After years of problems in Europe –including the PIIGS1, Cyprus and a worse than-expected, Europe-wide recession – one could be forgiven for wondering what's next. The fact is, however, that barring a euro breakup or the collapse of an important European financial institution, credit ratings are likely to remain largely unchanged.
Around 70% of Europe's top 100 banks have negative ratings outlooks and one can justifiably be concerned about any number of issues: worsening asset quality in Italian banks; problems with domestic banks in Spain; wholesale funding dependence in French banks; falling real estate in Dutch banks; and asset liability mismatches in Nordic banks. Then there is Europe's inability to create a common resolution framework.
However, whether old or new, these problems are largely offset by continued support from individual governments and the European Central Bank (ECB), so while banks' credit fundamentals may continue deteriorating, their ratings are likely to remain linked to those of their sovereign nations for now. As for corporates, investment-grade issuers outside of the most cyclical sectors have experienced limited deterioration of fundamentals while potential liquidity issues, particularly at the lower end of the credit spectrum, were promptly dealt with by the more-than-favourable liquidity conditions in debt markets.
As a result, while economic conditions may deteriorate in 2013, and while 2014 may witness a weak recovery, we believe bank ratings will be supported and corporate fundamentals will remain underpinned by geographical diversification, by the conservative financial policies of better names and by the limited refinancing needs of weaker issuers.