After S&P Euro Warning... EFSF Today, Banks & Insurance Companies Tomorrow

The entire world now knows about the European Union warnings from S&P on Monday.  This morning came word that the ‘AAA’ long-term credit rating on the European Financial Stability Fund is now also being placed on CreditWatch Negative.  Investors really need to consider the “cause and effect” here.

The first thing we want to stress is that this should have not caused a move lower in the market as it did when the headlines hit this morning.  It should have been assumed.  If you are solely dependent upon a “AAA” entity or entities and suddenly the ratings of the guarantor are at-risk, your rating is at risk too.

The second and most important thing is that investors better just go ahead and assume that the banks and insurance companies in the Euro-Zone will also come under CreditWatch review as a result or they could rather easily get an outright downgrade if they were already on CreditWatch.  After all, guess who holds all that European sovereign debt!  At the end of November S&P made the announcement of its “criteria changes” to 37 of the world’s largest banking outfits and their subsidiaries. As many of these outlooks are already negative, logic would lead toward a belief of a formal downgrade if ‘politics’ do not get in the way.

The EFSF was affirmed at ‘A-1+’ for its short-term rating.  S&P noted, “Depending on the outcome of our review of the ratings on EFSF member governments, we could lower the long-term rating on the EFSF by one or two notches, if any. The issuer and issue ratings we will assign to EFSF following our CreditWatch review will likely be the same as the lowest issuer rating we assign to the rated EFSF members we currently rate ‘AAA’, unless there
are offsetting credit enhancements in place.”

While no one wants to see these debt downgrades, if the United States is no longer a true “AAA” rating, then how can some of these nations be “AAA” today?  The current debt crisis in Europe is far worse than the squabbles we had in the United States.  Imagine if the United States saw a sudden 200 basis point rise in interest rates because of concerns about access to capital and because of growing default risk for the long-term.

Today’s “new” news that the EFSF is being placed on CreditWatch Negative should not be a surprise.  Downgrades or further “negative reviews” of the banks and insurance companies based in the same underlying countries in Europe should be coming soon.  That is what happened here in the United States.

Again, think only about “cause and effect.”  We are living in a world that is reacting to the headlines that should have already been known.

JON C. OGG