July 2013 Fitch Credit Outlook

7/27/2019 July 2013 Fitch Credit Outlook

1/16

Credit Market Research

www.fitchratings.com 17 July 2013

Global

The Credit OutlookProspect of Monetary Stimulus Exit Reveals Latent Risks

Special Report

Volatility With Elusive Growth: Market volatility has increased as speculation regarding the

timing of the inevitable wind-down of monetary stimulus in the US and Europe grows. This

drives sentiment in both equity and credit markets as evidence of firm economic growth

remains elusive. Fitch Ratings expects the prolonged and uncertain process of central bank

exits from unprecedented quantitative easing and historically low interest rates to generate

periodic bouts of market volatility.

Emerging Markets Risk-Off: Emerging-Market (EM) bonds, currencies and equities were hit

hard in the recent market sell-off. Although improved sovereign credit fundamentals reduce the

risks from tighter global liquidity, higher interest rates and FX risk, weaker EMs face challenges.

Credit growth and shadow banking trends in China are raising concern about financial stability.

Housing Market Rate Sensitivity: Historically low and stable base interest rates have

supported recovering US and European housing markets, with improved loan affordability and

asset performance in RMBS transactions. There are signs the increased rates may hamper

turnover in this market which is central to broader economic recovery.

Banks Face Investment Losses: Rising interest rates and a steepening yield curve will put

pressure on investment portfolios and capital ratios as unrealised losses flow through financial

statements. Market volatility will also affect funding costs and market access.

Corporate Issuance Headwinds: Rising rates could slow the pace of issuance, especially for

lesser established lower-quality credits, as investors turn more selective. Growth remains anaemic,especially in Europe, and several sectors continue to struggle with excess capacity and weak cash

flow generation. Improving profits are mainly due to efficiency programmes, not top-line growth.

Economic Recovery Flagged: Global growth should gradually pick up pace in H213 and

2014-15 as the US gathers steam and the eurozone approaches a cyclical turning point. A

broad-based economic recovery across the currency union is a prerequisite for crisis resolution.

Many EMs face more challenging growth conditions.

Rating Outlooks and Mix: The proportion of ratings on Negative Outlook or Watch remained

high across most sectors during H113, reflecting weak economic conditions in many regions

and the unresolved eurozone crisis. However, financial institutions, corporates and project

finance had modest 1-2pp reductions in this ratio. By contrast, sovereigns, international public

finance and structured finance trended in the opposite direction. The rating mix deteriorated inmost sectors but at a more moderate pace than in prior years.

Figure 1

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Sovereign US Publ Fin Intl Publ Fin Financials

Corporates Infrastructure SFNegative outlooks(% of portfolio)

Negative Rating Outlooks and Watches

Source: Fitch

Analysts

Monica Insoll+44 20 3530 [email protected]

Mariarosa Verde+1 212 908 [email protected]

Trevor Pitman (Regional Credit OfficerEMEA and APAC)+44 20 3530 [email protected]

Eileen Fahey (Regional Credit Officer US)+1 312 368 [email protected]

a See appendix for full author list.

The Credit Outlook provides an

overview of Fitch Ratings outlook

across all rated sectors and regions,

identifying the main macro factors that

will drive credit trends over the next

12-24 months. It is published

semi-annually.
mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]://www.fitchratings.com/jsp/general/video_all.jsp


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The Credit OutlookJuly 2013

2

Sovereigns

Global sovereign ratings remain under downward pressure due to the eurozone crisis, high

public- and private-sector debt levels, weak banking sectors, a difficult growth and economic

policy environment and idiosyncratic EM political and other credit developments. In H113 there

were 13 notches of downgrades of foreign-currency ratings, compared with 10 notches ofupgrades. The ratio of Negative to Positive Outlooks is just under 3:1, signalling that further

downgrades are likely, with ten developed-market (DM) names on Negative Outlook and none

on Positive Outlook.

Figure 2 Figure 3

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DM EM All(% of portfolio)

Negative Outlooks & Watches

Source: Fitch

AAA13%

AA10%

A11%

BBB28%

BB17%

B18%

Rating DistributionAs at 30 Jun 2013

Source: Fitch

CCC & below2%

There were also two recordings of a comparative rarity: the sovereign defaults of Jamaica and

Cyprus (Local-Currency IDR). The trend of convergence in the ratings of DM and EM ratings is

continuing, with the majority of the foreign-currency downgrades year to date taking place in

DM and most of the upgrades in EM countries. This trend should continue in 2013 and 2014.

Fitch Ratings expects global growth to gradually pick up in H213 and 2014-15 as the USgathers steam and the eurozone approaches a cyclical turning point. Its latest forecasts for

world GDP growth are 2.4% in 2013, 3.1% in 2014% and 3.2% in 2015. However, forecasts are

lower for many EMs owing to strains from spill-overs from advanced countries and China, more

difficult policy trade-offs, a decline in credit growth, and structural bottlenecks.

