Rating threat to force rethink by Spanish corporates

Moody’s or Standard & Poor’s may cut Spain’s credit rating in the first quarter, RBS strategists say, over fears of a deepening recession, mounting bank losses and rising political tensions between regions and the central government. With the kingdom clinging to investment-grade by just one notch, companies have to seriously consider their financing options in the event that Spain falls to speculative grade. Companies in Spain have already turned to bond market as a decades-long torrent of short-term credit slows to a trickle – the result of a liquidity squeeze at Spain’s troubled banks. A sovereign downgrade would exacerbate the situation by hitting domestic banks’ ratings and therefore their ability to fund themselves efficiently. That in turn would further constrict financing to the corporate sector.

For Spain’s big diversified multinationals, access to bond markets should remain relatively secure. Despite the likelihood of stark headlines, they have increased their involvement in the capital markets just as investors’ demand for corporate bonds is peaking – driven by a search for yield and an exit route from once-safe haven sovereigns.

Several of Spain’s big multinationals may not be affected at all since ratings agencies have told a number of them – including Telefonica, Gas Natural, Repsol and Iberdrola among others – that their rating may remain fixed a notch or two above the normal sovereign ceiling should Spain be cut.

They are paying a hefty premium, however. Fears of a downgrade, the weak economy and the distant threat of a euro break-up mean a large, geographically-diversified Spanish corporate pays around 150 basis points more than its German rival. It could pay significantly more than that if Spain’s credit rating is cut by two or three notches.

Spain’s big multinationals are also exploring strategies to reduce the ‘Spanish premium’ or avoid it completely. Some, like Telefonica and Santander, are raising capital by listing foreign subsidiaries in their home markets. Meanwhile power utility Iberdrola has attracted strong interest in debt issues by its British and US subsidiaries, and has paid significantly lower yields than the parent company in the process.

Spain’s big diversified players could rely on debt capital markets even in the event of a severe deterioration in the outlook for southern Europe and a downgrade of the entire corporate sector to sub-investment grade territory. That is what happened to Portuguese companies when the sovereign was downgraded a year ago. Yet EDP, its biggest power utility, was still able to launch bonds on the euro, Swiss franc and retail markets last year.

Those transactions were a sign that a more discerning investor is emerging. Rather than ditching everything periphery-related (as many did at the start of the eurozone crisis), investors are now starting to go beyond ‘domicile’ and actually examine whether corporates have the management, strategy and capacity to navigate the crisis, regardless of where they are based. In EDP’s case, ‘investment-grade only’ funds still buy around three quarters of its bonds. Comparable ‘fallen angels’ in Spain should be confident that the market would give them similarly preferential treatment.

Higher financing costs might seem hard on those multinationals for which Spain represents only a modest proportion of sales, but many companies face a much more perilous funding situation. The vast majority of Spanish firms are infrequent issuers and brittle international confidence in its economy is becoming an increasing barrier for companies hoping to access the capital markets. A downgrade would likely swell the number of investors moving to less volatile, geographically diversified stocks and further starve bond-market hopefuls of funding.

So how would these unrated and less diversified players – many of them multi-billion euro businesses – bridge the funding gap created by constricted domestic bank lending and the small pool of retail or domestic institutional fixed income investors? The only solution is to embrace a new approach to capital markets: set new standards in corporate governance and disclosure and dedicate management’s time to marketing the company’s story to international and high yield bond investors.

Companies in Spain adjusting to life at speculative grade would also have to alter their tactics on the size and timing of any issue. Spain’s ‘window market’ was closed for long spells in 2012, and speculative grade companies would be even more restrained. With perhaps as few as one or two windows a year, the message would be ‘go as quickly and as big as you can’. And with more competition for the smaller pool of funds in the high yield market, companies would need to examine pricing too. The prize for those who can access capital markets is a significant strategic edge over competitors. With such a strong motivation to issue and greater reliance on the bond market, Spanish corporates this year could easily issue more than the EUR18 billion its private sector is expected to have sold in 2012. 

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