S&P report card says European banking recovery is stalling

The following statement was released by the rating agency): The European banking industry's moderate rebound from the 2008-2009 financial crisis is stalling because of dimming growth prospects in the eurozone and volatile, risk-averse wholesale funding markets, Standard & Poor's Ratings Services said in its report card, "European Bank Rebound Falters Amid Slowing Economies And Market Turmoil," published today.

"We believe that the further recovery of the industry will hinge on restoring order to the sovereign debt market, shoring up confidence in bank funding markets, and avoiding a double dip into recession in the large European economies," said Standard & Poor's credit analyst Scott Bugie.

Turmoil in the sovereign debt markets and uncertainties about banks' capital adequacy and future resolution regimes for failing banks have eroded market confidence, increased wholesale funding costs, and blocked market access for some banks. Weakening sovereign creditworthiness damages bank creditworthiness by decreasing the value of government bonds held by banks, restricting access to funding, and eroding confidence in the government's capacity to support troubled banks. Problems in the banking industry also negatively affect sovereign credit quality.

The prospects for European banks are weak for the rest of 2011 and into 2012, despite the improvement in the financial profiles of most banking groups after the severe shock of the financial crisis and recession. Earnings in 2010 and the first half of 2011 bounced back from their trough, mainly due to a drop in credit loss provisions and relatively strong contributions from securities sales and trading. European banks also have built up their capital adequacy since the crisis, but need to improve it further to meet the demands of regulators and creditors and to restore market confidence. Reduced investor appetite for bank equity will likely lead banks to reduce risk assets more aggressively to improve capital adequacy, which in turn may accelerate the trend in deleveraging of companies and households in Europe.

If the eurozone slipped back into recession, we would expect credit losses to increase again. The amplitude of losses would depend on the depth and duration of the double dip into recession. If the second recession was of the same magnitude as 2008-2009's, the rate of credit losses could exceed that of those years, because the marginal borrowers that benefitted from loan extensions and restructurings over the past 2-3 years are in weakened condition.

"Our outlook on the ratings for half of the 50 largest European banking groups is negative. The gap between the most and least creditworthy European banks has widened," added Mr. Bugie.