Credit Market Research

Global SpecialReport

The Credit Outlook

NavigatingaRiskLadenRecovery

Analysts
Monica Insoll +44 20 3530 1060 monica.insoll@fitchratings.com Mariarosa Verde +1 212 908 0791 mariarosa.verde@fitchratings.com Trevor Pitman (Regional Credit Officer EMEA and APAC) +44 20 3530 1059 trevor.pitman@fitchratings.com Eileen Fahey (Regional Credit Officer US) +1 312 368 5468 eileen.fahey@fitchratings.com David Riley (Sovereigns) +44 20 3530 1175 david.riley@fitchratings.com Fernando Mayorga (Public Finance EMEA) +34 93 323 8407 fernando.mayorga@fitchratings.com Group Credit Officers James E. Moss (Financial Institutions) +1 312 368 3213 james.moss@fitchratings.com Eric Friedland (Public Finance US) +1 212 308 0632 eric.friedland@fitchratings.com Peter Patrino (Insurance) +1 312 368 3266 peter.patrino@fitchratings.com John Hatton (Corporate EMEA and APAC) +44 20 3530 1061 john.hatton@fitchratings.com Timothy Greening (Corporate US) +1 312 368 3205 timothy.greening@fitchratings.com Thomas McCormick (Global Infrastructure and Project Finance) +1 212 908 0235 thomas.mccormick@fitchratings.com Stuart Jennings (Structured Finance) +44 20 3530 1142 stuart.jennings@fitchratings.com Outlooks Please refer to sector outlooks at www.fitchratings.com/outlooks Appendix: Select Related Research

Highlights
A global economic recovery is occurring but it remains fragile with possible pitfalls. In this environment, Fitch Ratings expects macro factors to continue to dominate credit markets. Accommodative policy support and emerging market dynamism are important drivers of growth. Although macro risks remain, Fitchs rating outlooks are continuing to stabilise across most sectors. This reflects both improved credit profiles and downgrade action, followed by stabilisation at such lower levels. In the US, Fitch has recently upgraded GDP forecasts. However, the economy is vulnerable to shocks, with weak labour and housing markets. There has been determined positive action to boost growth, notably through the extension of tax relief and a second round of quantitative easing (QE2), to which the financial markets have responded enthusiastically. However, there is a risk that QE2 could undermine confidence in the US dollar and raise inflation expectations. It also poses challenges for the rest of the world, including fastgrowing developing and emerging economies. Together with exceptionally low interest rates, quantitative easing may result in yieldseeking capital and financial flows undermining economic and financial stability in strongergrowing emerging markets (EMs). In the euro area, support measures have been substantial, although at times hampered by inconsistent communication from the regions policymakers. Confidence in the sustainability of public finances and bank liquidity and asset quality will remain fragile and sovereign credit profiles will continue to be under pressure. It is likely that there will be further episodes of extreme market volatility and a risk that more euro area member states (EAMS) will be forced to seek financial support from the EU and IMF. Fitch believes the euro zone will muddle through rather than break up in the wake of systemic sovereign debt defaults or become a fully fledged fiscal union. Strained public finances in the developed world are also mirrored by subnationals, with tax revenues under pressure and often rigid operating expenditures. In the US, local and state governments are currently experiencing financial stress at a level not seen for decades. However, Fitch believes that, as a class of debt, municipal
Global Financial Institutions Rating Outlook Trends
Rating outlook negative (%) 40 30 20 10 0 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410P Source: Fitch Rating outlook positive

Global Corporates Rating Outlook Trends

(%) 40 30 20 10 0 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410P Source: Fitch Rating outlook negative Rating outlook positive

www.fitchratings.com

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taxbacked credit remains resilient and that while the incidence of default may increase from very low historical levels, defaults will continue to be isolated situations. The interaction between sovereign debt concerns and financial sector stability continues to be a key source of fragility in peripheral EAMS. This tight linkage produces rating actions for banks and structured finance transactions in tandem with rating changes for the sovereign. This has been illustrated by the downgrades of Greece, Spain, Ireland and Portugal. Real estate remains a weakness, negatively affecting banks and structured finance. The legacy of overleveraged commercial real estate and in the US residential real estate as well financed during the peak 20052008 period is a continuing source of stress, as well as an impediment to broader economic recovery. Corporates have largely weathered the crisis well. They have resized and are building cash piles based on accessing external funds and internal cost cuts. Credit risks include increased M&A activity as well as even more shareholderbiased actions such as share buybacks and dividend increases. Capex is starting to expand moderately again following severe restraint in the last two years. EMs are thriving overall or at least managing to stage an impressive recovery from the credit crisis. This diagnosis applies to sovereigns as well as other asset classes.

