Fitch Ratings has said that the market turmoil that besieged the financial markets in August 2007 will test the robustness of the system following Q207 ratings migration results. These results saw the par-value of corporate bond upgrades in Europe, the Middle East and Africa (EMEA) again outpace downgrades, this time by a margin of 2.4:1. Moreover, ratings migration for banking and finance, insurance and supranational (BFI) securities (where much of the market dislocation has occurred) were even higher. In contrast, ratings migration for industrial securities (a segment where fundamentals remain benign) still has a slight negative bias.

In its review of the EMEA corporate bond market in Q207, published today, Fitch noted that reasons for the BFI downgrades included concerns over capitalisation levels, loan book concentrations and exposures to structured investments. Meanwhile, BFI upgrades typically reflected improved profitability, risk management and exposures, greater diversification and/or benefits stemming from having higher-rated parents. Among industrials, negative rating actions remain dominated by shareholder-friendly activities (particularly among investment grade (IG) corporates), whereas rating actions among speculative grade (SG) corporates tend to have a positive bias reflecting persistent sound underlying fundamentals.

The par-value of upgrades in Q207 totalled EUR544.5bn (or 16.6% of non-'AAA' rated securities outstanding at end-Q107), up from EUR452.9bn in Q107. This compared favourably with the EUR223.1bn of Q207 downgrades. These downgrades were significantly higher than those recorded in Q107 (EUR67bn) on account of a methodological bias arising from changes to the calculation of composite all-agency ratings. BFI upgrades were again affected by the methodology bias - ignoring rating changes stemming from the bias would have resulted in an upgrade/downgrade ratio closer to 5:1 for the BFI sectors, as opposed to a headline ratio of 2.8:1.

Industrial bond upgrades, however, continued to be overshadowed by downgrades with 0.9:1 ratio in Q207. IG and SG securities continue to follow divergent paths, with IG securities seeing downgrades top upgrades by a margin of 1.4:1 (which then rises to 4.7:1 when 'BBB' category securities are omitted). SG securities saw a positive ratings bias, reporting a downgrade/upgrade ratio of 0.6:1.

The EUR358.2bn of fresh issuance in the quarter (bringing the total of corporate bonds outstanding at end-Q207 to EUR6.3bn) represented a decrease on a sequential basis, but a significant increase year-on-year. Reflecting the appetite towards risk and the liquidity that prevailed in the first half of the year, the strong volumes in Q207 coincided with record syndicated and leveraged loan raisings, totalling USD649bn or 50% higher than the corresponding period in 2006.

However, as BFI sectors still account for around 85% of total bonds outstanding at end-Q207 and around 90% of the value of all rating actions, the recent turnaround in sentiment and evaporation of liquidity is expected to contribute to a less favourable rating trend in the second half of 2007. Additionally, the more cautious attitudes of investors are expected to affect bond issuance and loan volumes in Q307, and even into Q407 if the level of uncertainty persists.