December 1, 2017 / 9:25 PM / 16 days ago

Fitch Affirms San Marino at 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) LONDON, December 01 (Fitch) Fitch Ratings has affirmed San Marino's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB-' with a Stable Outlook. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS San Marino's governance indicators, income per capita, and level of public debt compare favourably with the 'BBB' median, and the country is a net external creditor. However, it is exposed to a large banking sector with high impaired assets, there are gaps in economic, fiscal and external data, and resilience to shocks is curtailed by the small size of the population (32,000), limited economic diversification and high dependence on Italy. Recent developments have reinforced our view that the high level of non-performing loans (NPLs) in the banking sector, particularly at the largest bank, Cassa di Risparmio della Repubblica di San Marino (CRSM), will require large capital injections by the government. According to a recent audit commissioned by CRSM, cleaning up the bank's balance sheet and phasing in higher capital standards would require close to EUR500 million (equivalent to 35% of San Marino's GDP). This follows the Asset Quality Review (AQR) earlier in the year, which revealed a system-wide capital shortfall of 18% of GDP relative to San Marino's minimum regulatory requirement or 33% of GDP relative to a proxy of a Basel 3 CET1/RWA ratio of 8%, a key reason for our downgrade in June 2017 to 'BBB-'. There is a high degree of uncertainty over the size and timing of public support to the banking sector and whether there will be shareholder or creditor burden-sharing, but the government's strategy is likely to become clearer in the months ahead. The revised 2017 budget had incorporated EUR200 million of new debt for equity injections, to be financed partly with San Marino's first international issuance, but the authorities are now considering a broader range of financing sources and to phase bank support over a longer period. A recent government decree allowed CRSM to provision an additional EUR485 million against its NPLs, with government recapitalisation backing this spread over a prolonged period, up to 2040. Weak bank profitability and capital continue to constrain efforts to improve asset quality. Fitch expects the sector to make another loss in 2017 with no significant improvement in profit margins and administrative costs, as banks' business models have been challenged by more stringent regulation on transparency and the low interest-rate environment. NPLs in nominal terms have fallen in line with the size of balance sheets (bank assets are now equivalent to around 330% of GDP, down from 360% in 2016, and 600% in 2008). However, the NPL ratio remains high, at close to 43% of total loans. Bank liquidity is still at a manageable level but has fallen further over the last six months and the decline could continue. Overall financial sector reform progress remains relatively gradual in our view, and includes the recent introduction of a credit register. Public debt is forecast to be flat in 2017, at 22.0% of GDP, which compares favourably with the 'BBB' median of 40.5%. However, successive state recapitalisations of CRSM totalling 16% of GDP from 2012-2016 have driven down San Marino's fiscal reserves, to a forecast 1.7% of GDP at end-2017, from 10.4% at end-2011, reducing fiscal flexibility. The absence of a track record of external borrowing, together with banking sector risks arising from weak asset quality, incomplete financial sector reform, and the lack of a "lender of last resort" capability, and no track record of external borrowing reduce public debt tolerance, in our view. San Marino's underlying fiscal position is expected to remain close to balance, broadly in line with government targets. We forecast fiscal deficits (excluding bank recapitalisations) of 0.5% of GDP this year, 0.2% in 2018 and 0.3% in 2019. Higher revenues from a planned, temporary introduction of a property tax in 2018 and the phasing-in of a new VAT will offset higher interest costs and public infrastructure spending from 2018. We have maintained our previous assumption that from 2018-2020 the government injects a total of 15% of GDP into the banking sector, pushing up public debt to 36.0% of GDP in 2020. Under our longer-term projections, which assume a further 10% of GDP injection into banks, trend GDP growth of 1.3%, and an average primary fiscal surplus of 0.3% of GDP, public debt rises to 46.6% of GDP in 2026. Recent data points to moderately higher GDP growth than expected at our last review. Full national accounts data for 2016 is not yet available but there has been a provisional upward revision to close to 2% (from the original 1.1%), and following GDP growth of 0.5% in 2015. Unemployment this year has fallen steadily to 7.7% in September from 8.4% in January, while inflation remains subdued, up 1.1% y-o-y in September. We forecast GDP will rise 1.5% in 2017 and 1.4% in both 2018 and 2019, helped by ongoing economic integration with Italy and firmer external demand. Ongoing financial sector deleveraging continues to constrain a faster recovery from San Marino's deep recession from 2009-2014 during which GDP fell by a third. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns San Marino a score equivalent to a rating of 'BBB+' on the Long-Term FC IDR scale. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows: - Structural Features: -2 notches, to reflect: a) banking sector risk and the likelihood that further state recapitalisations of the sector will be required, reflecting the results of asset quality reviews, the very high level of NPLs relative to the size of the economy, lack of profitability, and the absence of an effective 'lender of last resort'; and to a lesser extent b) data gaps. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The main risk factors that, individually or collectively, could trigger negative rating action are: - Further banking sector weakness that increases the risk of additional contingent liabilities appearing on the sovereign balance sheet. - Deteriorating fiscal balances resulting in a marked increase in government debt to GDP. The main risk factors that, individually or collectively, could trigger positive rating action are: - Strengthening of the banking sector, including improved asset quality, liquidity, profitability and capital. -Reduction of government debt to GDP or rebuilding of fiscal buffers over time, for example through stronger economic growth or fiscal adjustment. KEY ASSUMPTIONS - Confidence in the banking sector and adequate liquidity are maintained, and there is an orderly process of tackling weak capital and asset quality. - Our long-term debt sustainability calculations are based on average annual GDP growth of 1.3% from 2017-2026; an average primary surplus of 0.3% of GDP (excluding bank recapitalisations); a steady increase in marginal interest rates from 2017; and public sector recapitalisations of the banking sector totalling 15% of GDP spread equally over 2018-2020, and a further 10% from 2021-2025. The full list of rating actions is as follows: Long-Term Foreign-Currency IDR affirmed at 'BBB-'; Outlook Stable Short-Term Foreign-Currency IDR affirmed at 'F3' Country Ceiling affirmed at 'BBB+' Contact: Primary Analyst Douglas Winslow Director +44 20 3530 1721 Fitch Rating Limited 30 North Colonnade London E14 5GN Secondary Analyst Alex Muscatelli Director +44 20 3530 1695 Committee Chairperson Jan Friederich Senior Director +852 2263 9910 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Country Ceilings Criteria (pub. 21 Jul 2017) here Sovereign Rating Criteria (pub. 21 Jul 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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