Funding
HY and EM issuance continued support from yieldseeking investors Euro zone periphery sovereigns struggle for market access US public finance retail investor reliance may turn from strength to sensitivity Structured finance gradual reopening of funding markets Banks face substantial refinancing needs, including government guaranteed debt A number of market factors as well as impending regulation are expected to affect access to funding in several sectors in 2011. In the low interest rate environment, bond markets are continuing to display high appetite for corporate risk, allowing highyield (HY) borrowers to benefit by terming out and swapping bonds for loans. US HY bond demand should continue from both traditional and nontraditional bond investors as returns from other fixedincome products are less compelling and defaults remain low. HY funds should see similar inflows up until the point interest rates begin to rise. In Europe, Fitch anticipates continuing supply in the absence of speculative grade loan markets as banks and CLOs remain constrained with legacy exposures and costs associated with regulatory capital and funding. However, the limited European HY investor base will continue to be discerning. Best positioned are well regarded, frequent borrowers in favoured sectors with high singleB ratings and above. More marginal corporate and leveraged buyout borrowers with low singleB ratings attempting to refinance bank loan maturities will be less favoured. In the US public finance area, negative news flow regarding the creditworthiness of certain municipalities has led to jitters in this otherwise stable and large market. While Fitch believes such fears are overdone, the large proportion of retail investors in this asset class may be a weakness should defaults occur, even if only in isolated cases. In the euro zone, peripheral economies are likely to continue to struggle to secure continuous market access. However, overall, Fitch expects net borrowing by central governments across Europe to fall in 2011 as governments implement budget cuts. After several years of severely curtailed funding ability, the structured finance market is gradually reopening. Nevertheless, refinancing remains difficult for many structured finance segments, including CMBS. For banks, the many different regulatory initiatives for introducing various forms of bailin debt at senior as well as subordinated levels are raising the level of complexity for investors. Funding remains a concern for banks in Ireland, Greece, Portugal and the Spanish cajas, which continue to depend on lines from the ECB and the private repo market. There are still some question marks around how easily banks will be able to replace governmentguaranteed debt as this falls due, although there is investor appetite for covered bonds. Fitch considers that most
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northern European banks will not have difficulties with funding in 2011, given their deeper domestic investment markets, including for covered bonds, and more interest from international capital markets. Solvency II may lead to insurance company asset reallocation Solvency II, which will impact insurance companies capital requirements, may lead to a reallocation of assets towards those with lower risk profile potentially increasing government bond exposure to the detriment of corporate bonds.

Outlooks Overview
Outlooks mostly stabilising Challenges remain for US RMBS, developed market sovereigns and certain public finance segments
60 50 40 30 20 10 0 Q307 Q407 Q108 Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410

Negative Outlooks
Banks Corporates Sovereign US Publ Fin Aggregate (ex.SF, Infrastructure, Intl Publ Fin) (% of portfolio) 70 Insurance SF Infrastructure Intl Publ Fin

Source: Fitch

(Quarter/year)

On the whole, outlooks have continued to stabilise across most sectors, reflecting both improved creditworthiness and downgrade action, with subsequent rating stabilisation. Outlooks on insurance ratings have stabilised over recent quarters as asset risk is increasingly captured within the current rating levels. However, a small number of other market segments remain challenged. In structured finance, the rating outlook for US residential mortgagebacked securities (RMBS) is negative due to the continued falls in house prices, the large inventory and lengthening loan resolution timelines. The magnitude and severity of negative rating actions in 2011 are expected to decline substantially, compared with prior years levels. Developed market sovereigns, notably peripheral EAMS, are struggling with large fiscal financing needs against the backdrop of fragile and volatile funding markets. Many subnationals, both in Europe and the US, share these problems. The rating outlook for these issuers is negative in certain segments.

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Sovereign
Outlook Trend Negative for developed market sovereigns Positive for EM sovereigns
Sovereign Negative Outlooks
Sov DM (% of portfolio) 30 25 20 15 10 5 0 Q307 Q407 Q108 Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410
BB B 1 9% Source:Fitch A 1 3% B B 20% B 1 7%

Sovereign Rating Distribution as at

Sov all

Sov EM

31 Dec 2010
CCC&below 1% A AA 16% A A 1 4%

Key Risks In Europe, failure to meet fiscal targets and prolonged economic stagnation In the US, failure to put public finances onto a sustainable path over the medium term Excessive and volatile capital inflows pose mediumterm risks to macrofinancial stability in EMs

Source: Fitch

(Quarter/year)

