European credit quality improves but outlook still cloudy, S&P says

New York, July 17 - Credit quality in the European Union improved in the second quarter but the outlook still remains cloudy, S&P said Wednesday.

During the quarter the ratio of downgrades to upgrades dropped to 3.4:1 from 20.5:1 in the first quarter, S&P said.

And the rating agency anticipates the number of downgrades will continue to decline, reflecting "the heavy downgrades that have occurred year to date combined with market expectations of nearing a bottom."

But S&P added that credit quality will continue to be limited by a poor earnings environment, weak economic fundamentals and a low volume of asset sales amid widespread equity-market jitters.

S&P also warned that there could be "a few more" high-profile downgrades, as indicated by business headlines seen since the beginning of the third quarter.

However a "double-dip" recession or renewed worsening in credit quality remains unlikely, providing the fragile economic recovery does not change course, S&P added.

During the second quarter the rating agency downgraded 34 European credits and upgraded 10 with dollar values of $184 billion and $18.4 billion respectively.

By comparison, there were 41 downgrades and two upgrades in the first quarter.

Telecommunications was the worst affected sector in the second quarter with 11 downgrades and no upgrades.

Banking saw five downgrades and there were four each for media and entertainment and utilities.

The 10 upgrades included, three in the banking sector, two each in capital goods and oil and gas exploration and production and one each in transportation, utility and metals, mining and steel.

Speculative grade accounted for 41% of downgrades, down from a record high of 49% in the first quarter, S&P said.

Geographically, nine of the downgrades were in Germany, followed by the Netherlands at seven, and France and the UK at four each.

There was only one fallen angel; Italian packaging company Reno De Medici SpA, was cut to BB+ from BBB-.

The two rising stars were UK-based rail infrastructure company Railtrack plc and Swedish capital goods company Alfa Laval AB.

European Union issuers saw 11 defaults in the first half of the year on $6.4 billion of debt.

Seven of the defaults were in the second quarter on $6.4 billion of debt.

They were Versatel Telecom International NV, CompleTel Europe NV, KPNQwest NV, NTL Business Ltd., Diamond Cable Communications plc, Grapes Communications NV and Kirch PayTV GmbH & Co.

The 12-month speculative-grade default rate rose to 12.41% at the end of June compared to 8.46% in January.

S&P anticipates default rates will peak in the third quarter and "decelerate modestly thereafter."

At July 9, 68% of the 446 European Union companies had stable outlooks, 25% had either a negative outlook or were on CreditWatch with negative implications and only 7% had either a positive outlook or CreditWatch with positive implications.

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