The current financial sector slump will continue through 2008 and into 2009, testing bank creditworthiness, says Standard & Poor's Ratings Services in a report, After the Credit Boom, Banks And Brokers Face A Sobering Year In 2008 published yesterday.

"The downturn is unsettling because it comes in the context of relatively strong global economic growth and historically low corporate default rates," said Standard & Poor's credit analyst Scott Bugie.

The structured finance market has been significantly affected and it may take years for the market to return. To date, the large financial groups have announced $90 billion in write-downs of collateralised debt obligations (CDOs), sub prime securities, and leveraged loans.

"Although the CDO write-downs have grabbed headlines, of equal concern are the systemic risks the downturn has highlighted," said Bugie.

Because sub prime mortgage risk is embedded throughout the financial sector, the downturn in US housing, particularly in the sub prime segment, has led to a series of negative events in the global debt markets.

In 2008, earnings of banks and brokers likely should continue on the weakening trend that started in the second half of 2007, particularly in the US. Lower business flows from housing finance and fixed-income origination and trading will limit revenues, while higher risk premiums on funding and rising provisions for loan losses will weigh on pretax profits.

Credit quality in the US and European consumer finance sector will likely erode, and troubles in mortgage finance may spread to the commercial real estate sector, putting further pressure on performance. Earnings in 2008 will also suffer from additional losses on structured securities backed by sub prime mortgages and other assets.

Reduced earnings in 2008 will not, however, lead to bank downgrades across the board. Most banks' strong franchises and financial resources will allow them to withstand a significant period of stress.

"The large complex financial institutions reside in the 'AA' and 'A' rating categories, reflecting a still-ample capacity to withstand a more-difficult operating environment, such as the one we expect in 2008," said Bugie. "An example of a bright spot amid the gloom has been the deft liquidity management of wholesale-funded US broker-dealers, despite the volatile conditions and reduced market access."

As a general rule, negative credit cycles test the creditworthiness of companies and lead to greater divergence in ratings. We expect this in 2008. More-difficult conditions in 2008 will increase pressure on entities with relative weaknesses, while giving the stronger groups opportunities to reinforce their market positions.