The double burden comprising the global liquidity crisis and fears about a painful slowdown in the e...
The double burden comprising the global liquidity crisis and fears about a painful slowdown in the eurozone have negatively affected risk premiums in Central and Eastern Europe. After the peak in mid-September CEE credit spreads again rose sharply in the last couple of weeks and reached new all-time highs, mainly due to the liquidity problems of European financial institutions (Fortis, Dexia, Hypo Real Estate, Icelandic banks). The cost of insuring sovereign debt has soared, pricing in an increasing risk of default, which reflects the lack of confidence among investors. They are sending the message that credit tightening can evolve very quickly, and are charging high risk premiums.
Concerns regarding the credit tightening in the CEE region are not supported, in our view. The banks in CEE are not at all involved in any sub-prime related investments and so had no need to write off their assets. Spreads between key interest rates and money market rates indicate much higher confidence among local banks. Furthermore, the effectiveness of CEE banks in mobilising funds from the public is much greater than in Western Europe.
In times of financial turmoil, investors are looking for safety. Treasuries and government-related issuers are particularly in demand. Besides that, investors are looking for corporations from defensive sectors.
On the primary market, issuers are also showing a preference for short maturities as a way of avoiding having to bear the burden of the high refinancing cost over many years. The new issues must be attractively priced. Thus, due to the high spreads of the new Eurobonds, a revaluation of existing bonds may be expected on the secondary market in some cases.
Credit markets are expected to remain 'closed' in the coming months. Considering the high credit spreads, we expect the companies in 2008 to refinance outstanding debt mainly by cashflows and bank loans, although banks in the CEE region are also becoming more selective in lending.
The credit quality of CEE corporates remains relatively robust, with only a few rating impacts. The deterioration in the upgrade/downgrade ratio is mainly due to the negative rating impacts on speculative-grade corporations.
Looking ahead, while the credit markets welcomed the coordinated approach of European countries in supporting their financial systems, it will take time until the credit freeze comes to an end. So, the volatile movement by CDS spreads will continue until confidence returns and the credit spreads should remain at a high level.
CEE investment-grade companies have in general strong cashflow generation. Moreover, funding is backed up by loan facilities with banks. Therefore, we do not expect firms to witness a liquidity risk. However, the economic slowdown is a threat to operating cashflows, particularly in cyclical industries and at speculative-grade firms.
- By Alihan Karadagoglu, credit research analyst at Erste Group
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