Developed Markets

Europe
It is likely that there will be further episodes of extreme market volatility and a risk that more EAMS may be forced to seek financial support from the EU and IMF. Moreover, the dramatic deterioration in market access and funding conditions for several EAMS is eroding their sovereign credit fundamentals as the cost of borrowing approaches levels that in the longrun are not consistent with public debt stabilisation in light of mediumterm growth prospects. Until economic adjustment and recovery are secure, especially in the socalled peripheral EAMS, confidence in the sustainability of public finances and bank asset quality will remain fragile and credit profiles will deteriorate, placing further downward pressure on bank and sovereign ratings. While the epicentre of the 20072009 financial crisis was in the US and UK, and public finances in both have deteriorated dramatically, it is sovereign creditworthiness of EAMS that has been subjected to the greatest market scrutiny and financing pressure. This focus is driven by concerns that in the absence of monetary and exchange rate flexibility, the peripheral economies will stagnate as they struggle to regain competitiveness and close large current account imbalances. Fears over euro sovereign creditworthiness and the viability of the euro area have been compounded by worries about the health of some European banks, notably in the periphery and those that remain reliant on wholesale and especially ECB funding. The crisis is systemic inasmuch as it reflects concerns about the viability of the euro as well as countryspecific vulnerabilities. The policy response has been extensive, yet has not so far succeeded in preventing episodes of extreme market volatility and runs on sovereigns and banks, as the Irish crisis starkly illustrated. In part this is due to a widespread belief that only full fiscal, economic and political union will ensure the survival of the euro, which in Fitchs opinion is neither being pursued nor likely. The fragility of confidence in the euro area also reflects miscommunication and mixed messages from European policymakers, especially with respect to euro area sovereign debt default and perceived regulatory forbearance and lack of full disclosure of losses by some banks. Until further clarity is provided on the mechanics of the European Stability Mechanism (ESM), concerns about policymakers intentions regarding private creditors will continue to weigh on investor confidence.

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North America
In the US, fears of a doubledip recession have receded considerably with the extension of tax relief agreed in December 201 and the QE2 in November. High frequency activity has also turned more positive, reflecting strength in private consumption and corporate profitability. QE2 was launched in November 2010 in an effort to further stimulate the economy and reduce the risk of deflation. It follows an initial round of asset purchases in November 2008 and consists of the purchase by the US Federal Reserve (Fed) of a further USD600bn of longterm treasury securities by the end of Q211. Together with ultralow interest rates, and in the absence of a credible fiscal consolidation strategy, QE2 risks undermining confidence in the US dollar and raising inflation expectations. It also poses challenges for the rest of the world, including fastgrowing developing and emerging economies. Nonetheless, the risks associated with the current stance of monetary policy, including QE2, must be set against the risk of deflation and the fragile economic recovery and high unemployment and seen in the context of the Feds dual mandate of price stability and maximum employment. The impact of QE2 on the real economy is very uncertain, but it is likely that other things being equal it implies higher asset prices (and hence household and corporate net worth) and a weaker US dollar, boosting net exports. Ever since Chairman Bernanke first hinted at QE2 in a speech made on 27 August 2010, equities have responded positively. In contrast, in the period preceding his speech and beginning from the joint EUIMF rescue of Greece on 23 April 2010, the S&P had fallen by 12%. On 17 December 2010, President Barack Obama signed into law a number of tax relief measures, including extending Bushera tax cuts, reauthorising insurance benefits to the unemployed, and extending credit for lowincome families. The measures also included a new payroll tax reduction for workers and a number of child, education and investment tax incentives aimed at boosting growth. According to Congressional Budget Office estimates, the measures equate to a USD858bn package. This is equivalent to around 2.6% of GDP for both 2011 and 2012, with the total cost of the package (from 2011 until 2020) equivalent to around 5.5% of GDP. Fitch expects the new plan to add around 0.6% to GDP growth in 2011 and 2012. Despite the boost to the nearterm economic outlook of the additional fiscal stimulus, it does imply both budget deficits and debt will be higher than previously projected. The US fiscal metrics will be the worst of any AAArated sovereign. However, the extraordinary fundamental credit strengths associated with the flexibility and dynamism of the US economy, as well as the US dollars status as the global reserve currency, imply a higher debt tolerance than for other AAA and highly rated sovereigns. Nonetheless, the absence of a credible mediumterm fiscal consolidation strategy is eroding confidence in the sustainability of public finances and commitment to low inflation, with potentially adverse implications for the US sovereign credit standing. Emerging Markets The contrast in economic and credit outlook between EMs and socalled advanced economy sovereigns is becoming more pronounced. EM economies are estimated to have grown at almost three times the rate of advanced economies in 2010 and public finances are on a broadly improving trend. Capital flows to fastgrowing EMs, especially in Asia and Latin America, do pose policy challenges, especially with respect to monetary and exchange rate policies and the potential for price and asset market inflation. Despite these challenges and the uncertain economic and sovereign credit prospects for advanced economies, the outlook for EM sovereign credit ratings is broadly positive.

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Outlook Trend
Mostly stable, but negative in a small number of revenue supported sectors

PublicFinance US
US Public Finance Negative Outlooks
Rev. supported (% of portfolio) 10 8 6 4 2 0 Q307 Q407 Q108 Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410 Tax supported All

US Public Finance Rating Distribution as at 31 Dec 2010

B CCC& B B 0.9% belo w 2.1% 0.3% A AA B B B 1 3.8% 7.6% A 24.1 % A A 51 .3% Source:Fitch

Source: Fitch

(Quarter/year)

Key Risks
Continued real estate downturn Increasing pensionrelated fixed costs Downshifting of state responsibilities to local governments