US Federal Reserve forward guidance on the timing of the tapering of quantitative easing (QE)

and eventually raising interest rates precipitated a broad market sell-off and increase in

volatility from the middle of May, even though the comments should not have been a great

surprise and reflect more upbeat US growth prospects. Other major central banks, including the

ECB and Bank of England have indicated that monetary tightening is distant, while the Bank of

Japan plans to continue expanding its balance sheet aggressively. Nevertheless, US monetary

policy has the greatest impact on global interest rates and risk appetite owing to the role of the

US dollar as the pre-eminent reserve currency and main denomination for foreign-currency

borrowing, as well as the size of the US capital markets.

Fitch expects the prolonged and uncertain process of central bank exit from unprecedented QE

and historically low interest rates to generate periodic bouts of market volatility.

Developed Markets

The eurozone crisis and related economic, fiscal, political and financial trends are continuing to

drive negative rating actions. However, the intensity of the crisis eased in H113, despite

recession, record unemployment, uncertainty following the Italian elections and the bail-out in

Cyprus which led to bank failure, capital controls and a domestic debt default. Fitchs

longstanding view is that a resolution of the crisis will require ongoing country-level fiscal and

structural adjustment, greater progress towards a banking union and a broad-based economic

recovery across the currency union.

Outlook Trend

Downward pressure on eurozone

sovereigns less intense.

Positive momentum for EMs slowing.

Key Risks

Eurozone crisis.

Sharp slow-down in China.

Tightening of US monetary policy,

triggering more adverse financing

conditions.


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3

Overall, nine DM sovereigns (six in the eurozone) are on Negative Outlook and none on

Positive Outlook. The net four rating notches of downgrades in H113 compares with 18 (across

seven countries) in 2012, of which 16 were in the first half of the year. There were two DM

upgrades: Greece (B-/Stable) and Iceland (BBB/Stable), demonstrating the potential for crisis-

hit countries to regain some lost rating ground as they start to recover. In H213, Fitch

downgraded France to AA+/Stable from AAA/Negative.

Emerging Markets

The strong net upward momentum in EM sovereign ratings since 2010 has slowed as many

face more challenging growth conditions and political pressures. Future EM rating changes are

likely to be driven more by country-specific factors than global macro trends.

Several large EMs are experiencing strains from spill-overs from advanced economies as well

as China, difficult policy trade-offs, a declining impact from credit growth and structural

bottlenecks. 2012-13 will see the second-weakest BRICs' growth (after 2009) since the

Russian crisis in 1998. Fitch has reduced its 2013-2014 growth forecasts for all four of the

BRIC nations, although forecasts for China remain high with projected growth of 7.5% in 2013

and 2014, followed by 7% in 2015 despite current challenges.

In H113, the balance of EM upgrades and downgrades remained skewed slightly to the upside,

with upgrades of Lithuania, Mexico, Thailand, Jamaica, Philippines and Uruguay the latter

two to investment grade. Three-quarters of the J.P.Morgan Emerging-Market Bond Index

(EMBI) is now rated investment grade by Fitch, up from one-third in 2008. But there were

downgrades for Egypt, Jamaica and South Africa, as well as China local-currency ratings. The

latter mainly reflects an increase in risks to financial stability related to rapid credit growth and

size of the banking and shadow-banking sectors, as well as the increased indebtedness and

contingent liabilities of local governments. So far in H213, Egypt was downgraded again

following an intensification of political instability, while Mozambique and Latvia was upgraded,

the latter after the decision that it will adopt the euro in January 2014.

EM bonds, currencies and equities were hit disproportionately hard by the market reappraisal

of US monetary policy, despite prior concerns over excessive capital inflows and strong

exchange rates. Fitch does not anticipate widespread EM credit distress owing to a secular

improvement in credit fundamentals, which reduces risks from tighter global liquidity, higher

interest rates and FX risk. However, the Fed move adds to worries over slowing growth,

Chinas financial stability, softer commodity prices and a series of political shocks.

Prospective Fed tightening raises risks facing weaker EMs, such as those with large external

financing needs and low foreign reserves, high levels of leverage, vulnerable debt structures,

those that have seen strong inflows of hot money and bank credit growth, or have weak policy

frameworks or credit fundamentals. The Feds early move may be for the better in the long termfor EM by taking some froth off the top of the market, slowing the pace of hot money capital

inflows, easing the pace of credit growth and preventing a misallocation of risk storing up

greater problems further down the line.

Related Research

2013 Mid-Year Sovereign Review andOutlook (July 2013)

Sovereign Data Comparator (June 2013)

Global Economic Outlook (June 2013)

Banking Union's Impact on Sovereigns(June 2013)

Why Sovereigns Can Default on LocalCurrency Debt (May 2013)

Ageing Costs: The Second Fiscal Crisis(January 2013)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=711119http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=711119http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=711676http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=711583http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710055http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710055http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708023http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708023http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696570http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696570http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696570http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696570http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708023http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708023http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710055http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710055http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=711583http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=711676http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=711119http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=711119


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4

Public Finance US

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Rev. supportedTax supported

All(% ofportfolio)


Source: Fitch

AAA13%

AA49%

A26%

BBB8%

BB2%

B0.4%


Source: Fitch

CCC &

below0.3%

Outlook Remains Stable for US States

The stable outlook reflects the expectation of manageable budget challenges in anenvironment of continued slow economic and revenue growth. A modest recovery has helped

stabilise the financial position of most states through fiscal year 2013 and enabled rebuilding of

financial cushions. Continued austerity in education and other spending is expected, as

spending for Medicaid and pensions continues to outpace revenue growth in many cases.

