July 5 (IFR) - The EU summit has not resolved the long-term aspects of the eurozone crisis, and investors need to be concerned about contagion and the ultimate health of core countries Germany and France, Egan-Jones rating agency said.
The small but aggressive agency, which has issued sharper ratings downgrades in Europe than its competitors, said the two countries remain heavily exposed to the debt of other fragile EU members.
While attention has been focused on the current woes of Spain and Italy, the agency believes that France and Germany face serious and deep troubles of their own.
“From a credit quality stance, France and Germany are hurt by what’s coming out of the summit,” said Sean Egan, the agency’s managing director.
“From our perspective, their credit quality is being used to support the weaker countries,” he said. “With the passing of each quarter, the debt-to-GDP ratio has risen -- and we don’t see any change in sight for that trend.”
He and the agency’s ratings co-head Bill Hassiepen took pains to underscore their belief that investors should watch the two countries closely.
“France is the next stop on the train of worry,” Egan said. “The country’s credit quality is likely to be on most investors’ radar over the next couple of months.”
Hassiepen said he had detected “the recipe of a major malfunction” ahead.
“From an investor’s standpoint, there will be a massive amount of pain,” he said.
The agency has signaled its bearish point of view very clearly in recent weeks.
It cut France’s credit rating to BBB+ from A- last month, partly on concerns that the government may need to prop up ailing French banks; the assets of France’s five largest banks equal an astounding 282% of the country’s GDP, Egan said.
In comparison, the Big Three rating agencies have been far less aggressive on the country’s sovereign debt rating; S&P downgraded France to AA+ from AAA in January, while Moody’s and Fitch still have it at AAA -- seven notches higher than that of Egan-Jones.
Egan-Jones has also cut Germany’s rating one notch to A+, saying that the country will be stuck with massive uncollectible receivables as a result of its sizable exposure to the southern eurozone nations.
Germany can get back perhaps only about 50% of the loan money it is owed, the agency said.
Moreover, Germany’s debt-to-GDP ratio was 87% as of 2011, while France’s was 99.9%. These figures are much higher when unfunded liabilities such as social security, pensions and healthcare are included.
These unfunded liabilities will stifle growth for many years, Egan says. As EU growth slows and unemployment rises, budget pressures in France and Germany will rise.
What’s more, Germany and France carry much of the burden of bolstering other eurozone members through their contribution to the European Stability Mechanism (ESM).
According to data released by the member states, the first two tranches will be paid in 2012, another two tranches in 2013, and a final tranche in the first half of 2014.
According to European Commission data, the third- and fourth-largest contributors are Italy and Spain, accounting for 30% of the ESM’s funding.
If those two nations needed a bailout themselves, the agency said, then much of the rest of the funding burden will fall on Germany and France, which are already the top contributors at a combined 47%.
This is one reason, Egan says, why investors need to worry about the contagion risk and focus on a wider problem than merely Spain and Italy.
“The market often times (focuses) on one or two things at a time”, before turning its attention elsewhere, he said.
The eurozone debt crisis has already spread through Greece, Ireland, Portugal and Cyprus, with these nations asking for bailouts. Spain has formally asked for a bailout for its banks.
The banking sector looks even worse than the sovereigns’ credit profile, with banking systems larger than the sovereign.
Hassiepen said that several Italian banks, such as Unicredit and Banca Monte dei Paschi di Siena, are already technically insolvent.
“Those two alone could pull the entire euro system down,” he said, adding that another, Intesa Sanpaolo, is “barely holding on”.
The core eurozone banks have heavy exposure to all the unsteady peripheral members, helping to accelerate their weakness in asset quality and capital. Their banking systems are leveraged with debt and, according to the IMF, European banks as a whole are leveraged at 26 to 1.
Deutsche Bank and the three largest French banks all have so-called tangible common equity ratios of less than 3%, meaning that a small drop in the value of their assets could wipe out all their equity. These institutions will need a substantial amount of capital to get equity ratios back to a more acceptable 6%.
Disruptions in global capital markets and likely deposit runs could still put pressure on funding. The banking system is “far more important for funding operations in Europe than it is in the US,” Egan said.
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