Trading on Downgrade Review of Spain and Its Biggest Banks

Moody's Investors Service announced on Monday morning that it was placing the credit rating of Spain and five of its biggest banks under review for possible downgrades, while downgrading the credit rating of six Spanish regions.

One of the main factors cited by Moody's for Spain's possible downgrade was the recent official rescue package that was implemented in order to prevent Greece from defaulting on its debts.

Moody's Investors Service said that the rescue package set a precedent in which investors who own bonds from countries with high debt burdens or large budget deficits were being forced into shouldering the burden of more risk.

The Moody's report addressed the Greek rescue package, saying that "the official support package for Greece has negative credit implications for non-Aaa-rated euro area sovereigns with large debt burdens and/or high deficits."

Moody's also noted that the rescue package did not work as well as hoped because of market concerns over more private sector involvement in future restructurings like Greece's.

Another factor that may lead to Spain's credit rating being downgraded is that the federal government has little control over the spending of the country's powerful regional governments.

Moody's Investors Service downgraded six of these regions today and placed seven others under review, saying that "the downgrades of the six Spanish regions reflect the deterioration in their fiscal and debt positions," and that the review for downgrade of the seven other regions "reflects the placement under review for downgrade of Spain's rating."

Regarding the regional governments' affect on the federal government's finances, the report said that Moody's "will assess the likelihood that the central government will again be able to compensate for fiscal slippage at the regional government level. Any additional measures at the regional government level, both to correct the fiscal slippage currently evident and to address the structural spending pressures on the regional finances, will also be assessed during the review period."

Although Moody's praised the federal government for unpopular structural reforms that are being put in place to reduce spending and increase government revenue, the efforts of the Spanish government are being undermined by Spain's regional governments.

Traditionally, the regional governments have had a great deal of control over their spending, so they will need to match the efforts of the federal government if Spain is to lower its fiscal deficits.

Another factor that is a cause for concern of Moody's is the low growth rate of the Spanish economy.

This may be the most serious issue related to Spain's possible credit rating because there is little that the Spanish government can do to bolster growth under the current economic conditions.

In fact, Spain's effort to reduce its deficit by raising taxes and reducing spending is much more likely to slow economic growth.

The country's unemployment rate has already risen to a level of more than 20%, which is the highest unemployment rate in the eurozone.

With a combination of high unemployment, increasing taxes and reduced government spending, it's unlikely that the Spanish economy will improve any time soon.

To make matters worse, in another report released by Moody's Investors Service earlier today, Moody's said that it was placing five of Spain's biggest banks under review for a downgrade, including two banks that trade on American stock exchanges: Banco Santander (NYSE: STD) and Banco Bilbao Viscaya Argentaria (NYSE: BBVA).

Moody's said that its "bank rating reviews have been prompted by its concurrent review of the Spanish government's bond ratings."

The possible downgrade of Spain and its biggest banks will surely put more pressure on the euro.

Many have been questioning whether or not the euro can survive, as the likelihood of defaults in troubled eurozone countries like Spain, Portugal, Ireland and Italy increases.

Investors who feel that more defaults and restructurings are coming may want to consider the ProShares UltraShort Euro (NYSE: EUO) or the CurrencyShares Swiss Franc Trust (NYSE: FXF).

If the viability of the euro is questioned further, shorting the euro or investing in the safe haven currency of the Swiss Franc are two actions that could protect a portfolio from any fallout from a Spanish downgrade.

For those who feel that the concerns over Spain's credit rating are overblown, the iShares MSCI Spain Index Fund (NYSE: EWP) or the banking stocks mentioned earlier in this article are worth consideration.

Although Moody's has placed the credit rating of Spain and its biggest banks under review, the rating agency has also said that Spain is taking the right steps to lower its fiscal deficits.

Moody's also said that if Spain's credit rating is lowered, it will probably be by just one notch, so a downgrade of Spanish debt is not likely to be as serious as the previous downgrades of other troubled eurozone countries.