The US public finance outlook for 2011 is characterised by limited economic and tax revenue recovery, the scheduled phasingout of federal fiscal relief for the states, and the likelihood of continued state aid cuts and local property tax base weakness. As in 2010, local and state governments (LSGs) across the country will face varying degrees of fiscal and economic pressure as the prospects for recovery differ widely across the sector. In light of this pressure, Fitch anticipates downgrades to continue to outpace upgrades, although ratings stability will continue to dominate the sector. Governments reliant upon property taxes will be negatively affected by continued falls in real estate values. Declining state funding and/or the shifting of responsibilities from states to local governments will present an additional burden to municipal budgets, many of which are already strained by the withdrawal of federal stimulus money this year. With falling revenues, reserve levels will continue to decline. An increasing proportion of LSGs will report minimal or even negative amounts of operating fund balance at the end of 2011, which may lead to increased borrowing for cash flow, although Fitch believes most will continue to retain at least a moderate level of reserves. Costcutting efforts will focus on wage cuts. Labour contracts with low or zero wage increases have become increasingly common, and this trend will likely intensify in 2011. In addition, healthcare plan design changes and the introduction or extension of employee costsharing will be important tools for LSGs seeking to cut costs. Temporary and permanent layoff activity is also likely to continue. However, pensionrelated fixed costs will continue to play a prominent, and sometimes increasing, role in municipal budgets. US LSGs are currently experiencing financial stress at a level not seen for decades. However, Fitch believes that, as a class of debt, municipal taxbacked credit remains strong and that while the incidence of default may increase from very low historical levels, defaults will continue to be isolated situations. In addition, LSGs have captive tax bases and strong control over taxing and spending, and bond security for general obligation and dedicated tax bonds is very strong. Further, due to market norms of 20 to 30year principal amortisation, large bullet maturities and consequent refinancing risk are limited. Debt levels for these issuers are relatively low, with annual debt service representing a relatively small part of budgets. The taxsupported debt of an average state is equal to just 3%4% of personal income, and local debt roughly 3% 5% of property value. Debt service is generally less than 10% of a LSGs budget, and in many cases much less.

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PublicFinance International
Outlook Trend Negative for developed market subnationals Stable to positive for EM subnationals

Intl. Public Finance Negative Outlooks

(%o fpo rtfo lio ) 20 15 10 5 0 Q409 Q1 0 1 Q21 0 (Quarter/year) Q31 0 Q410

International Public Finance Rating Distribution as at 31 Dec 2010

B 6% CCC& belo w 1 % A A A 15%

B B 1 5%

B BB 9% A 1 8% Source:Fitch A A 36%

Key Risks Slowerthanexpected fiscal recovery Inability to cut back operating expenditure sufficiently Continued difficulties in accessing longterm financing

So urce:Fitch

EMEA
Fitch expects negative rating actions to continue to dominate in 2011, primarily in developed markets in Europe, as local and regional governments (LRGs) try to cope with a more challenging fiscal environment. This reflects the frailty of the global economic recovery and expectations that many subnationals will continue to find it difficult to rein in operating expenditure sufficiently or quickly enough. In addition, measures to maintain capital expenditure both as anticyclical measures and as an instrument to modernise the local economy will mean that overall expenditure will remain high. Rating actions should begin to stabilise in 2012 as fiscal revenues begin to normalise. On the other hand, the budgetary performance of subnationals in European emerging markets economies, such as Russia and Turkey, have not been as badly affected, as they have traditionally reported higher operating margins and accumulated considerable reserves from surpluses in previous years. In fact, Fitch has taken positive rating actions in LRGs in these countries. On the revenue side, Fitch expects fairly flat recovery of tax receipts. The global downturn has had a profound negative impact on tax collections. LRGs in western Europe experienced a sharp decline in fiscal revenues during 2009 and 2010 but the decline is expected to level off in 2011. Stillweak consumer confidence and high levels of unemployment will particularly hit VAT and personal income tax receipts respectively. Propertyrelated tax revenues are also expected to be depressed both as a result of the halt in construction activities in many countries and the continued decline in house prices which has contributed to a contraction in the tax base. As in the past couple of years, Fitch expects the deterioration in budgetary performance to be most pronounced for those subnationals that also have very rigid operating expenditure and a high proportion of current to total expenditure. Many LRGs have been unable to cut back total expenditure sufficiently and quickly enough to compensate for the reduction in revenues. For example, for Spanish and Italian regions which are responsible both for the delivery of education and health care, the combination of reduced revenues and inability to cut expenditure quickly enough have contributed to considerable deficits. Although measures have been introduced to curb the rise in expenditure (with cutbacks in many nonessential services and in some countries cuts in public servant salaries), these have not been sufficient to compensate for the revenue loss. The increasing budget deficits have resulted in sharp funding requirements. With access to the capital markets more challenging and expensive for some LRGs, funding has needed to be obtained on a shortterm basis, thereby increasing refinancing risks.