The key uncertainty in the outlook is the impact of potential federal deficit reduction decisions.

State revenue systems quickly reflect changing economic conditions, so any negative

economic effects of federal fiscal consolidation could open budget gaps. In the area of direct

federal funding, unless there are significant cuts to Medicaid, by far the largest area of federal

funding to the states, Fitch expects direct reductions to be manageable.

Local Governments Still Facing ChallengesSlow revenue recovery combined with continued spending pressures will continue to present

budgetary challenges. An extended period of declining to flat revenue has taken its toll on local-

government budgets and service levels. Property tax base declines have generally reversed,

although taxable property values remain well below the pre-recession peak. Tax revenue is

showing moderate growth overall. State aid is likely to be stable assuming potential federal aid

reductions to states are manageable. After four to five years of cuts many local governments

are less able to reduce discretionary spending, while upward pressure on pension and other

inflexible costs continues.

Revenue Sectors Mostly Stable

While each of the tax-backed sectors faces challenges, all the revenue sectors, with theexception of housing, have stable outlooks. The essential services provided by the water and

sewer sector, monopolistic business nature, and local rate setting are key factors in the sectors

performance stability. Drought conditions persist in much of the central and western part of the

US. However, historical development of supplies and storage across the nation largely has

insulated municipal credits from operational issues, and in turn, financial weakening.

Strong fundamentals for the public power sector, including autonomous rate-setting authority,

electric service essentiality, and reliable cash flow, should allow the sector to retain a solid

fiscal foundation and support its stable outlook despite the persistent challenges of expanded

environmental regulation and stagnant demand. For colleges and universities, Fitch expects

relatively stable balance-sheet management and enrollment, although pressures on the latter

are anticipated in certain market segments due to the continuing rise in tuition costs. Inaddition, the full impact of sequestration as it relates to research funding has yet to be

determined, but large research institutions typically have the budgetary flexibility to manage

through the potential uncertainties.

Outlook Trend

Mostly stable for state governments.

Local governments facing financial

pressure from slow recovery in tax

revenues and continued spending

pressures.

Revenue-supported issuers mostly

stable, but GSEs negative outlooks

weigh on the housing sector.

Healthcare sector vulnerable to

changes in federal policy and deficit

reduction negotiations.

Key Risks

Rising employee healthcare, pension

and other benefit related costs.

A low growth economy.

Negative economic effects following

deep or accelerated federal deficit

reduction.

Related Research

U.S. Public Finance Credit View: States(May 2013)

U.S. College Tuition and Affordability(May 2013)

Hospitals, Medicare,and SequestrationCuts (March 2013)

U.S. Public Power Peer Study (June 2013)

Local Government Pension Analysis(April 2013)
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5

Non-profit hospitals and healthcare systems management initiatives addressing the changing

environment should result in another year of stable operating performance. However, Fitch

believes that there is more uncertainty beyond 2013 as opportunities for further cost cutting

wane and as a wave of expected reimbursement reductions are realised under the full

implementation of the Patient Protection and Affordable Care Act (PPACA) beginning in 2014.

Sequestration cuts were mainly manageable for most hospitals. However, longer-term deficit

reduction negotiations could result in larger than expected reductions in healthcare funding.

The outlook for the tax-exempt housing sector remains negative, reflecting primarily the

Negative Outlook on GSE-guaranteed mortgage-backed securities backing state housing

finance agency issues.

Public Finance International

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(% ofportfolio)


Source: Fitch

AAA10%

AA16%

A9%

BBB40%

BB20%

B6%


Source: Fitch

Developed Markets

Almost half the portfolio of international public finance issuers with foreign-currency ratingsremain on Negative Outlook despite some stabilisation in the most recent quarter. The majority

of these Negative Outlooks reflect the Negative Outlook attached to the sovereign of the

country in which the issuers are located mainly Italy or Spain.

In the past year, numerous issuers in the A category, notably in Italy and Spain, have been

downgraded, boosting the proportion of ratings in the BBB category. There could still be

selective downgrades in these countries and possibly in France and Poland, as either the local

economy weakens, expenditure rigidity increases or central government tightens its purse

strings. Meanwhile, issuers in the BB category have grown , partly due to several new issuers

having been assigned BB category ratings.

Fitch has introduced a rating floor for regiona l issuers in Spain, currently set at BBB or one

notch below the sovereign rating. Based on the creation of an emergency liquidity fund, giving

issuers access to government funding, the agency believes that sovereign support would be

forthcoming for selected Spanish entities at an investment-grade level of probability. Elsewhere

in Europe there is mostly stability. In Germany, for example, a constitutional mechanism,

obliging the sovereign and other Laender to support a Land in difficulties, underpins the AAA

ratings of the Laender.

