S&P Issues Walk Thru On Follow Up Downgrades Of European Banks And Insurers

Tyler Durden's picture

As expected in the aftermath of the concluded S&P ratings action on European sovereigns, the next action is for the rating agency to go ahead and start cutting related banks and insurers, as we noted over the weekend with many of the main European banks anticipated to see one or two notch cuts potentially as soon as today. Which is why the just released report "How Our Rating Actions On Eurozone Sovereigns Could Affect Other Issuers In The Region" will be read by great interest by many to get a sense of when the next shoe is about to drop. Here is what it says on that topic.

BANKS

 

In December, we placed the ratings on some 85 eurozone banking groups,  representing more than 150 issuers, on CreditWatch with negative implications  after we took a similar action on 15 European sovereigns. This reflects the  interconnected risks we see between the sovereigns and the European banking system. Governments can affect the creditworthiness of banks in multiple ways. Over the past four years--particularly in Europe and the U.S.--we've seen governments support banks with fresh capital, more liquidity, asset insurance, and guarantees.

 

Our revised bank, Banking Industry Country Risk Assessment (BICRA), and sovereign rating criteria, all published recently, provide a comprehensive framework for assessing these interactions. (See the list below for titles and publication dates.) This framework helps us to measure and comment upon the evolving relationship between banks and governments in a coherent and globally consistent manner.

 

We'll strive to resolve the ratings on banks we placed on CreditWatch as a result of the eurozone sovereign action as quickly as possible, but certainly within the next four weeks. We will seek to resolve these CreditWatch actions for entire banking systems, one country at a time.

And insurers:

we may lower the ratings on certain other insurers because of indirect factors associated with the sovereign actions. These indirect factors arise because we consider that many insurers in Europe are affected, to varying degrees, by their aggregate exposure to eurozone sovereign debt, elated bank debt and deposits, the resulting impact on capital adequacy, and the impact of the slowdown we expect to see in economic activity in the eurozone.

 

We're likely to issue rating actions in two tranches. The first tranche will include ratings that are directly affected, based on our criteria, by the sovereign rating actions. We expect to take these actions within one week. The second tranche includes other insurers not directly affected by our criteria, but rather by indirect effects. We expect to take these actions within four weeks.

So while a downgrade may not come today, it is coming shortly. Just in time for it to be "priced in" and have no incremental impact, even though it does, just like the sovereign downgrade will (more in an upcoming post), although it will surely do miracles for the market's sense of complacency.

Full report:

LONDON (Standard & Poor's) Jan. 17, 2012--Standard & Poor's Ratings Services said today that the rating actions that it took on 16 European Economic and Monetary Union (EMU or eurozone) sovereigns on Jan. 13, 2012, could lead to rating actions on other issuers in Europe over the next four weeks.

These actions will be guided by our practice-specific criteria, which identify direct or indirect linkages between credit quality for sovereigns and entities
or companies--such as local and regional governments, government-related entities (GREs), banks and insurers--whose credit fortunes may be related to those of the sovereigns.

In addition, for nonsovereigns that are currently rated above the revised sovereign ratings, Standard & Poor's considers an issuer's or transaction's
degree of exposure to country and sovereign credit risk in assessing whether to rate above the sovereign rating level. Within the eurozone, our criteria
allow a wider ratings differential between sovereigns and nonsovereigns than in other jurisdictions. That's because we believe nonsovereigns benefit directly or indirectly from a combination of factors in the region that mitigate country risk. This differential varies according to the level of the sovereign rating, as well as the issuer's or transaction's degree of exposure to country risk.

The scope and timing of associated rating actions depend on the degree of linkage between each sovereign and related entity or company, as well as broad implications from potential lower levels of government support.

LOCAL AND REGIONAL GOVERNMENTS

Interconnections between the credit quality of a sovereign and local governments are manifold, in particular through the ability of the sovereign to influence the predictability of local governments' institutional frameworks, revenue and expenditure mix, and ongoing extraordinary support.
Therefore, under our criteria for local and regional governments (LRGs) and their related sovereigns, we generally cap the ratings on LRGs based on the long-term foreign currency rating on the related sovereign. Following the ratings actions on the eurozone sovereigns on Jan. 13, 2012, we will review the ratings on the 35 LRGs placed on CreditWatch with negative implications on Dec. 7, 2011, following similar actions on their respective sovereigns.

We expect that downgrades on LRGs will most likely be limited to those currently on CreditWatch. Those downgrades could be up to two notches, depending on the actions we took on the related sovereign. In addition, we might assign negative outlooks to entities that were not CreditWatch, in line with the direction of the outlooks on their respective sovereigns.

GOVERNMENT-RELATED ENTITIES WITH AN "ALMOST CERTAIN" LIKELIHOOD OF SUPPORT

Under our criteria for government-related entities, Standard & Poor's rates GREs the same as their sovereign when we believe there is an "almost certain" likelihood that they would receive timely and sufficient extraordinary support from that sovereign in case of stress. Consequently, in the wake of our rating actions on eurozone sovereigns on Jan. 13, we expect we may be taking similar actions on 26 eurozone GREs for which we believe the likelihood of extraordinary government support is "almost certain," and for which, in our view, nothing immediate is likely to diminish the prospect of government support.

CORPORATE AND INFRASTRUCTURE

Some additional 27 eurozone GREs and non-GREs in our corporate and infrastructure (IFR) sector--including utilities--have been on CreditWatch
negative since Dec. 7 and 8 as a result of the CreditWatch listing of their sovereigns. Infrastructure companies account for the bulk of those on CreditWatch because they are often partly or fully government-controlled and generally have high exposure to country risk. Their status as GREs is a
determining factor for most of the CreditWatch placements because the sovereign rating is a key element for these ratings.

