwrite those debts.
As Moody’s notes:
“The outlook on most banks' senior debt and deposit ratings remains negative, reflecting the negative outlook on the sovereign rating and the negative outlook on banks' standalone credit profiles, given the challenging operating environment in Spain. Some bank ratings remain under review, mainly because these banks are currently involved in consolidation efforts that may affect their standalone credit strength and the systemic support which might be available to them.”
When it downgraded Spanish government bonds on March 10 from Aa1 to Aa2, following a ratings review which it began back in mid-December, Moody’s explicitly charged the government with underestimating the likely scale of the bank bailout it was setting itself up for. The cost, Moody’s said, “will exceed the government’s current assumptions, leading to a further increase in the public debt ratio”, which is already high enough to be sending shivers through the euro.
Another problem, the ratings agency pointed out, is that the nature of regional government in Spain means that there is a limited amount the central government can do to initiate sustainable and structural improvement in general government finances. Local politicians can, to an alarming extent, just ignore central directives and spend their heads off to keep their voters happy. That keeps the rioters off the streets but it creates a good deal of pressure, driving the Spanish ship of state inexorably towards the rocky shores of financial catastrophe.
According to Bloomberg, Spanish banks need some 15.2 billion euros to meet their minimum capital levels, and the downgrades will do nothing to help persuade investors that, as Bloomberg’s Charles Penty and Emma Ross-Thomas put it, the “battered balance sheets” of these banks offer anything like the potential return investors will be seeking to take on a risk of this magnitude.
Further reading on the banking crisis:
- Banking Transparency and the Robustness of the Banking System, by Solomon Tadesse
- Keeping Money in the Bank, by Brian Caplen
- Understanding and Forecasting the Credit Cycle—Why the Mainstream Paradigm in Economics and Finance Collapsed by Richard A. Werner
Tags: credit rating agencies , Moody's , rating downgrade , senior debt , sovereign debt , Spain , Spanish banks