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Fitch Downgrades San Marino to 'BBB-'; Outlook Stable
June 2, 2017 / 8:07 PM / 6 months ago

Fitch Downgrades San Marino to 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) Link to Fitch Ratings' Report: San Marino - Rating Action Report here LONDON, June 02 (Fitch) Fitch Ratings has downgraded San Marino's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'BBB-' from 'BBB', with a Stable Outlook. Fitch has revised the Country Ceiling down to 'BBB+' from 'A', and downgraded the Short-Term Foreign-Currency IDR to 'F3' from 'F2'. KEY RATING DRIVERS The downgrade to 'BBB-' reflects the following key rating drivers and their relative weights: HIGH In our view, developments in the banking sector have increased the likelihood that sizeable state recapitalisations will be required, adding to public debt. The results of the Asset Quality Review (AQR) commissioned by the Central Bank of San Marino, while still provisional, are expected to reveal a system-wide capital shortfall (relative to San Marino's regulatory minimum requirement) of around 18% of GDP. The equivalent capital shortfall relative to a proxy of a Basel 3 CET1 ratio of 8% of risk-weighted assets would be close to 33% of San Marino's GDP. Fitch considers that private sector solutions will prove insufficient to make up identified capital shortfalls, resulting in further state injections over time. The need for public banking sector support partly reflects ongoing weaknesses in asset quality and profitability across the sector. The non-performing loan (NPL) ratio stood at 43.4% of total loans at end-2016, compared with 44.2% six months earlier. At the same time the NPL coverage ratio has fallen to 26.2% at end-2016, from 28.7% at end-2015. Taken together, unprovisioned NPLs equate to close to 85% of San Marino's GDP. The sector continues to be loss-making, as net margins are squeezed by low interest rates, the burden of NPLs, and the challenge of adapting banks' business model to improve competitiveness in the more transparent regulatory environment. A sizeable part of the expected capital shortfall identified by the AQR relates to overvaluation of bank assets, particularly of San Marino real estate. The San Marino authorities plan to accompany public interventions with strengthened financial sector regulation and oversight, and we anticipate somewhat greater impetus for bank restructuring. Our public debt projections incorporate state injections in the banking sector totalling 15% of GDP from 2018-2020, although there is a large degree of uncertainty around the exact size and timing of interventions, which reflects the provisional nature of the AQR results and the uncertain bank and government response. MEDIUM There has been a steady depletion of San Marino's fiscal reserves alongside a moderate increase in public debt, reducing fiscal flexibility. Reserves fell to 1.9% of GDP at end-2016, from 2.5% a year earlier (and from 15% of GDP in 2009) while public debt increased to 22.0% of GDP in 2016 from 19.7% in 2015. This has been driven by public recapitalisations of San Marino's largest bank Cassa di Risparmio della Repubblica di San Marino (CRSM) totalling 16% of GDP from 2012-2016. Incomplete financial sector reform, contingent liability risks from the banking sector, the absence of a 'lender of last resort' capability, and no track record of government external borrowing reduce public debt tolerance, in our view. The IDRs also reflect the following key rating drivers: San Marino has governance indicators and income per capita that are significantly above the rating peer group, and is a net external creditor. General government debt, at 22% of GDP compares favourably with the 'BBB' median of 41% and the country has a history of fiscal prudence, which helps mitigate weak financing flexibility. However, resilience to shocks is curtailed by the small size of the population (32,000), limited economic diversification and high dependence on Italy. There are also gaps in economic data, and the banking sector is still large relative to the economy, with bank assets close to 360% of GDP, albeit down from 600% in 2008. There has been a return to mild economic growth since San Marino's deep recession from 2009-2014, during which GDP contracted by a third. Final national accounts data is not yet available for 2016, but GDP growth is estimated at 1.1%, up from 0.5% in 2015. More high-frequency indicators point to a moderate strengthening of the recovery in 2017, and the unemployment rate fell to 8.0% in April this year, from 8.6% a year ago. Fitch forecasts GDP growth of 1.3% in 2017 and 1.4% in 2018, as earlier efforts to improve financial transparency continue to underpin greater economic integration with Italy. We expect a moderate pick-up in both investment and private consumption, offsetting ongoing financial sector deleveraging. Fitch forecasts fiscal deficits of 0.4% of GDP in 2017 and 0.3% in 2018, similar to the 0.3% deficit in 2016 (excluding last year's 2.8% of GDP public recapitalisation of CRSM). We expect the composition of the 2017 budget to be largely unchanged, and for 2018 a moderate increase in tax revenues from introduction of VAT to offset higher infrastructure spending, which has been delayed in recent years. We also forecast a near balanced budget in the medium term, in line with the government's stated objective. The new government, which took 58% of the vote in December's second round election run-off, is somewhat more left-leaning than its predecessor but we do not expect a sizeable shift in overall fiscal and macroeconomic policy. 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 required, reflecting the results of the AQR, 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 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 LT FC 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, 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 - Fitch has incorporated further public sector recapitalisations of the banking sector totalling approximately 15% of GDP, spread equally over 2018-2020. - Our long-term debt sustainability calculations are based on average annual GDP growth of 1.4% from 2017-2026, GDP deflator inflation rising to 1.5%, an average primary balance of -0.1% of GDP (excluding bank recapitalisations), and a steady increase in marginal interest rates from 2017. - Fitch assumes that San Marino will continue to strengthen its international cooperation agreements in economic, tax and political areas, helping to reduce risks from external policy shocks, particularly from Italy. 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 Michele Napolitano Senior Director +44 20 3530 1882 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Summary of Data Adjustments - One data adjustment has been made; adopting the governance score for Italy as a proxy for governance in San Marino, as there is not a full set of World Bank governance indicators available for San Marino (for example, there are no indicators for Government Effectiveness, Regulatory Quality, and Control of Corruption). 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