An increasing proportion (18%) of the portfolio is composed of specialised public-sector entities

not directly supported by tax revenues, as distinct from local or regional governments. This

reflects governments seeking to instil a more market-aware approach in their departments,

agencies and subsidiaries; and to encourage markets to share more directly in the risks of

certain government supported activities. Fitch expects this trend to intensify as these entities

seek to reduce their dependence on sovereign or subnational governments for funding and

expand their scope of action.

Outlook Trend

Negative Outlooks on almost half the

portfolio with risks concentrated in

France, Italy and Spain.

Balance of portfolio has mostly

Stable Outlooks.

Key Risks

A sovereign downgrade in France,Italy or Spain would lead to multiple

downgrades.

Weaker economic performance or

austerity measures could lead to

reduced financial flexibility and

downgrades.

Changes in methods of funding or

increased responsibilities could

result in downgrades.

Related Research

French Regions Financial Monitor 2013(June 2013)

Group of Mexican States Rated by Fitch:

Medians of Key Indicators (April 2013)Public Finance (EMEA) International -Rating Criteria Hierarchy (April 2013)

Russian Subnationals: Stable PerformanceAmid Increasing Centralisation(March 2013)
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Outlook Trend

Stable outlooks dominate majority of

markets.

Negative sector outlooks continue in

Taiwan, Italy and French Life.

Key Risks

Continuing low interest rates or

significant spike of 500 bp or more

(slow steady increase would be a

positive). Potential reach for greater yield

adding to asset risk.

Sovereign downgrades or contagion.

North America

US banks possess buffers in the form of enhanced capital levels, improved funding,

strengthened liquidity profiles and broad-based stability in key asset quality metrics. Generally

North American banks have strengthened credit quality more than Developed European ones.

These should promote continued rating stability in an environment which still presents some

challenges. Key issues to navigate in coming quarters include rising interest rates and a

steepening of the yield curve as policy rates are expected to remain low into 2014. This will

produce pressure on investment portfolios and capital ratios as unrealised losses flow through

financial statements.

Tepid economic growth limits opportunities to expand loan portfolios and constrains the

opportunity for margin expansion for a universe that is generally structured to benefit from

higher rates. The increase in intermediate rates in response to the Feds tapering

announcement in June may hamper the recovery in the residential real estate market.

Residential mortgage loan portfolios remain the weakest area of bank loan portfolios. The

regulatory environment also remains fluid as regulators strive to finalise the details of a broad

range of new regulations in response to the recent crisis. Progress on key areas such ascapital rules and resolution process for large banks will help remove uncertainty that is clouding

investor decision-making.

Canadian banks remain a bright spot with little to no change in ratings throughout the crisis and

turmoil over the past few years. Conditions and trends in the domestic residential real estate

market mirrored some of the trends that produced bubbles in other countries. However, the

authorities seem to have taken timely action to ease immediate pressure.

Emerging Markets

The credit profiles of banks across emerging markets will be affected by how recent asset

growth seasons and how future growth is managed. Broadly, economic conditions remain

relatively stable and risk management should continue to help keep the level of developingproblem assets at manageable levels. These dynamics can be seen at work in Brazil where

sharper than expected economic deceleration following high asset growth is producing some

downward pressure on bank performance. However, ratings (some recently upgraded to

investment grade) are expected to hold as liquidity and capital buffers are proving resilient.

Contrary to the situation in developed markets, a dozen sovereign ratings have been upgraded

to investment grade (three being restored to investment grade) since the onset of the crisis.

This has provided lift for support-driven IDRs, but more importantly highlights potential for a

more favourable operating environment for banks, albeit still subject to periods of volatility.

Credit trends in China are raising concern given the level of growth and the activity of shadow

banking making system asset quality trends difficult to track.

Insurance

Greater economic stability in 2013 has steadied insurance companies financial strength, and

especially those in EMEA, which is reflected by the decline in Negative Outlooks. Most insurers

maintain moderate debt and have not been encouraged by low interest rates to issue

disproportionate volumes of debt. Any upward movement in interest rates is therefore not

expected to materially raise interest costs.

In most major developed countries, the sovereign rating remains two or three notches above

the highest-rated domestic insurer. In Spain, however, the highest-rated domestic insurer is at

the same level as the sovereign, and in Italy and Japan as a result of international

diversification at one notch higher than the sovereign, making it more likely that these ratings

would move if the sovereign rating were downgraded.


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8

In Europe, sovereign risks have generally diminished since July 2012, resulting in lower yields

and gains in value, to the benefit of many insurers. With expectations of improved economic

conditions through 2014, interest rate rises will probably follow, causing a drop in debt

securities values. Most bond portfolios are currently holding large unrealised net gains and net

unrealised losses would develop if rates rose by more than approximately 200bp.

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210

Q

410

Q

211

Q

411

Q

212

Q

412

Q

213

(Quarter/year)

EMEA NA All

(% ofportfolio)


Source: Fitch

AAA0.5% AA

9%

A52%

BBB33%

BB3%

B1%


Source: Fitch

Life

The greatest concern for life insurers is the risk of a prolonged low interest rate environment as

asset rollover is putting pressure on interest margins. As a consequence, insurers are

increasingly considering placing a small portion of investments in higher-yielding assets,

including mortgage loans in the US and infrastructure and commercial real estate investments

in Europe. Credit risks may increase, but in view of the small volumes and slight additional risk

involved, should remain manageable over a short-term period.