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FinancialInstitutions
Outlook Trend Peripheral euro zone banks and Spanish cajas under most direct and immediate pressure Other major markets expected to maintain slow trek to stability, with risk of multinotch downgrades now greatly subsided Key Risks Uncertain timing and framework to establish funding stability for banks and sovereigns in peripheral euro zone Return of normalised employment levels may be prolonged, which pressures already stressed retail exposures in some markets and restrains new business activity in the commercial sectors Tighter regulatory regimes yet to be fully defined and bank response to such not fully developed in terms of form and substance Potential negative ratings impact on banks at Support Rating Floors from momentum to implement resolution legislation
Financial Institutions Negative Outlooks
EMEA (% of portfolio) 60 40 20 0 Q307 Q407 Q108 Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410
BB B 29% Source:Fitch B B 1 0% A 34%

Financial Institutions Rating Distribution as at 31 Dec 2010

All
B 12% CCC& belo w A AA 2% 1% A A 12%

North America

EM

Source: Fitch

(Quarter/year)

Developed Europe There are divergent trends in European banks. On balance, the credit outlook for banks in the region is stable, but around a quarter of bank Issuer Default Ratings (IDRs) are on Negative Outlook. The unsettled situations in Ireland, Greece, Portugal and to some extent Spain are likely to dominate rating actions in early 2011. Banks in these countries and troubled banks elsewhere in Europe are facing difficulties accessing traditional sources of market funding. Banks have become dependent on government programmes and especially on the ECB. The financial positions of most banks in northern Europe and Italy and the larger Spanish banks are either stable or improving. Northern European banks were hit by the crisis earlier than their southern European peers, largely because of exposures to structured products and central and eastern Europe. Domestic European asset quality in northern Europe outside the UK and Ireland has held up relatively well. These banks probably have the worst behind them. However, generally stabilised standalone positions are balanced by growing political and social momentum to ensure that taxpayers money is not called on next time around to support banks. Notable progress is being made to enact bank resolution legislation. Fitch rates around a quarter of banks in the region at their Support Rating Floors. Most Outlooks on these ratings are Stable, reflecting the agencys view that governments will continue to support banks senior creditors in full at least until the banking crisis in Europe subsides. Implementation of resolution schemes is moving in parallel with regulatory pressure, most notably from Basel III, to strengthen capital and liquidity buffers to ensure that the likely need for state support reduces. North America The financial performance of US banks should continue to show improvement, adding a stronger foundation to a stable rating outlook. Concerns still persist related to unsettled conditions in residential real estate and funding and liquidity markets which, while improving, remain below historical norms. Fitch believes the banks possess the financial resources to withstand further deterioration in real estate. Challenges to meet new standards set by financial reform legislation will be significant for many banks and choices made to respond to the new landscape will be important in determining the new financial performance norms for US banks. Emerging Markets The rating outlook for emerging market (EM) banks remains a bright spot on the global banking landscape. Challenges and concerns centre on areas such as the EM operations of banks based in developed markets that may be overly reliant on the former as a source of growth and profits. Also, eastern Europe may feel increased drag from problems in the euro zone.

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Insurance
Outlook Trend Continued stabilisation expected in 2011, albeit potentially at slower pace than recent quarters Key Risks Commercial real estate asset losses Interest rate risk Nonlife pricing and reserving Outlooks on insurance ratings have stabilised over recent quarters as asset risk is increasingly captured within the current rating levels. In recent stress tests related to sovereign asset exposure, issuers rated by Fitch demonstrated resilience to extreme scenarios. Since mid2008, the global portfolio has experienced heavy downgrade activity, led by the US life insurance sector. The agency has downgraded 36 out of 55 rated groups one or more times since September 2008, most by one or two notches. The percentage of Negative Outlooks dropped further in early 2011 as nine US health insurance groups were affirmed and moved to Stable Outlook following analysis related to healthcare reform risk. Insurers are also contending with a variety of complex regulatory issues, including the introduction of Solvency II.
Insurance Negative Outlooks
EMEA (% of portfolio) 70 60 50 40 30 20 10 0 Q307 Q407 Q108 Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410
B A A A B B 1 % 1 % 3% B B B 40% A 43%

Insurance Rating Distribution

All

North America

as at 31 Dec 2010

A A 12%

Source: Fitch

(Quarter/year)

Source:Fitch

Life
Improvement in asset values and financial market liquidity has led to a significant drop in unrealised investment losses. Total asset losses since the beginning of the credit crisis are now expected to approach but remain within Fitchs stress analysis. Favourable 2010 earnings trends are expected to continue into this year, but will lag precrisis levels due to lower interest rates and steps taken to reduce investment portfolio risk. Other positive steps taken include lessening reliance on institutional funding sources and revamping risk mitigation programmes. The US sectors large inforce variable annuity business is likely to be a nearterm drag on profitability. In Europe, the main challenge for life insurers is coping with the low interest rate environment, given the levels of guaranteed crediting rates.

NonLife
While profit fundamentals and traditional cyclical factors are less favourable than in recent years, they are adequately captured in current ratings. Investment market recovery and improved underwriting performance have returned capital to pre crisis levels, following material reductions in 2008. In many European countries, the weak premium rate environment for motor insurance continues to be a drag on earnings. Issuers are seeking to address this issue through widespread premium rate increases, but tangible earnings improvement is unlikely to occur until late 2011/2012. In the US, these challenges include expected premium declines due to price competition, high runrate accident year loss ratios and low investment yields.

