DBRS Confirms the Autonomous Community of Catalonia at BB (high), Trend Remains Positive

DBRS Ratings GmbH (DBRS) confirmed the Long-Term Issuer Rating of the Autonomous Community of Catalonia at BB (high) and its Short-Term Issuer Rating at R-4. The trend on all ratings remains Positive.

KEY RATING CONSIDERATIONS

The Positive trend on Catalonia’s BB (high) ratings reflects (1) the continued improvement in the region’s finances in 2018 and the expectation of further fiscal consolidation in 2019 (independent of one-offs related to the regional financing system); (2) the positive track record on the economic and financial management fronts in spite of political tensions in the region and; (3) a political agenda pursued by the current regional government perceived as less confrontational towards the national government.

In addition, the trend change to Positive from Stable of the Kingdom of Spain´s Long-Term Foreign and Local Currency – Issuer Rating of A on 20 September 2019 reinforces, in DBRS’s view, the Positive trend on Catalonia’s ratings. This reflects the economic and financial linkages between both government tiers. The trend change at the sovereign level was prompted by DBRS’s view that risks to Spain’s ratings are now skewed to the upside and that the conditions that supported the country’s solid economic growth and steady improvements in public finances in recent years should continue going forward.

Catalonia’s ratings remain underpinned by (1) the region’s positive economic indicators and the slow but continued improvement in its fiscal performance; and (2) the financing support provided by the Kingdom of Spain to the regional government. While DBRS continues to view the political situation in the region as a source of uncertainty, the rating agency considers that the impact of the political tensions between Catalonia and the national government on the regional economy or more generally on its fiscal and financial management have remained limited.

Catalonia’s Long-Term Issuer Rating currently remains at the BB (high) level given the region’s high debt metrics and a still challenging political environment. Although DBRS expects the region’s debt reduction to be a slow and lengthy process and the political noise over independence to remain over the long-term, it considers that the region’s intrinsic performance has improved in the last two years and that key milestones are reachable for the region to strengthen its creditworthiness further in the next 12 months.

RATING DRIVERS

The ratings could be upgraded if: (1) the relationship between the region and the national government remains relatively stable with debt and fiscal management staying insulated from any potential rise in political tensions; (2) the region continues its fiscal consolidation towards a balanced budget position and improves its debt sustainability metrics further; or (3) the Kingdom of Spain’s rating is upgraded.

By contrast, a return to a Stable trend could stem from: (1) a material escalation of the political tensions between the region and the national government that would substantially worsen the relationship between both government tiers. Specifically, and although unlikely given the existing track record, indications that the financing support received by the region may be reduced would have negative credit implications; or (2) there is a deterioration in Catalonia’s underlying fiscal position and a reversal in its decreasing debt-to-operating revenues ratio.

RATING RATIONALE

The Political Environment Remains a Key Rating Consideration

Despite the Positive trend, the political environment continues to weigh on Catalonia’s ratings. The pro-independence regional government has somewhat softened its independence rhetoric — in part supported by the government change at the national level in June 2018 — but political uncertainty remains. Following the national elections in April, center-left PSOE (Partido Socialista Obrero Español) failed to garner enough support in Congress to form a government, and therefore, Spain is now heading to new elections on 10 November 2019. The national election results and the outcome of the trial of former Catalan politicians (“the trial”) expected before year-end will be critical to assess how the political situation evolves.

Given upcoming political milestones, DBRS does not exclude the possibility of an escalation of the conflict in the months ahead. Nevertheless, any impact on Catalonia’s overall economic, fiscal and debt performance should remain limited. This assessment is supported by the sound regional track record since the peak of the political conflict in October 2017. DBRS highlights that overall, the economic momentum in Catalonia remained strong throughout 2018.

In addition, the liquidity and financing support provided by the national government to the region remained unaffected. The application of the Article 155 of the Spanish Constitution (through which the national government placed the region and its finances under its administration and management), although it heightened political tensions, did not derail the region’s fiscal trajectory in 2018. Nevertheless, going forward, any material worsening of the relationship between the national and regional governments could prompt DBRS to revise its assessment of the region’s political risk; a key consideration for the region’s ratings.