Because we view these GREs as having less than "almost certain" likelihood of extraordinary support under our criteria, the sovereign ratings do not alone determine our ratings on these GREs. Given their direct exposure to the sovereign, however, we generally cap our ratings on eurozone GREs at the rating on the sovereign. Nevertheless, under specific circumstances discussed in our criteria, "Rating Government-Related Entities: Methodology And Assumptions," Dec. 9, 2010, and "Nonsovereign Ratings That Exceed EMU Sovereign Ratings: Methodology And Assumptions," published June 14, 2011, we may rate a GRE higher than its sovereign. This includes exceptional cases where the GRE's stand-alone credit profile (SACP) is higher than the sovereign foreign currency rating and if we consider that the sovereign has a limited willingness and ability to impair the GRE's credit standing in periods of stress.

The differential allowed between our rating on a eurozone non-GRE issuer and its relevant sovereign under our nonsovereign ratings criteria is two to six notches (if the sovereign is rated investment-grade). This is subject to our view of underlying company creditworthiness, the issuer's proportion of sales generated in the relevant jurisdiction, and our view of the sector's degree of sensitivity to country risk, as outlined in our criteria.

BANKS

In December, we placed the ratings on some 85 eurozone banking groups, representing more than 150 issuers, on CreditWatch with negative implications after we took a similar action on 15 European sovereigns. This reflects the interconnected risks we see between the sovereigns and the European banking system. Governments can affect the creditworthiness of banks in multiple ways. Over the past four years--particularly in Europe and the U.S.--we've seen governments support banks with fresh capital, more liquidity, asset insurance, and guarantees.

Our revised bank, Banking Industry Country Risk Assessment (BICRA), and sovereign rating criteria, all published recently, provide a comprehensive framework for assessing these interactions. (See the list below for titles and publication dates.) This framework helps us to measure and comment upon the evolving relationship between banks and governments in a coherent and globally consistent manner.

We'll strive to resolve the ratings on banks we placed on CreditWatch as a result of the eurozone sovereign action as quickly as possible, but certainly within the next four weeks. We will seek to resolve these CreditWatch actions for entire banking systems, one country at a time.

INSURERS

The ratings on various entities belonging to 15 European insurance groups have been on CreditWatch negative since we placed the ratings on 15 of the 17 eurozone sovereigns on CreditWatch in December (see "Various European Insurers Placed on CreditWatch Negative Following Recent Sovereign Rating Actions," published Dec. 9, 2011). This reflects our view that the insurance sector is exposed to sovereign creditworthiness because insurers tend to invest large portions of their assets in domestic government bonds and domestic banks. Furthermore, our sovereign ratings reflect our view of country risk, which we consider insurers are also facing, as weak or weakening economies can affect insurers' revenues and earnings.

Based on our criteria, certain insurer financial strength ratings may be directly affected by the sovereign rating actions. For example, the local
currency sovereign rating limits the ratings on most domestic-only insurers, either because their assets include material amounts of domestic sovereign debt, domestic bank debt, or domestic bank deposits, or because they have a largely domestic customer base.

In addition, we may lower the ratings on certain other insurers because of indirect factors associated with the sovereign actions. These indirect factors arise because we consider that many insurers in Europe are affected, to varying degrees, by their aggregate exposure to eurozone sovereign debt, elated bank debt and deposits, the resulting impact on capital adequacy, and the impact of the slowdown we expect to see in economic activity in the eurozone.

We're likely to issue rating actions in two tranches. The first tranche will include ratings that are directly affected, based on our criteria, by the sovereign rating actions. We expect to take these actions within one week. The second tranche includes other insurers not directly affected by our criteria, but rather by indirect effects. We expect to take these actions within four weeks.

STRUCTURED FINANCE

Following the eurozone sovereign CreditWatch placements, we put the ratings on 270 European structured finance tranches on CreditWatch negative on Dec. 9, 2011, and eight covered bond programs on CreditWatch negative on Dec. 15, 2011. (See "270 European Structured Finance Tranches Placed On CreditWatch Negative After Eurozone Sovereign CreditWatch Placements" and "Ratings On Eight Covered Bond Programs Placed On CreditWatch Negative After Eurozone Sovereign CreditWatch Placements.")

In those instances, we indicated what the potential rating resolution could have been. Those structured finance ratings and covered bond programs have what we consider either a direct link to the rating of the countries whose CreditWatch was resolved Jan. 13, 2012, or are exposed to a portfolio where most of the assets are located in one or more of those countries, or that we consider to have a high exposure to the country risk of any particular sovereign entity.

The "link" between the sovereign risk and the ratings on those structured finance transactions or covered bond programs is usually expressed as a "cap" or a maximum notch uplift from the sovereign rating.

Therefore, since the CreditWatch placements on those sovereign entities have now been resolved, we will apply our criteria to determine the actual impact on those structured finance transactions and covered bond programs.

According to our criteria, we expect that for transactions that we consider to have a direct link to the rating of a country, the ratings would be linked to the rating of that country. But for those transactions that instead are exposed to portfolios where most of the assets are located in one or more of those countries and where we consider the country risk exposure as "low," the rating impact will depend on the rating of the sovereign in question.

In particular, in case of "low" country risk exposure, the maximum uplift we would assign is six notches above the rating of the country where the assets of the portfolio are domiciled, if the rating of the country is in the investment-grade category, or five notches if the rating of the country is
between 'BB+' and 'B'. However, for those transactions or covered bond programs that we assess as having a "high" country risk exposure, the maximum uplift we would assign is two notches above the rating of the country where the assets of the portfolio are domiciled, if the rating of the country is investment-grade, or one notch if the rating of the country is between 'BB+' and 'B'.

We will strive to resolve the CreditWatch placements related to the eurozone CreditWatch placements within two weeks.