Telefonica could become the largest European ‘fallen angel’ in history, says Aviva

The downgrade of Spanish company Telefonica by Moody’s could have serious knock on implications for the European corporate bond market, said today Nancy Utterback, senior credit analyst at Aviva Investors.

On June 20, Moody’s Investors Service downgraded the Spanish telcommunications provider’s long-term senior unsecured and issuer ratings to Baa2 from Baa1, as the agency said the Spanish economic crisis will continue to weight on consumer spending.

According to Aviva, the rating cut could result in Telefonica ultimately losing its investment grade status, with serious effects for the European corporate bond market.

“Moody’s recently downgraded Spain to Baa3, which is the cusp of investment grade territory and it has left ratings under review for further downgrade. The agency is waiting for the results of the government’s remaining bank liabilities post the bailout package and is also looking for material progress towards European fiscal unity and Eurobonds,” Utterback said.

Due to the multiple channels of contagion that exist between the sovereign and corporate issuers, Moody’s added that going forward Telefonica will not be rated more than one notch above Spain.

“With the direct link, one of the largest investment grade bond issuers in Europe with €38bn in publicly traded bonds now only needs Spain to be downgraded another two notches and it will be categorized as High Yield by Moody’s. With Spain’s rating still officially under review, this could happen by the end of 2012,” the analyst said.

Further downgrades by other ratings agencies would have an impact on both the investment grade bond indices and the European high yield market and Telefonica slipping into high yield territory could set a negative example, with other companies in peripheral Europe potentially to follow.

“Market participants are particularly concerned that Telecom Italia would be next, although for now Italy has a higher credit rating than Spain at A3 by Moody’s and BBB+ by S&P. Together the two companies have €63bn in publicly traded debt and represent just over 3.5% of the European investment grade corporate bond market,” she said.

Utterback added: “Telefonica alone would be the largest European ‘fallen angel’ in history, and its €24bn in euro and sterling denominated bonds would suddenly constitute 9% of the European high yield market. The concern is that the European High Yield investor base simply isn’t big enough to take on such quantities of debt. The company could potentially sell debt in the USD market where the High Yield investor base is much larger, however this would be at higher interest rates.”

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