Reinsurance
Good earnings stability and strong capital are unlikely to be impeded by key challenges, subject to normal catastrophe experience. Reinsurers proved to be one of the most resilient of all insurance sectors during the financial crisis. However, that resilience has resulted in more competitive conditions. Pressures are mounting from softening premium rates, reduced demand and lowinterest rates.

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Outlook Trend EMEA outlooks stabilising and turning mildly positive in 2011 US: gradual improvement

Corporates
Corporate credit trends in 2011 should remain on the same trajectory as in 2010, with modest economic growth, improving operating profiles and good liquidity offsetting a number of stillweak macroeconomic factors. As the risk of a doubledip recession recedes, companyspecific event risk will act as the primary catalyst for downgrades. Downgrades are expected to occur largely from selfinflicted shareholderfriendly actions or at the initiation of external activists/acquirers. Although the pendulum will continue to swing away from debtholders to shareholders, dividends and share repurchases will be largely sourced from existing cash and excess cash flow rather than from releveraging. Global macro concerns remain tangible enough that most corporate issues remain cautious in their outlooks on spending and investment. Companies with emerging market exposure continue to see growth from this portfolio. Overall, few companies see boom times ahead.
Corporate Negative Outlooks
EMEA (% of portfolio) 60 50 40 30 20 10 0 Q307 Q407 Q108 Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410
B B 17% B BB 41 % Source:Fitch B 14%

Key Risks The temptations of corporates holding cash Financial market crisis impact on confidence and liquidity Opportunities and threats of a fragile recovery

Corporates Rating Distribution

All

North America

EM

as at 31 Dec 2010
CCC& belo w A A 1 % 3% A 24%

Source: Fitch

(Quarter/year)

EMEA
Macroeconomic uncertainty includes the spending cuts being undertaken by many European governments these will not have an effect until well into 2011 or possibly 2012, and ongoing sovereign debt concerns provide further risks. Risks arising from companies own actions, such as M&A, share buybacks and increased capex are highest in pharmaceuticals, mining and, to a lesser extent, telecoms.

US
Margin expansion will be more limited than the gains seen in 2010 due to higher raw material costs, costcreep from the draconian cost cuts taken at the depth of the credit crisis, and a moderation of the inventory restocking gains achieved in early 2010. 2011 may provide some indication of whether there is pentup demand among US consumers that were forced to deleverage during the crisis, or whether a new frugality mindset is taking hold ie, higher savings and lower spending that could have longerterm demand and growth implications.

High Yield
Booming appetite for HY debt in the capital markets during 2010 has helped reduce the refinancing risk in this segment globally. In Europe, Fitch anticipates continuing supply in the absence of speculative grade loan markets as banks and CLOs remain constrained with legacy exposures and costs associated with regulatory capital and funding. In the US, modest GDP growth, improving corporate fundamentals and a lower trending default rate is expected to continue to drive strong issuance. Bond forloan takeouts are expected to continue to drive a majority of refinancing volume, in particular secured bond volume, in 2011.

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GlobalInfrastructureandProjectFinance
Outlook Trend Generally stable energy and social infrastructure Stable to negative for transportation and whole business securitisations The dominant trend for energy infrastructure globally in 2011 is stable because, in general, energy infrastructure assets are well insulated from the uncertainties of the global economic outlook. This follows a stabilisation of Outlooks in 2010 following significant downgrades in 20082009. The outlook for transportation infrastructure assets varies across the globe; it is stablenegative in the US and EMEA and stable in AsiaPacific and Latin America. The negative trend in westernEurope is concentrated in the whole business securitisation portfolio, where Negative Outlooks increased in 2010 after 2009 Negative Rating Watches were resolved by downgrades with credits remaining on Negative Outlook.
Infrastructure and Project Finance Negative Outlooks
NA (% of portfolio) 60 50 40 30 20 10 0 Q309 Q409 Q110 Q210 Q310 Q410 Source: Fitch WE EM All

Infrastructure and Project Finance Rating Distribution as at 31 Dec 2010 CCC&

B BB 3% 8% below 1% AAA 5% AA 24% BBB 24% A 35%

(Quarter/year) Source: Fitch

North America and Latin America

US energy and industrial credits that rely substantially on power purchase agreements are relatively insulated from demand and price changes in the energy market. However, merchant power facilities that are not fully contracted and continue to be exposed to low gas prices and low dispatch remain on Negative Outlook. Performance of transportation assets are highly correlated to changes in the macro environment and also regional pressures. The decline in demand at transportation facilities subsided in late 2010, and demand is increasing in many cases. Credits remaining on Negative Outlook in the transportation sector are predominantly those with a debt structure requiring increased volumes and/or tariffs to maintain a leverage profile consistent with the rating. Latin American economies have overall recovered quickly. Transportation credits have stabilised, with many experiencing growth. Power credits typically benefit from power purchase agreements and favourable regulatory schemes insulating them more from price and demand shifts and continue to perform as expected.

