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Research Update:

Ratings On Spain Raised To 'BBB/A-2'On Improved Economic Prospects;Outlook Stable

Primary Credit Analyst:

Frank Gill, London (44) 20-7176-7129; [email protected]

Secondary Contact:

Marko Mrsnik, Madrid (34) 91-389-6953; [email protected]

Analytical Group Contact:

SovereignEurope; [email protected]

Table Of Contents

Overview

Rating Action

Rationale

Outlook

Key Statistics

Related Criteria And Research

Ratings List

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MAY 23, 2014 1

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Research Update:

Ratings On Spain Raised To 'BBB/A-2' OnImproved Economic Prospects; Outlook Stable

Overview

• We have revised our average 2014-2016 real GDP growth projections forSpain upward to 1.6% from 1.2% reflecting the effects of labor and otherstructural reforms.

• We are therefore raising our long- and short-term sovereign creditratings on Spain to 'BBB/A-2' from 'BBB-/A-3'.

• The outlook is stable, reflecting our current view that risks to theratings on Spain will remain balanced over the next two years.

Rating Action

On May 23, 2014, Standard & Poor's Ratings Services raised the long- andshort-term foreign and local currency sovereign ratings on the Kingdom ofSpain to 'BBB/A-2' from 'BBB-/A-3'. The outlook is stable.

Rationale

The upgrade reflects our view of improving economic growth and competitivenessas a result of Spain's structural reform efforts since 2010, including the2012 labor reforms. Reflecting the effects of these reforms and ourexpectation that monetary policy in the eurozone will remain highlyaccommodative, we have revised our average 2014-2016 GDP growth projectionsfor the Spanish economy to 1.6% from 1.2%. We also expect that recoveringemployment will contribute to improvements in the country's fiscal positionand the stabilization of financial system asset quality.

Preliminary Eurostat estimates of first-quarter 2014 real GDP growth indicatethat the economy grew 1.6% on an annualized basis. While this figure may besubject to considerable revisions, it nevertheless appears to be supported bya gradual recovery in employment growth across a broadening range of sectors,as indicated by social security data, particularly in tourism, but also inmanufacturing, as well as in the non-tradeables sector. In our view, recentreforms to the retail sector deregulating opening hours, liberalizingtemporary contracts, and business start-ups also appear to be supportingSpain's economic recovery.

Most competitiveness metrics show considerable gains for the Spanish economy,supporting the economy's reorientation toward external demand:• Unit labor costs have declined by an estimated 8% since 2009 (Eurostatdata), the strongest adjustment in the eurozone over the period with the


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exception of Greece and Ireland.• Spain's export share in global trade has continued to grow. The realeffective appreciation of the euro since mid-2012 has so far notundermined Spanish companies' favorable export performances, but couldpose a risk should it continue unabated.

• Very low inflation, at close to zero since September 2013, is areflection of excess economic capacity in the labor market, in our view.This is confirmed by declining wages, especially in the domesticnon-tradables sector.

At the same time, however, declining nominal earnings have slowed down theprocess of economy-wide deleveraging. While Banco de España (central bank)data indicates that, between 2010 and 2013, household and corporate debtdeclined by an estimated 25% of GDP to 206% of GDP (even as GDP itself wasdeclining), public sector indebtedness increased by some 30 percentage pointsto almost 92% of GDP over the same period. Therefore, total leverage in theeconomy (corporates, households, and general government) stood at more than300% of GDP in the third quarter of 2013, only surpassed by Ireland andPortugal in the eurozone. When the euro was introduced in 1999, the Spanisheconomy's total debt ratio was just over 150% of GDP.

We believe that Spain's recovering economy will support fiscal consolidationand enable public debt to gradually decline, as private debt continues to begradually paid down. We view stronger tax receipts so far in 2014 asindicating a cyclical improvement in the budgetary position.

We also continue to see net export growth as an important contributor to GDP,given expectations of further deleveraging in the public and private sectors.Nevertheless, in our view the still very high debt levels in the economy willprobably lead to an extended period of relatively subdued domestic demand ascompanies and households attempt to reduce leverage. Should inflation remainat the extremely low levels of the last six months for extended periods, thedeleveraging process might take longer still.

