The rating agency DBRS Ltd. says that it expects 2010 will be a less tumultuous year than 2009, but that the increased significance of government activity has added to uncertainty.

In a new report released Wednesday, DBRS suggests that most financial institutions it rates will face elevated business and fundamental risks in 2010, albeit to a much lesser extent than in 2009.

“Liquidity has been largely restored, risk in legacy assets largely contained and loan losses are beginning to stabilize as economic recovery begins. In some cases, government assistance has been withdrawn and/or programs discontinued,” it notes.

“That said, the industry remains fragile, susceptible to a double recession, and commercial real estate will continue to be a challenge for many banks.”

The firm observes that “how and when governments unwind fiscal stimulus and manage deficits will have a big impact on how 2010 and beyond play out. Governments at all levels will increasingly have difficult choices of whether to cut program spending, increase taxes, continue running greater-than-planned deficits and/or defer debt problems through inflation or devaluation of their currencies.”

In addition, monetary policy will affect all credits, it says, as will regulation. “How governments regulate industries, including the capital markets, be it banks, life insurance companies, pension funds, credit rating agencies, hedge funds or finance companies, could have unintended consequences and as such may affect credit quality in 2010.”

For financial Institutions in particular, it says that, “Changes in the regulatory framework and legislative foundations will add significant uncertainty… in 2010. The form, direction and extent of these changes remain unclear, especially given the divergence across countries and jurisdictions. Most of the changes are likely to already have been accommodated by the DBRS methodologies for financial institutions, but new approaches to government support and “too big to fail” could lead to modifi cations in our assessment of systemic support.”

The borrowing needs of governments will also have a crowding-out effect on private sector borrowing in 2010, it observes. “The question is whether governments need greater funding than anticipated or whether targets will be met and debt capital needs absorbed by the market.”

The greatest risk to corporate ratings in 2010 will be how the economy plays out, DBRS says. “Should the International Monetary Fund forecasts of 3.9% 2010 world GDP growth, 2.7% U.S. growth and 2.6% Canadian growth materialize, this would certainly reduce the likelihood of meaningful negative rating actions in 2010.”

“In general for the DBRS corporate rating universe, balance sheets are healthy and liquidity has been managed effectively to mitigate downside risk to capital markets and interest rates in 2010. Cash flow margins have generally been restored, primarily through cost-side management; hence, growth in earnings will be highly dependent on global and domestic economic conditions. That said, barring a shock to the system, we expect healthy cash flow growth in 2010,” it says.

“Finally, the consumer continues to be highly leveraged, with a higher proportion of variable rate debt than in past recessions and, therefore, vulnerable to interest rate increases. We expect de-leveraging to continue in 2010 and limit the upside to the aforementioned IMF forecasts,” it adds.

In the report, Peter Bethlenfalvy co-president DBRS, concludes, “We expect 2010 to be less heart thumping. However, the role of governments and the decisions and actions made in 2010 may have the greatest impact on rating changes at DBRS.”