Key Risks Tepid economic growth Cost and availability of refinancing Fuel prices

EMEA
Transportation is the sector with greatest exposure to economic conditions and it has experienced significant reductions in air, port and road traffic since 2008. Well located and mature European road networks located in countries with a high degree of economic resilience, have stable outlooks while standalone concessions or those employing an aggressive financing strategy have negative outlooks. Large hub airports with proven demand history and supportive regulation will perform significantly better than smaller, regional or niche facilities. The large oil and gas projects in Fitchs portfolio (notably liquefied natural gas and oil production) tend to be mega scale projects initiated at times of much lower oil prices. They have breakeven levels in the USD20/ to USD30/barrel range and are therefore very resilient to commodity price movements. Renewable power projects continue to be tested by resource (wind) availability in certain cases.

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Structured Finance
Outlook Trend Negative for US RMBS, predominantly stable for EMEA RMBS Stable for the mostsenior CMBS classes, less so for subordinated Global ABS generally stable Key Risks Higher unemployment than anticipated, risk of double dip recession Impact of negative equity on residential mortgage borrowers Impact of austerity measures on performance The general trend in structured finance is for continued outlook stabilisation.
Structured Finance Negative Outlooks
EMEA (% of portfolio) 50 40 30 20 10 0 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410 (Quarter/year) BBB 15% A 12% BB 10% AA 12% B 12% North America All

Structured Finance Rating Distribution as at 31 Dec 2010

CCC& below 12% AAA 27%

The data in the chart reflects numbers of tranches giving bias to thinner subordinated tranches at the expense of thicker senior tranches. Subordinated tranches are more likely to have negative outlooks, while senior ones are more likely to have a stable outlook. Further, senior tranches are usually paid down first which will increase the proportion of subordinated tranches. Ratings which have moved into distressed categories are not assigned outlooks. This also impacts the relative proportions of outlooks. Source: Fitch

US
Slowly recovering economic conditions in the US will support gradual improvement in asset performance in the coming quarters, and the rating outlook for structured finance overall is stable. However, the profile of Outlooks as depicted in the above graph, which is based on the number of classes, appears negative due to the tendency of more numerous thinner subordinated classes (representing a smaller share of the capital structure) to have a Negative Outlook compared to thicker senior classes, as well as the large volume of RMBS tranches in the dataset. Improvements will be limited, however, given the low rate of GDP growth and persistent high unemployment. Also, access to capital remains constrained for some sectors, as US financial markets have not structurally adjusted to broad changes in regulatory requirements and accounting rules introduced in 2010. Finally, the legacy of overleveraged real estate financed during the peak 20052008 period continues to be a source of stress in related sectors, and an impediment to stronger economic recovery. The Outlook for ABS ratings continues to be Stable, with a few exceptions. Positive momentum in asset performance trends is expected to continue for credit card and auto ABS sectors, despite pressure on consumers from high unemployment levels. New issuance continues particularly in autorelated asset classes and recent transactions have been characterised by more disciplined loan origination practices and higher credit enhancement levels. Privatesector student loan transactions remain an area of relative weakness, with generally Negative rating Outlooks. Rating Outlooks of RMBS reflect expectations of a further 10% decline in housing prices nationally before stabilising. The large shadow inventory of distressed and unsold properties, combined with lengthening loan resolution timelines, will continue to pressure performance. Fitchs Outlook for prime, AltA and subprime RMBS ratings remains primarily Negative. However, the magnitude and severity of negative rating actions in 2011 are expected to decline substantially, compared with prior years levels. The impact of negative equity on borrower performance remains a key variable in 2011. CMBS rating Outlooks reflect an expectation of further increases in loan delinquency rates in 2011, as high leverage and weak assetspecific attributes
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pressure loan performance. At the same time, however, commercial property market fundamentals have shown signs of stabilisation, and this is expected to continue. The gradual return of liquidity to the CMBS market is a further positive development. Fitch expects greater rating stability in 2011, particularly for investmentgrade CMBS, once a current review of 20062008 transactions is completed. In structured credit, asset performance in corporate loan transactions has benefited from a resurgence of liquidity to the HY loan sector, which has offset negative effects of weak economic growth. Rating Outlooks for high investment grade classes of middlemarket and highyield corporate loan transactions continue to be Stable. Ratings on trust preferred CDOs, which incorporate prospective stress to bank trust preferred obligations, continue to have a Negative Outlook due to volatility associated with distress in regional banks.