Fiscal Consolidation Continues, Supported by Strong Economic Growth

On the fiscal side and in line with DBRS’s expectations, Catalonia’s fiscal performance continued to improve in 2018. Its deficit for the year stood at -0.44% of the region’s gross domestic product (GDP), just above the target of -0.40% set by the national government, but substantially better than the -2.84% deficit recorded in 2015. Catalonia’s fiscal consolidation since 2015 was largely driven by the positive real GDP growth reported on average over the last four years in the region (3.3%) and the rest of Spain (3.1%). Marked GDP growth led to a pick-up in tax revenues — regional taxes and the region’s share of national taxes — which, coupled with continued control over regional expenditure, led to a rapid reduction in the headline deficit figures.

In 2019, DBRS expects that economic growth in the region albeit slowly decelerating to around 2.2%, will remain supportive. Nevertheless, Catalonia’s fiscal target of a near balanced budget position appears to be at risk. Reaching the deficit target of -0.1% of GDP will require, in DBRS’s view, the resolution of the current political stalemate at the national government’s level. Catalonia, together with other autonomous communities, have so far not received the additional transfers from the regional financing system (revised 2019 entregas a cuenta), corresponding to approximately EUR 0.87 billion for the region (close to 0.4% of regional GDP).

This situation reflects the absence of a fully functioning national government and the recent call for new Parliamentary elections on 10 November 2019. DBRS however considers that any negative deviation from the -0.1% deficit target would remain primarily driven by the one-off revenue shortfall. It is therefore unlikely to challenge the fiscal consolidation recorded by the region in recent years.

The National Government’s Financing is Critical to the Region’s Creditworthiness

The debt financing provided by the national government to its regions, the favorable conditions attached to it and DBRS’s expectation that this support will continue going forward are critical for Catalonia’s rating. The region’s large financing and refinancing needs have significantly benefited from the national government’s support since 2012.

DBRS also views positively the shift in the region’s financing source in 2019 from the Fondo de Liquidez Autonómico (FLA, a financing from the national government aimed at regions not complying with deficit and debt targets, based upon strong conditionality), to the Facilidad Financiera (which provides cheap financing to regions meeting targets without conditionality), as it underpinned the strengthening of the region’s fiscal performance in recent years.

While Catalonia’s debt is very high at EUR 82.0 billion at the end of 2018, or 291% of its operating revenues, DBRS gains comfort on its sustainability, given the national government’s support, which represents more than 70% of the regional debt stock, and the very low funding costs from which the region currently benefits. DBRS also highlights that the regional debt-to-revenue ratio decreased in 2018 for the third consecutive year — from 334% in 2015 — supported by lower financing needs and dynamic operating revenues. In its baseline scenario, DBRS continues to anticipate that this positive trend would continue in 2019 and 2020; isolated from possible one-offs related to the regional financing system.

RATING COMMITTEE SUMMARY

The DBRS European Sub-Sovereign Scorecard generates a result in the BBB (high) – BBB (low) range. Additional consideration factored into the Rating Committee decision included the uncertainty related to the political environment in the region and its potential impact on the region’s relationship with the national government as well as the region’s medium-to-long-term economic prospects.

The main points discussed during the Rating Committee include: the relationship between the national government and the Autonomous Community of Catalonia and the political situation in the region and in the country. In addition, the region’s debt trajectory, fiscal consolidation and economic growth were discussed.

For more information on the Key Indicators used for the Kingdom of Spain, please see the Sovereign Scorecard Indicators and Building Block Assessments: https://www.dbrs.com/research/350580/

The national scorecard indicators were used for the sovereign rating. The Kingdom of Spain’s rating was an input to the credit analysis of the Autonomous Community of Catalonia.

Notes:
All figures are in euros (EUR) unless otherwise noted.

The principal applicable methodology is Rating European Sub-Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include the Autonomous Community of Madrid, Bank of Spain, Independent Authority for Fiscal Responsibility (AIReF), Instituto Nacional de Estatística (INE). DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a 12-month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings GmbH are subject to EU and US regulations only.

Lead Analyst: Nicolas Fintzel, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global Financial Institutions and Sovereign Ratings Group
Initial Rating Date: July 6, 2018
Last Rating Date: March 29, 2019

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