Heightened scrutiny of the use of captive reinsurers led by New York regulators, whohighlighted the shadow insurance industry in a recent report, could spur some change in

current financing and risk management practices.

Non-Life

More frequent and severe losses from catastrophes since 2011 have not depleted the reserves

or earnings of reinsurers as much as might have been anticipated. Sound risk management

has generally kept claims manageable, premiums remain at economic levels and investors in

search of diversification and better yields have been willing to provide sufficient quantities of

funding and capital at reasonable rates. The low interest rate environment is also impacting

non-life insurers, but to a lesser extent than life insurers. Non-life insurers are seeing steady

improvement in 2013 earnings.

Related Research

Workers Compensation Insurance MarketUpdate (June 2013)

Hurricane Season 2013 (A Desk Referencefor Insurance Investors) (May 2013)

2012 Statutory Trends for U.S. LifeInsurance Sector (May 2013)

Property/Casualty Industry StatutoryResults and Forecast (May 2013)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710610http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709092http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709092http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709092http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709092http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708267http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708267http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707915http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709092http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709092http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709092http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709092http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710610http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710610http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710610http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709092http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709092http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708267http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708267http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707915http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707915http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707915http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707915http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708267http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708267http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709092http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709092http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710610http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710610


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Corporates

Figure 12 Figure 13

0

10

20

30

40

Q207

Q407

Q208

Q408

Q209

Q409

Q210

Q410

Q211

Q411

Q212

Q412

Q213

(Quarter/year)

EMEA NAEM All(% of portfolio)


Source: Fitch

AA1%

A18%

BBB43%

BB20%

B16%

CCC &below

2%


Source: Fitch

North AmericaThe outlook for US corporate credit quality continues to be favourable with a definite biastowards affirmations and upgrades outnumbering downgrades. Credit conditions in the US

corporate market remain stable despite lacklustre first quarter GDP growth and profitability

remains at very healthy levels. First-quarter earnings were largely within expectations, with

shortfalls occurring predominantly in revenues rather than profits. Efficiency programmes and

weaker commodity prices point to continued favourable margin performance, and headcount

reductions remain commonplace. This should result in a stronger second half, but full-year

expectations have moderated.

Capital spending remains constrained due to lack of end-demand, with few sectors needing

increased capacity. Longer-term overseas expansion plans in markets such as China and

Brazil have also been restrained. Regulatory concerns remain prominent with US issuers asthe implementation of the Affordable Care Act approaches, and climate change and tax reform

remain on the political agenda. Although M&A activity was not as strong as expected in the

first half, strategic acquisitions should pick up as the cost of capital remains attractive and top-

line growth remains slow. Shareholder-friendly actions continue to increase, particularly among

investment-grade names.

EMEA

Fitch continues to rate EMEA corporates assuming anemic economic growth prospects, with

most turnover growth above 2% to 3% attributable to issuers with EM exposure. Negative

Outlooks are concentrated within the Italian, Portuguese and Spanish utility portfolio, reflecting

weak domestic growth and energy demand), regulatory and fiscal interference, and structural

changes in generation (renewables, nuclear). The recent market upheaval caused a pause in

bond issuance. Lesser established lower quality credits may find even 8%-10% coupon debt

harder to place as investors are more selective.

APAC

Speculation surrounding the scale of the Feds asset purchase programme will continue to

drive sentiment in both equity and credit markets. However, Fitch expects longer-term asset

price movements to reflect corporate fundamentals that cannot be obscured entirely by the flow

of liquidity into the markets and a reach for yield by investors in a low-rate environment.

Optimism about higher Chinese growth in early 2013, which saw a flood of cross-border

corporate bond issuance in both investment grade and high yield (HY) averaging more than

USD17bn a month, has been tempered by market reactions to potential US reductions in QE.

Nonetheless, growth remains steady across the majority of countries within the region and is

supportive of stable and improving corporate credit profiles in most sectors. Rating figures have

Outlook Trend

US corporates have financial

resources to support positive

economic growth prospects.

EMEA corporates forecasts include a

mixture of anaemic local growth andhigher levels for emerging markets.

Increased interest costs already

factored into Fitchs forecasts.

Key Risks

Interest rate increases negatively

affecting US and European HY bond

markets.

EMEA recession and disruptive

market access.

Related ResearchFitch 50 Europe (July 2013)

Fitch 50 - Structural Profiles of 50 LeveragedU.S Credits (July 2013)

US Corporate Bond Market: First-Quarter2013 Rating and Issuance Activity(May 2013)

Scenario: Effects of a European Lost Decade

on Corporates (May 2013)

Asia-Pacific Corporates: Financial ForecastUpdate (April 2013)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707236http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707236http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=712469http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706278http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706278http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706278http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=705315http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706278http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=712469http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707236http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=712340http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=712469http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=712469http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707236http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707236http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707236http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706278http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706278http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=705315http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=705315http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=705315http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=705315http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706278http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706278http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707236http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707236http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707236http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=712469http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=712469http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=712340


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10

been distorted by concentrations of downgrades (outnumbering upgrades 2:1 so far this year)

in the technology and natural resources sectors. Yen depreciation has had an impact on trade

flows, boosting export performance for many Japanese entities who have struggled with

competition over the last few years particularly from South Korean corporates.