Last year, Spain's current account was in surplus for the first time sinceSpain joined the European Economic Community in 1986, implying a net externaladjustment of more than 10% of GDP since 2008. Over the last five years, theSpanish economy has become more open; exports are now equivalent to 34% of GDPcompared with 27% in 2008, though the large current account adjustment alsoreflects a 13% decline in nominal domestic demand over the period. Risingcurrent account receipts (CARs), initial private-sector deleveraging, andreplacing foreign debt with equity liabilities have enabled a reduction innarrow net external debt to 2.8x CARs in 2013 from a 2009 peak of 3.8x.Despite the decline, we expect that the figure will remain the 12th highestamong the 129 sovereigns rated by Standard & Poor's (seehttp://www.spratings.com/sri; click on "All countries" and select the"External Balance Sheet" tab).

We project that the Spanish government will broadly meet and potentiallyslightly improve its revised general government budgetary deficit target of


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Research Update: Ratings On Spain Raised To 'BBB/A-2' On Improved Economic Prospects; Outlook Stable

5.5% of GDP in 2014. However, we see risks to achieving the more ambitious2015 and 2016 budgetary targets of 4.2% and 2.8%, respectively (equivalent toa nominal adjustment of 1.35% of GDP annually). While we believe that theeconomic recovery will help reduce the deficit--through the cyclical increasein revenues from consumption, and income taxes, as well as gradually reducedunemployment transfers--we believe that without further deficit-reductionmeasures, the government is unlikely to meet its targets.

We also expect that with the upcoming 2015 regional and general elections,ongoing deep socioeconomic challenges and significantly reduced capital marketpressure could lead to fiscal and structural policy slippages. This couldjeopardize medium-term government deficit and economic growth targets.

We expect Spain's net general government debt to increase to about 93% of GDPin 2017 from 88.5% of GDP in 2014, excluding the guarantees related to theEuropean Financial Stability Facility (EFSF; see "S&P Clarifies Its ApproachTo Accounting For EFSF Liabilities When Rating The Sovereign Guarantors,"published on Nov. 2, 2011, on RatingsDirect). At the same time, averagegeneral government interest payments will likely represent about 9% of generalgovernment revenues during 2014-2017. Finally, we do not expect the Spanishgovernment to incur additional significant fiscal costs linked to banks'recapitalization.

The rating remains constrained by what we classify as very high private andpublic debt levels, a weak external economic balance sheet, and a weakmonetary transmission mechanism that appears to be placing parts of Spain'scorporate sector at a competitive disadvantage in terms of relative financingcosts. At the same time, we expect persisting tensions between the centralgovernment and regional authorities to be contained.

Outlook

The stable outlook incorporates our current view that risks to Spain's ratingswill remain balanced over the next two years.

We could consider raising the ratings on Spain if:• The budget deficit declines further and general government debt metricsstabilize; or

• The external position continues to improve, bringing narrow net externaldebt to below 150% of CARs or markedly easing the cost of or access tofinancing for the private sector.

The ratings could come under renewed downward pressure if:• Economic growth prospects falter; or• It appears to us that net general government debt will likely overshoot100% of GDP (regardless whether this is due to fiscal slippage, weakeninggrowth, deflationary pressures, or one-off items that push up debt, suchas the crystallization of contingent liabilities); or

• Interest payments rise sustainably above 10% of general government


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revenues; or• Spain's current account balance weakens again.

Key Statistics

Table 1

Kingdom of Spain - Selected Indicators

2007 2008 2009 2010 2011 2012 2013e 2014f 2015f 2016f 2017f

Nominal

GDP (US$

bil)

1,441 1,593 1,454 1,385 1,454 1,322 1,359 1,368 1,384 1,432 1,484

GDP per

capita

(US$)

32,186 34,891 31,452 29,790 31,166 28,238 29,116 29,228 29,479 30,407 31,418

Real GDP

growth

(%)

3.5 0.9 (3.8) (0.2) 0.1 (1.6) (1.2) 1.3 1.8 1.8 1.8

Real GDP

per capita

growth

(%)

1.7 (1.1) (5.0) (0.7) (0.3) (2.0) (0.9) 1.0 1.5 1.5 1.5

Change in

general

government

debt/GDP

(%)

(0.8) 5.0 12.2 7.6 8.7 12.5 7.1 6.8 5.3 3.4 3.4

General

government

balance/GDP

(%)

2.0 (4.5) (11.1) (9.6) (9.6) (10.6) (7.1) (5.4) (4.8) (3.4) (2.9)

General

government

debt/GDP

(%)

36.3 40.2 54.0 61.7 70.3 84.0 91.6 96.5 99.3 100.1 100.0

Net

general

government

debt/GDP

(%)

23.8 27.9 40.6 51.5 61.8 75.0 84.3 88.5 91.4 93.0 93.1

General

government

interest

expenditure/revenues

(%)

3.9 4.3 5.0 5.3 7.0 8.2 9.0 9.2 8.9 8.9 8.9

Oth dc

claims on

resident

non-govt.

sector/GDP

(%)

167.0 172.0 175.9 177.6 171.8 157.3 142.1 133.6 131.4 129.9 127.8

CPI

growth

(%)

2.8 4.1 (0.2) 2.0 3.1 2.4 1.5 0.1 0.5 0.5 1.2

Gross

external

financing

needs/CARs

+use. res

(%)

291.8 331.8 373.0 367.9 308.3 297.6 260.5 242.9 219.2 207.4 197.5


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Table 1

Kingdom of Spain - Selected Indicators (cont.)

