S&P Expects Europe Spec-Grade Defaults to Rise

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Europe’s speculative-grade corporate default rate is expected to rise slightly by next year amid lingering credit instability, slow economic growth and a growing concentration of companies in the lowest levels of junk-grade ratings.

Standard & Poor’s is projecting a rise in Europe’s speculative-grade corporate default rate to 1.8% by next summer, reporting that the “prolong downturn” in commodities prices and market volatility.

While the rate is slightly above the existing 1.6% default rate, it remains “well below” the average default rate of 3.4% experienced between 2002 and 2016. The projected 2017 rate is also below the 2.4% 12-month trailing default rate from June 2015 and 2.2% at the end of 2015.

“While most indicators of economic conditions and credit performance remain relatively benign, some are turning more negative, suggesting that the recent low-default environment may not be sustained much longer,” the global fixed income report issued Tuesday stated.

S&P reports six European speculative-grade corporate defaults in the second quarter among nonfinancial companies (after none in the first quarter).

Those signs include a rise in the “negative ratings bias” for spec-grade European corporates to 18.3%. That figure represents the proportion of outstanding ratings among speculative-grade firms that have either a negative outlook or on a negative credit watch. The historical average is 23.3%, but has been rising since mid-2014.

Commodities remain a troubled area, accounting for nearly half of European speculative-grade corporate downgrades while comprising only 6% of outstanding speculative-grade ratings.

Declining spec-grade debt issuance to €90 billion in Europe for the 12 months ending in June 2016 was a 20% year-over-year decline. It featured a lower proportion of debt rated ‘B-’ and below by the ratings agency: what was less than 9% in 2015 was less than 5% for the first half of 2016, “suggesting rising risk aversion among investors.”

The number of companies rated ‘B’ or lower by S&P has more than quadrupled since 2011. But the proportion of these firms now comprises 50% of the speculative-grade universe, up from 30% only five years earlier. That is a reflection of issuers turning to capital markets due to a void in lending by banks, however, according to S&P.  

“This changing ratings distribution is partly due to significant growth in Europe's high-yield bond market following the financial crisis of 2008-2009,” the report stated. “As banks consolidated their lending, corporates increasingly turned to capital markets as a source of funding.”

Another risk factor is the maturity wall. European companies had about €90 billion in debt rated ‘B-’ or lower that is coming due through 2021, “for which the recent issuance slowdown could mean higher refinancing and potential default risk,” the report stated.

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