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

DBRS Ratings GmbH (DBRS Morningstar) 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 sound fiscal performance recorded by the region in recent years, despite 2019 being affected by one-offs; (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 Positive trend on the Kingdom of Spain's Long-Term Foreign and Local Currency – Issuer Rating of "A" reinforces, in DBRS Morningstar’s view, the Positive trend on Catalonia’s ratings. This reflects the economic and financial linkages between both government tiers. The Positive trend at the sovereign level reflects DBRS Morningstar’s view that risks to Spain’s ratings remain skewed to the upside and that the conditions that supported the country’s solid economic growth and steady improvements in public finances should continue going forward

Catalonia’s ratings remain underpinned by (1) the region’s robust economic indicators and its sound fiscal performance; and (2) the financing support provided by the Kingdom of Spain to the regional government. While the political situation in the region remains a source of uncertainty, its impact on the regional economy or more generally on fiscal and financial management has remained limited. The possible consequences of the new Coronavirus Disease (COVID-19) on the Catalan economy will remain a focus point in coming months for DBRS Morningstar. The rating agency currently considers that any impact would largely be concentrated over one or two quarters, but lasting effects on tourism or the industrial sector that translate into weaker fiscal outcomes would be credit negative.

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 Morningstar 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 three years and that greater visibility on regional parties' future political agenda should be reachable in the foreseeable future.

RATING DRIVERS

The ratings could be upgraded if: (1) the relationship between the region and the national government remains relatively stable after the upcoming regional elections, 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

While the regional pro-independence party, Esquerra Republicana de Catalunya (ERC), implicitly supported through its abstention the formation of a coalition government led by the Partido Socialista Obrero Español (PSOE) at the national level in January 2020, political uncertainty in the region remains. In particular, new regional elections, most likely to be held by the summer of 2020 could potentially mean the resurgence of political tensions, as the outcome of the vote might bring ERC to reconsider its implicit support for Prime Minister Sanchez’s government and harden the pro-independence stance.

DBRS Morningstar believes that regional elections that would confirm a softer strategy on the independence question, such as the one currently followed by ERC, and reduce political tensions between both government tiers, would benefit its assessment of the region’s political risk and subsequently support Catalonia’s ratings.

Fiscal Consolidation Stabilises on the Back of Strong Economic Growth

On the fiscal front, Catalonia’s fiscal performance largely stabilised in 2019, with a provisional deficit representing -3.6% of the region's operating revenues, in line with the deficit of -3.5% recorded in 2018. DBRS Morningstar expects the region's deficit-to-gross domestic product (GDP) figure for the year to possibly worsen compared to the 2018 deficit of -0.44%. However, DBRS Morningstar considers that any deterioration of the deficit-to-GDP metric would likely reflect one-offs affecting the regional outcome. These are likely to include (1) lower VAT receipts for close to 0.2% of the regional GDP; and (2) an expected exceptional adjustment related to highway concessions for around 0.1%. Left aside these one-offs, DBRS Morningstar estimates that the deficit figure for the region may have reached 0.3%-0.4% of GDP, underperforming the target of -0.1% but roughly in line with 2018.

Overall, Catalonia’s fiscal consolidation since 2015 has largely been driven by positive real annual average GDP growthof 2.9%. This led to a pick-up in tax revenues which, coupled with control over regional expenditure, led to the reduction in the deficit figures. In 2020, the approval of the first regional budget since 2017 will be key to assess the region's control over its expenditure. DBRS Morningstar expects economic growth in the region to decelerate to around 1.5%-1.6% in 2020. This weaker growth scenario is however likely to be exacerbated by the recent COVID-19 outbreak. Given how fluid the current situation is, DBRS Morningstar will closely monitor how events unfold in coming weeks and months to assess their potential impact on the region's economic performance.

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 Morningstar’s expectation that this support will continue, remain critical for Catalonia’s ratings. While Catalonia’s debt is very high at EUR 81.8 billion at the end of 2019, or 278% of its operating revenues (preliminary figures), DBRS Morningstar gains comfort on its sustainability, given the national government’s support.

The Spanish Treasury currently holds about 73% of the regional debt stock and Catalonia has benefited from very low funding rates in recent years. DBRS Morningstar also highlights that the regional debt-to-revenue ratio decreased in 2019 for the fourth consecutive year — from 334% in 2015 — supported by lower financing needs and dynamic operating revenues. In its baseline scenario, DBRS Morningstar continues to anticipate that this positive trend would go on in 2020 and 2021.

RATING COMMITTEE SUMMARY

The DBRS Morningstar 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 economic growth and the potential impact of the COVID-19 on its trajectory were discussed. Debt levels and fiscal consolidation were also points discussed in the Rating Committee.

For more information on the Key Indicators used for the Kingdom of Spain, please see the Sovereign Scorecard Indicators and Building Block Assessments: http://www.dbrs.com/research/357700

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 methodology is the Rating European Sub-Sovereign Governments, which can be found on the DBRS Morningstar website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal 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 Catalonia, Bank of Spain, Independent Authority for Fiscal Responsibility (AIReF), Instituto Nacional de Estatística (INE). DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS Morningstar 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 twelve month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar 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: September 27, 2019

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