High YieldThe threat of rising interest rates could provide headwinds to the US HY bond market and slow

the pace of issuance from its record-setting start in 2013 (H113: USD150bn). The leveraged

loan market (H113: USD610bn) seems less affected by the recent pullback as demand

continues to outstrip supply. In the absence of a global shock, leveraged loan activity is

expected to pick back up and spreads to tighten at some point in H213. Refinancing and

repricing will probably continue to drive most new issues in the near term as issuers continue to

lengthen their debt profiles. However, opportunistic financings could increase if spreads are

attractive and demand for loans remains strong.

European HY investors may increasingly focus more on fundamental credit quality than search

for yield. Global liquidity has supported asset price performance, yet European growth remains

anemic and several sectors continue to struggle with excess capacity and weak cash flow

generation. Rising benchmark borrowing rates may pull global liquidity from this market. These

prospects will probably hit aggressively priced BB as well as B credits exposed to excess

capacity in their sectors that may also exhibit high leverage. New issuance in 2013 remains

firmly on track to surpass the EUR65bn recorded in 2012 (H113: EUR60bn).

Global Infrastructure and Project Finance

Figure 14 Figure 15

01020304050607080

Q409

Q210

Q410

Q211

Q411

Q212

Q412

Q213

(Quarter/year)

NA WE EM All

(% of portfolio)

Source: Fitch


AAA3%

AA20%

A36%

BBB26%

BB8%

B5%

CCC &

below2%


Source: Fitch

EMEA

Slow growth and recession are having varied effects on European transportation. Size matters

and outlooks are stable for international gateway and primary hub airports, large toll-road

networks and ports with strong and diverse franchises. Negative outlooks are concentrated in

smaller concessions, facilities in ramp-up, or assets exposed to the weaker economies in

southern Europe.

The prospects for energy infrastructure projects are varied. The outlook is negative for

renewable energy projects in southern Europe exposed to the risk of tax increases and

additional operating requirements that may reduce net revenues, as recently observed in Spain

and Italy. Oil and gas project outlooks are stable as these continue to benefit from high selling

prices and strong demand despite a sluggish international economy. Transmission networks for

UK offshore windfarms have a stable outlook given supportive regulation and solid operating

performance to date.

The outlook for UK whole-business securitisations remains predominantly negative. Pub

groups continue to suffer declines in rents and beer income as consumer habits change and

Outlook Trend

North American infrastructure largely

stable with a negative outlook in the

merchant power sector.

Latin American infrastructure largely

stable; latent demand outweighs

potential slower economic growth.

EMEA infrastructure largely stable in

northern Europe but trending tonegative in southern Europe.

UK whole-business sector remains

negative despite a few bright spots.

Key Risks

Continued slow growth in US andLatAm economies.

Recession deepening and spreading

in Europe.

Government budget pressure

destabilising cash flows in European

projects.


11/16



11

Key Risks

Market volatility blows US recovery

off course.

Persistent deepening recession in

the eurozone.

even the more resilient managed pub sector is facing some challenges. Healthcare operating

margins will continue to decline as fee increases are unlikely to offset rising costs.

North America and Latin America

Growth in the US and the principal Latin American economies continues to be modest, but

supports Stable Outlooks on most energy projects and transportation infrastructure debt. Thepotential extent and effect of US deficit reduction remains an uncertainty. Growth in US air

travel, traffic on roads and bridges, and activity at ports are expected by Fitch to remain low,

reflecting the weak economy. Energy prices in all US markets are expected to remain low due

to lower natural gas prices brought about by shale gas development. Most energy infrastructure

projects are stable as they can pass through macroeconomic risks to higher rated off-taker

counterparties. US merchant power generation projects which cannot pass through risks are

the exception, have Negative Outlooks and will continue to be under pressure.

Infrastructure assets in the principal Latin American economies benefit from pent-up demand.

Brazil is facing economic and socio-political headwinds as it remains focused on key

deliverables for major international sporting events. We expect modest inflation and continued

low interest rates to facilitate transportation and energy investment plans in the other major

economies. Therefore Outlooks are broadly stable for Latin American infrastructure projects.

Structured Finance

Figure 16 Figure 17

0

10

2030

40

50

60

70

Q408

Q209

Q409

Q210

Q410

Q211

Q411

Q212

Q412

Q213

(Quarter/year)

EMEA NA All

(% of portfolio)


Source: Fitch

AAA26%

AA11%

A14%

BBB14%

BB9%

B12%

CCC14%


Source: Fitch

US

The overall outlook for US structured finance ratings remains stable. Fitch also expects

collateral asset performance to continue on a trend of either stability or gradual improvement in

most sectors. While the US economic recovery has been shallow, it has nevertheless been

sufficient to support a strengthening of credit performance across most sectors. This isexpected to continue, although perhaps unevenly. Downside risks associated with

macroeconomic, fiscal and monetary issues remain. Market volatility has also increased, as

speculation regarding the timing of the inevitable winding down of the QE3 monetary stimulus

grows. While shocks from these sources may affect the pace of economic growth and cause

periodic market turbulence, we do not expect their magnitude to be sizeable enough to

significantly impact ratings.

