Thanks to favorable market conditions, characterized by low interest rates, Spain's autonomous communities have started to replace large volumes of central government loans with commercial debt. In 2020, regions refinanced a total of €15 billion in debt. What's more, regular issuers, like Madrid, the Basque Country, and Navarre have remained active, and other regions have also returned to the market.

Consequently last year, for the first time in a decade, we saw a slowdown in Spanish regions' increasing funding exposure to the central government. The state rapidly took a central role in the regions' funding mix after it created dedicated facilities to cover regions' funding needs in 2012, going from zero to about 60% of total debt by 2018.

S&P Global Ratings believes Spanish regions' funding mix will keep shifting toward commercial debt. However, becoming less dependent on state financing will take time, given regional economic differences. Six of the 17 autonomous communities still showed more than 70% of financing was from the state as of year-end 2020, so some of them will continue to rely on the state's finances for the next few years. In our view, a diversified funding strategy often correlates with strong sophisticated management and may increase resilience to changing market conditions. However this has no direct impact on our ratings.

Regions Refinanced €15 Billion Of Central Government Debt In 2020

This amount represented 8.3% of the autonomous communities' outstanding central government loans last year. But the trend had already started in 2019 (see chart 1). Although many of the loans carried interest rates as low as 0.8% per year, regions have been able to refinance them at 0% or even in some cases negative interest rates, achieving substantial interest savings. We have seen further refinancing transactions in 2021 to date, albeit for a lower amount.

Chart 1

Bond Funding Is Recovering But Still Far From Historical Levels

In recent years, the amount of outstanding long-term bonds has been declining since the regions refinanced most of their maturing debt through the central government's liquidity facilities. Madrid, the Basque Country, and Navarre have been regular issuers throughout the past decade, while some other regions (Andalusia, Galicia, Castilla la Mancha, Asturias, and Castilla León, for example) have returned to the bond market.

Chart 2

These issuances have not been sufficient to fully compensate for the maturing bonds issues, that is, until 2020, when a recovery of overall outstanding bond volumes started taking hold. Some regions like Madrid, the Basque Country, and Andalusia have continued to issue sustainable bonds, thereby broadening their investor base, both in terms of the nature of investors and their geographic footprint. Regional bonds tend to have long tenors and very low interest rates.

For most Spanish regions, the share of bond-based funding is still quite far from peak levels in 2011 (see chart 3). Madrid and the Basque Country have maintained or even increased the proportion of bonds in their overall debt portfolios. Navarre, while remaining an active issuer, has also obtained bank funding in recent years, leading to an overall relative decline of bonds in its debt portfolio.

Chart 3

Most other regions have seen a decline in the share of bond issuance relative to total outstanding debt. Asturias and La Rioja, on the other hand, had no bond debt at the end of 2011, and have since established a presence in the markets.

Strategy And Market Conditions Could Spur Commercial Borrowing

We expect the increase in market-based funding to continue, due to ongoing refinancing of central government loans and potential decisions of some key regions to intensify their commercial borrowing. The share of commercial debt will likely continue to rise over at least the next two years.

In our opinion, favorable market conditions are likely to continue, fueling financial institutions' appetite for debt instruments to place their excess liquidity. In particular, we believe there is still scope for additional refinancing of regions' central government loans, especially for regions that still have a large proportion of state debt in their funding mix. On the other hand, for regions that have refinanced large amounts in recent years, the remaining central government loans carry comparatively low interest rates, diminishing the financial attractiveness of refinancing.

With fiscal rules suspended for 2020, 2021, and possibly also 2022, the central government will continue to use compliance with the 2019 fiscal targets (last binding ones) as the reference point to authorize regions to employ a mixed-funding strategy. That would allow them to borrow in the market while retaining access to the liquidity facilities. Regions that did not comply with the 2019 targets need to choose between covering all their needs through the FLA (Fondo de Liquidez Autonómico), which entails enhanced supervision and conditionality, or through market-based instruments (bonds or bank loans).

Some regions may decide it is too risky to opt for full market financing. However, if conditions remain favorable, several may choose to fund their needs entirely through commercial lending. For example, in 2021, we expect Andalusia (which complied with the 2019 targets) will cover about half of its total needs in the markets. Meanwhile Galicia, which narrowly missed the deficit target, will source all its funding requirements through bank loans and bonds. If more regions decide to go this route, that would tend to accelerate the transition from central government funding.

The State Will Remain A Core Funding Source For Many Regions

We expect a widening of the gap between regions in terms of the funding mix, with some regions structurally dependent on central government funding, while others gradually normalize their funding mix (see chart 4). This is despite the ongoing trend of loan refinancing and regions' renewed interest in bond issuance.

Chart 4

Some of the most indebted regions have not done any significant refinancing since 2012, while others, like Castilla La Mancha, Murcia, and Valencia have made some transactions. However, refinancing has had a limited impact on the composition of debt portfolios, due to the combination of high overall debt and additional new central government loans.

On the other hand, regions like Andalusia, Extremadura, Aragón, and the Balearic Islands have substantially decreased the proportion of debt to the central government (although this remains high; see chart 5). The Canary Islands, Galicia, and Asturias have been the most active in refinancing central government debt, while Castilla-León and La Rioja have also reduced their exposure, even though this was already low. Madrid currently has no central government debt and never had more than 7% of its total debt in the hands of the central government, thanks to its continued reliance on market-based funding. The special-status regions--Basque Country and Navarre--have never used central government funding.

Chart 5

Greater Funding Diversity Has No Direct Impact On Ratings

A region's funding structure does not have a direct influence on our rating decisions. However, in our view maintaining access to a well-diversified range of funding sources, including market-based funding, typically indicates sophisticated financial management. Relying on market-based funding entails interaction with investors, enhanced reporting, and transparency. These tasks require supplementary efforts and specialized expertise. We believe having a diverse funding base, in terms of instruments, type of investors, and their geographic footprint may increase an issuer's resilience to changing market conditions.

Editor: Bernadette Stroeder. Digital Design: Joe Carrick-Varty.