EMEA
Sovereign event risk continues to be an area of concern within the euro zone, particularly for Greece, Ireland and Portugal. Indeed, the downgrade of Irelands LongTerm IDR from A+ to BBB+ in December 2010 led to the imposition of a rating cap of AA on all structured finance transactions and the subsequent downgrade of several transactions. However, Outlooks generally across EMEA transactions have continued to show a stabilising trend, driven by anticipated performance improvement across several sectors. Continued stabilisation of performance has been seen across several jurisdictions in RMBS and the outlook for the sector overall is stable. The reduction in arrears, defaults and loss levels in 2010 is expected to be maintained in the coming year across UK, Dutch and German prime RMBS. While delinquencies rose steeply over the last two years in Spain, they have shown signs of stabilisation, a trend that Fitch expects to continue in 2011. However, concerns remain for Ireland, Greece and Portugal and some UK nonperforming transactions, particularly those concentrated on peak 2006/2007 vintages. The number of Negative Outlooks across CMBS decreased through 2010, following significant downgrade actions over the preceding several months. The decrease is also driven partly by downgrades to distressed levels where Outlooks are no longer applied. The sector remains divided across Europe between prime markets, which have shown signs of recovery, and nonprime markets, which remain depressed. Refinance risk remains significant for the peak in maturities in 2013, given continued moribund lending in the sector. Within the ABS sector, concerns remain for the Spanish consumer transactions; while delinquencies have begun to stabilise, the trend might be reversed by sluggish economic recovery and longterm unemployment. However, previous rating action has reflected these risks and further negative action should therefore be limited. Further rating action may also be seen across the Greek consumer assets as the impact of the fiscal tightening programme takes effect. UK credit card transactions are showing improved performance following an earlier significant deterioration and German auto transactions continued to exhibit stable trends. Fitch expects continued stability in structured credit senior note ratings, driven mainly by an expected improvement in the performance of SME CDOs. This reflects the benefit of transaction deleveraging and improved recovery expectations. Refinancing risk is still a concern for leveraged loan CLOs which outweighs positive trends in performance.

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Appendix : SelectRelatedResearch
Sovereign
Sovereign Review and Outlook: Contrasting Credit Outlook (December 2010) Global Economic Outlook: No Major Surprises in Global Recovery (December 2010) Contagion, Support and Eurozone Sovereign Ratings (December 2010)

Public Finance
Keys to Uncovering General Government Bond ProjectRelated Default Risks (Essentiality, Affordability, and Feasibility) (December 2010) High Demand/Diminished Supply (Changing Dynamics of Bank Facilities Market Heighten the Risk Profile for Some Municipal Borrowers) (December 2010) U.S. State and Local Government Bond Credit Quality: More Sparks than Fire (November 2010) Commentary on California Nonprofit Hospitals (October 2010) Impact of Commercial Real Estate on Municipal Credit (August 2010)

Financial Institutions
2011 Outlook: US Banks (January 2011) 2011 Outlook Emerging Market Banks: Different Crises Different Recoveries (December 2010) Major Japanese Banks: H1FYE11 Review (December 2010) Resolution Regimes and the Future of Bank Support (December 2010) Global Bank Rating Trends Q310 (December 2010) CDS Spreads and Default Risk (U.S. BrokerDealers) (November 2010)

Insurance
2011 Outlook: U.S. Property/Casualty Insurance (December 2010) UK NonLife Insurance: Profitable Underwriting Remains Key to Strong Earnings (October 2010) Italian Insurance Outlook (October 2010) French Insurance Outlook (October 2010 Japanese Life Insurance Sector: Calm After the Storm (September 2010) Global Reinsurance Review and Outlook (September 2010)

Corporates
European Leveraged Credit 2010 Review (January 2011) 2011 Outlook: US Corporate Credit (January 2011) U.S. Leveraged Finance Stats Quarterly ThirdQuarter 2010 (December 2010) 2011 Outlook: EMEA Corporates (December 2010) No Bubble in Corporate Bonds: Cash Pile Pressures Rise, Continued Caution Expected (November 2010) High M&A Risk in Western Europe Telecoms Sector (November 2010) EMEA Corporate Capital Expenditure: Emerging Markets Lead Return to Growth in 2010 (October 2010)

Global Infrastructure and Project Finance

Energy Infrastructure Outlook 2011 (December 2010) Rating Criteria for Airports (November 2010) Brazilian Infrastructure Sector: Balancing Opportunity and Risk (November 2010) Rating Indian BOTAnnuity Road Project Bonds (October 2010)

Structured Finance
EMEA Structured Finance Snapshot October 2010 (October 2010) Sovereign Risk Inseparable from Eurozone Securitisation Ratings (September 2010) European CMBS Loan Maturity Bulletin January 2011 (January 2011) Credit Card Movers & Shakers (UK) Q310 Performance (December 2010) US Structured Finance 2011 Outlook: Turning the Corner (December 2010) Originator Support for Spanish Structured Finance Transactions (November 2010) US Structured Finance Snapshot: October 2010 (October 2010) Auto ABS Losses in Reverse (November 2010) U.S. Credit Card ABS Tear Sheet (December 2010) U.S. RMBS: Still Under A Shadow (November 2010)

Credit Market Research

European Senior Fixed Income Investor Survey Q410 (December 2010) Global Corporate Rating Activity Update Third Quarter 2010 (December 2010) US Corporate Bond Market: A Review of Third Quarter 2010 Rating and Issuance Activity (October 2010) US High Yield Default Update (October 2010)

Macro Credit Research

The Impact of a China Slowdown on Global Credit Quality (November 2010)

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