ABS

In auto ABS the outlook remains stable for performance of prime assets and positive for ratings,

and stable for subprime asset performance and ratings. Asset quality metrics in auto ABS have

begun to weaken slightly but Fitch believes this represents a return to more long-term

sustainable levels, and base-case loss assumptions and positive rating momentum should notbe materially affected. In the credit card ABS sector, continued rating stability is expected, with

continued declines in personal bankruptcy filings being positive for performance, and reflecting

improvement in consumer quality, as economic growth supports a slowly falling unemployment

Outlook Trend

Stable in the US as economic

recovery gathers pace.

Negative for the recession-mired

eurozone periphery.

Related ResearchToll Road Network Peers Positioning(June 2013)

Peer Review of U.S. Toll Roads, (May 2013)

Peer Review of U.S. Ports (April 2013)

Infra-Read: Semi-Annual Newsletter for theInfrastructure Sector (April 2013)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=705795http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=705795http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708879http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=704337http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=704364http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=704364http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=704364http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=704364http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=704337http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708879http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=705795http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=705795


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12

rate. In contrast, the rating outlook for most student loan ABS remains negative, reflecting the

link in Federal Family Education Loan Program transactions to the long-term sovereign rating

via the guarantee provided by the Department of Education, as well as continuing asset

performance weakness in pre-recession private student loan securitisations. However, more

recently issued private student loan ABS carry stable outlooks as they benefit from more

stringent underwriting standards and robust structures.

CMBS

The outlooks for CMBS asset performance and ratings are generally stable. Property market

fundamentals are expected to continue the improving trend underway since 2010, benefiting

from economic growth coupled with limited new supply resulting from low construction. The

multifamily and hotel sectors in particular have recovered strongly, and income levels for such

properties in many markets have reached and even surpassed pre-recession peaks. The

sustainability of trailing-twelve month income is being carefully scrutinised in these sectors,

especially where higher income levels have attracted new construction in stronger markets.

Recovery of office properties has been strong among class A assets in core urban markets, but

uneven elsewhere. Retail has seen a slight improvement overall, but property-specific trends

vary widely, with some very high loss severities on properties in challenged areas or with

idiosyncratic issues. Rating stability will continue to be greater for investment-grade classes, as

lower-rated bonds still have some vulnerability to idiosyncratic losses on individual properties.

RMBS

An improving housing market and relatively stable macro environment have supported

improvement in asset performance metrics in most legacy RMBS. Fitch expects the trend of

increased rating stability in this sector to continue, although positive rating pressure will be

limited in the near term. Pre-crisis RMBS securities will continue to face a number of

challenges. Increases in house prices have outpaced the improvement in economic

fundamentals in many areas, and in some cases reflect more technical factors such as limited

supply and/or investor-driven demand. Furthermore, improvement in asset performance hasnot been uniform across sectors and vintages, as pre-2005 prime transactions continue to see

performance deterioration from the effects of adverse selection. Asset quality for transactions

issued since 2009 remains exceptionally strong with very strong performance supported by low

LTVs, full documentation and solid credit enhancement reserves.

Structured Credit

Fitch expects CLO collateral performance trends and ratings to remain stable, as these

transactions continue to benefit from historically low levels of HY defaults coupled with ongoing

deleveraging of their capital structures. Ratings of structured-finance CDOs are also expected

to remain stable as many have already accumulated enough credit enhancement to provide a

buffer against limited downgrades to their collateral assets, and the performance trends of the

latter are now generally stabilising or improving.

EMEA

The continuing recession in the eurozone is resulting in persistently high unemployment in a

number of countries. Combined with fiscal austerity and tightening of credit terms, this will pose

a challenge for the performance of securitised assets, especially in peripheral Europe. Price

declines and liquidity issues that are affecting residential and commercial property markets are

expected to put further pressure on transactions whose performance is closely related to cash

flows from property sales or refinancing.

The macroeconomic environment is unlikely to improve sufficiently in the next 6-12 months to

moderate the sovereign-linked maximum ratings currently applied to Spanish, Portuguese, Irish,

Greek and most recently Italian transactions. For France and the Netherlands only downgrades

of several categories would result in caps on ratings below AAAsf.

Related ResearchFitch Voice: Structured Finance (April 2013)

US RMBS 3Q12 Sustainable Home PriceProjection (April 2013)

US CMBS Loss Study: 2012 (April 2013)

US CMBS 2012 Loan Default Study(April 2013)

Student Loan ABS and the College TuitionBubble (July 2013)

SME Market Review: UK (June 2013)

SME Market Review: Spain (June 2013)

Covered Bonds Surveillance Snapshot(April 2013)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707418http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=705036http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=705036http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707115http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=703667http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=703667http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=711513http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=711513http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709696http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709645http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706685http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706685http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706685http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706685http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709645http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709696http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=711513http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=711513http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=703667http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=703667http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707115http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=705036http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=705036http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707418


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Financial institutions remain challenged by the weak macroeconomic position in Europe but

have been strengthening their balance sheets. There will, however, continue to be a limited

number of financial institutions with sufficiently high ratings to support the senior SF ratings.