Current

account

balance/GDP

(%)

(10.0) (9.6) (4.8) (4.5) (3.7) (1.2) 0.8 2.1 2.1 1.8 1.8

Current

account

balance/CARs

(%)

(29.0) (29.0) (16.0) (13.3) (10.0) (3.1) 2.0 5.1 4.9 4.2 4.1

Narrow

net

external

debt/CARs

(%)

299.5 286.6 379.2 329.5 278.9 295.0 282.5 254.5 231.0 208.7 187.6

Net

external

liabilities/CARs

(%)

244.2 227.1 322.0 266.4 228.7 247.0 254.2 232.8 213.4 190.0 167.9

Other depository corporations (dc) are financial corporations (other than the central bank) whose liabilities are included in the national definition

of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year

plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as

the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus public-sector liquid

assets held by nonresidents minus financial sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net

external lending. CARs--Current account receipts.

The data and ratios above result from S&P’s own calculations, drawing on national as well as international sources, reflecting S&P’s independent

view on the timeliness, coverage, accuracy, credibility, and usability of available information.

Related Criteria And Research

Related Criteria

• Sovereign Government Rating Methodology And Assumptions, June 24, 2013• Methodology For Linking Short-Term And Long-Term Ratings For Corporate,Insurance, And Sovereign Issuers, May 7, 2013

• Criteria For Determining Transfer And Convertibility Assessments, May 18,2009

Related Research

• Sovereign Defaults And Rating Transition Data, 2013 Update, April 18,2014

• Outlook On Spain Revised To Stable From Negative On Economic Rebalancing;'BBB-/A-3' Ratings Affirmed, Nov. 29, 2013

• S&P Clarifies Its Approach To Accounting For EFSF Liabilities When RatingThe Sovereign Guarantors, Nov. 2, 2011

In accordance with our relevant policies and procedures, the Rating Committeewas composed of analysts that are qualified to vote in the committee, withsufficient experience to convey the appropriate level of knowledge andunderstanding of the methodology applicable (see 'Related Criteria AndResearch'). At the onset of the committee, the chair confirmed that theinformation provided to the Rating Committee by the primary analyst had beendistributed in a timely manner and was sufficient for Committee members to


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make an informed decision.

After the primary analyst gave opening remarks and explained therecommendation, the Committee discussed key rating factors and critical issuesin accordance with the relevant criteria. Qualitative and quantitative riskfactors were considered and discussed, looking at track-record and forecasts.The chair ensured every voting member was given the opportunity to articulatehis/her opinion. The chair or designee reviewed the draft report to ensureconsistency with the Committee decision. The views and the decision of therating committee are summarized in the above rationale and outlook.

Ratings List

UpgradedTo From

Spain (Kingdom of)Sovereign Credit Rating BBB/Stable/A-2 BBB-/Stable/A-3Senior Unsecured BBB BBB-Short-Term Debt A-2 A-3Local Currency AAA

Fondo de Amortizacion del Deficit ElectricoSenior Unsecured* BBB BBB-

Fondo de Reestructuracion Ordenada Bancaria (FROB)Senior Unsecured* BBB BBB-

Banco de Sabadell S.A.Banco Financiero y de Ahorros S.A.Bankinter S.A.CaixaBank S.A.Senior Unsecured* BBB BBB-

*Guaranteed by the Kingdom of Spain.

Complete ratings information is available to subscribers of RatingsDirect atwww.globalcreditportal.com and at spcapitaliq.com. All ratings affected bythis rating action can be found on Standard & Poor's public Web site atwww.standardandpoors.com. Use the Ratings search box located in the leftcolumn. Alternatively, call one of the following Standard & Poor's numbers:Client Support Europe (44) 20-7176-7176; London Press Office (44)20-7176-3605; Paris (33) 1-4420-6708; Frankfurt (49) 69-33-999-225; Stockholm(46) 8-440-5914; or Moscow 7 (495) 783-4009.


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