Standard & Poor’s ratings agency denied on Friday it had not taken into account the recent reforms Spain had announced when it downgraded the country for the second time this year, saying Spain’s weaker-than-expected economic outlook and rising risks in the banking system had added to concerns and prompted the downgrade.
S&P cut its rating on Spanish sovereign debt by two notches late on Thursday and has a negative outlook on the country.
Moody’s and Fitch also have a negative outlook on Spain.
“The downturn will be longer and deeper than previously assumed,” Moritz Kraemer, Managing Director for European sovereign ratings at Standard & Poor’s rating agency told CNBC’s “Worldwide Exchange” on Friday.
“We think that there is considerable risk in the banking system in Spain, that it might need additional resources. Given that it is quite difficult for Spanish banks to fund themselves in the interbank market, you might wonder where those resources will come from and whether private investors…would be willing to provide additional capital," he said.
The agency believes there is a “considerable probability” that the Spanish state might be called upon to provide funding.
“The private funding has dried up for Spanish banks,” Kraemer said.
Spanish banks lent heavily for a real estate boom which came crashing down when the financial crisis hit. Now they are struggling to cope with the losses on those real estate loans.
"Spain’s going to continue to be a big story. Banks don’t want to lend because they don’t know what’s going to happen to the real estate market and they’re trying to get these assets off the books but not lending out for mortgages. There’s a vicious cycle going on," Bridget Gandy, managing director and co-head of EMEA financial institutions at Fitch ratings agency told CNBC.
Despite Spain’s insistence it will not seek aid, many investors fear that the government might eventually need to turn to the EU’s bailout mechanism for funds to inject into its banks.
Meanwhile borrowing costs for the Spanish state are rising to levels considered unsustainable by many analysts.
The European Central Bank could purchase more Spanish government bonds to force yields to come down, but that has raised concerns among investors that their bonds will be subordinate to the central bank’s and pushed down the credit ladder in the event of a potential restructuring.
If Spain did take aid from the European Union, the risk of subordination would partly depend on when Spain would take official money – assuming that it would, Kraemer said.
Spain’s government currently has no intention of seeking funds from international creditors.
If they sought funds under the EFSF or European Financial Stability Facility – the mechanism that will remain in place until July – there would be no subordination in the event of a default, Kraemer said.
But if they wait until July, when the ESM (European Stability Mechanism) replaces the EFSF, they would be subordinated, according to Kraemer.
"S&P's downgrade to BBB+/Neg from A/Neg is fairly aggressive considering that they previously lowered them two notches in January amid S&P's mass downgrade of European sovereigns. Usually a negative rating outlook (which they had after January's downgrade) indicates risk of a downgrade over 12-18 months. So the timing is perhaps a surprise," strategists at Deutsche Bank wrote in a note on Friday.
"Growth forecasts were also revised lower by S&P as they now see real GDP contraction of 1.5 percent and 0.5 percent in 2012 and 2013 versus a previous forecast of real GDP growth of 0.3 percent and 1 percent respectively. If growth wasn't so much of a problem then the risk of a downgrade will have been much less immediate," they said.