ABS

The asset performance outlook for consumer ABS remains broadly stable. Jurisdictions suchas Germany and the UK have more positive outlooks, where default and delinquency levels

have consistently outperformed our base case expectations. Even in economies that have

suffered greater stress, such as Spain, asset performance now appears more stable. Defaults

and delinquencies in Spain remain at high levels compared to other countries but are no longer

deteriorating. There is a greater risk of deterioration in asset performance in Italy and France

as delinquencies have previously been relatively low and economic strains are increasing.

Across ABS, the majority of negative rating Outlooks reflect ratings capped by, or linked to,

sovereign ratings. Indeed, the only negative Outlooks for Spain relate to the sovereigns

negative Outlook. Negative Outlooks for asset performance are most prevalent in Italian ABS.

RMBS

Similarly, the asset performance outlook for RMBS is also in large part driven by unemployment

and disposable income trends, mitigated for more recent transactions by stricter post-crisis

underwriting. Asset performance is supported by exceptionally low and stable base interest rates,

which have improved loan affordability. While an increase in base interest rates would be

negative for performance, rating outlooks assume continued low rates for the next two years.

Despite low base rates, the availability and terms associated with new mortgage debt continue

to deter or exclude potential purchasers. Very low property market liquidity and falling property

values have depressed loan recovery prospects and extended recovery times generally, but

especially in distressed markets (Greece, Ireland and Spain). Further pressure could come

from more extensive government intervention (payment holidays, restrictions on foreclosures,

forced debt forgiveness), which is already a factor in Ireland, Greece, Spain and Italy. Rating

Outlooks vary by country with expectations of deterioration in the peripheral eurozone, but with

stability generally expected elsewhere.

CMBS

Refinancing risk continues to be the main factor driving the largely negative Outlooks. New credit

availability for commercial property will remain low, focused on top-quality assets. Financing is

expected to gradually shift from bank to non-bank provision (senior debt funds, insurance

companies). With legal bond maturities totalling EUR3.1bn until the end of 2015, then EUR5.0bn

in 2016 and peaking at EUR10.4bn in 2017, servicers may be forced to liquidate collateral on

unfavourable terms with low recoveries, especially for transactions backed by non-prime assets.

These pressures are already reflected in ratings, with Stable Outlooks for transactions backed byprime properties and a mixture of stable and negative for non-prime assets.

Structured Credit

Lending constraints are also a major concern for leveraged loan CLOs, where traditional

banking and structured finance-related funding sources have dried up. Over the past two years,

these transactions have seen the refinancing wall reduced and pushed back thanks to intense

amend and extend activity. The return of the European CLO, albeit on a limited basis, should

provide a financing exit for some credits, notably those that cannot tap other means of

financing. Nonetheless, a portion of underlying obligors are likely to default and recoveries will

be lower due to the cyclical and highly leveraged nature of those obligors. Outlooks are stable

on the most senior classes and stable to negative on the mezzanine and junior classes. The

Outlooks for SME CLOs is stable, as Fitch anticipates that asset performance deteriorationaffecting Spanish, Italian and Portuguese transactions will be offset by high levels of credit

enhancement and amortisation. In these countries, the prolonged recession and property

market downturn will lead to further rises in arrears and falls in recovery rates.


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14

Covered Bonds

While Outlooks are stable in the rest of the world, it is negative for the peripheral eurozone and

nearly all covered bond ratings in Greece, Italy, Portugal, Spain and Ireland have a Negative

Outlook. This reflects the Outlooks on the related sovereigns and bank Issuer Default Ratings

in the case of the first four, and in the case of Ireland, the considerable challenges faced by its

housing and mortgage market.

Sovereign-related risk has continued to dominate the negative covered bond rating actions

taken within the eurozone and downward rating pressure is expected to continue while banking

and sovereign challenges remain in the eurozone. Banking union will reduce bank support

which could have a negative impact on covered bond ratings.


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Appendix: Contributing Analysts

Monica Insoll+44 20 3530 [email protected]

Mariarosa Verde+1 212 908 [email protected]

Trevor Pitman (Regional Credit Officer EMEA and APAC)+44 20 3530 [email protected]

Eileen Fahey (Regional Credit Officer US)+1 312 368 [email protected]

Ed Parker (Sovereigns)+44 20 3530 [email protected]

Matthew Taylor (Public Finance - International)+44 20 3530 1094

[email protected]

James E. Moss (Financial Institutions)+1 312 368 3213

[email protected]

Peter Patrino (Insurance)+1 312 368 [email protected]

John Hatton (Corporate)+44 20 3530 1061

[email protected]

Thomas McCormick (Public Finance - US; Global Infrastructure and Project Finance)+1 212 908 [email protected]

Stuart Jennings (Structured Finance)

+44 20 3530 [email protected]

Michael Larsson+44 20 3530 [email protected]
mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]


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July 2013 Fitch Credit Outlook

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