SOVEREIGN AND SUPRANATIONALSECTOR IN-DEPTH 1 August 2016ContactsIrina Baron Asst Dir-Research Associate irina.baron@moodys.comXian Li 212-553-1404Senior Research Analyst xian.li@moodys.comABOUT CAPITAL MARKETS RESEARCHAnalyses from Moodys Capital Markets Research, Inc. (CMR) focus on explaining signals from the credit and equity markets. The publications address whether market signals, in the opinion of the groups analysts, accurately reflect the risks and investment opportunities associated with issuers and sectors. CMR research thus complements the fundamentally-oriented research offered by Moodys Investors Service (MIS), the rating agency.CMR is part of Moodys Analytics, which is one of the two operating businesses of Moodys Corporation. Moodys Analytics (including CMR) is legally and organizationally separated from Moodys Investors Service and operates on an arms length basis from the ratings business. CMR does not provide investment advisory services or products.View the CMR FAQ Contact the CMR team Follow us on TwitterMoodys Analytics markets and distributes all Moodys Capital Markets Research, Inc. materials. Moodys Capital Markets Research,Inc. is a subsidiary of Moodys Corporation. Moodys Analytics does not provide investment advisory services or products.For further detail, please see the last page.Sovereign Risk ReportEconomic Stagnation and a Struggling Banking Sector Pressure Italian Sovereign Credit Risk Measures Sovereign EDF measures for most of the peripheral European nations have either declined over the past two weeks or held steady. The exception is Italys Sovereign EDFTM (Expected Default Frequency)1 metric, which measures the probability of default over the next five years, rose from 0.40% to 0.42% in the past two weeks, as seen in Exhibit 1 below. The increase indicates that investors are concerned about lingering risks from the Brexit vote, especially in combination with Italys sluggish growth and uncertain financial prospects. The same measures for Portugal and Spain, by contrast, decreased from 0.65% and 0.25%, respectively, to 0.63% and 0.23%. The United Kingdom's EDF measure remained relatively unchanged at 0.08%.Italys banking sector has lately become a concern. The countrys non-performing loans have increased to ª360 billion, equivalent to 18% of all outstanding loans three times the EU average. Italys prime minister Matteo Renzi has been working on tackling this problem by creating a private fund designed to backstop the sector, and a plan to securitize the loans with a government guarantee. These measures have yet to restore investor confidence, which is evident in the credit risk metrics for the Italy Banks and S&Ls group. The risk profile of the countrys banking system, proxied here by the median CDS-implied EDF measures for 16 Italian banks, has displayed considerably more risk than the corporate sector over the past year. The pace of deterioration of the median EDF measure...
