"The top-50 European banks face an exceptionally difficult environment due to the confluence of reduced asset valuations, contracted market liquidity, varying levels of capital strains, and extremely fragile investor and client confidence," says Jeff Sexton, New York-based analyst for Standard & Poor's Ratings Services, referring to a report published on Nov.5, 2008, on RatingsDirect titled Extraordinary Times, Extraordinary Responses--External Support For Major European Bank Ratings In The Face Of Acute Market Difficulties. "We expect the European banking system to continue to restructure and recapitalize. It will likely emerge with better capital and lower risk profiles, which would be positive for future creditworthiness. Before we get to this point, however, we expect to see continuing rating pressure as banks work through the dislocations. The median rating for the top-50 Western European banks has slipped to 'A+' from 'AA-' in the last month. "Banks also face the prospect of rising domestic credit problems as European economies weaken. Government support toward the banking sector underpins the ratings on systemically important banks, but does not, in our view, fix the sector's deteriorating fundamentals." "We are increasingly pessimistic about the depth and duration of the economic downturn, and we now expect it to be deeper than we did three months ago," said Standard & Poor's credit analyst Michelle Brennan. "Our view of the future business fundamentals for banks has therefore weakened over the quarter. Our ratings reflect these fundamentals so we believe that European bank ratings will remain under strong pressure over the coming quarters as profitability deteriorates and loans losses increase, even more so if funding remains scarce and expensive and even after the recently announced government-sponsored bank rescue plans," she adds. The severity of the current environment is evident in the numerous support packages launched by European governments, something not seen in decades. These measures are extraordinary as government actions, consistent with those that are made by supportive countries in times of extreme stress, are undertaken when no market-based solution is feasible. S&P expects these measures to provide stability to bank ratings that otherwise were potentially vulnerable to deteriorating market confidence and an associated credit cliff. "We believe these government measures are likely to help improve confidence in the banking sector, alleviating a key risk for banks' liquidity, but they will not solve all the sector's problems," says Brennan. "We can still envisage rating pressure based on weaker business prospects and financial profiles, even where systemic support has strengthened." Despite the expected prominence of government-guaranteed bank debt over the next three years, S&P will focus on what the underlying business models are going to look like as a result of the changes that the sector is undergoing, and what these business models will mean for creditworthiness.