S&P Predicts ‘More Challenging Year’ for European Corporate Credit

The speculative-grade default rate for European corporates, which stood at 6.3% at the end of Q312, will rise to 6.8% by the end of 2013, predicts Standard & Poor’s (S&P) in its
‘Corporate Credit Outlook Report 2013’
. S&P says that the figure will be driven by the still deteriorating credit quality of companies assigned private credit estimates, a weak eurozone economy, and looming debt maturities.

“While Europe’s corporate sector was able to weather existential pressure on the euro and a lurch back recession in 2012, we think 2013 will be a year when the corporate sector is not as readily able to detach itself from underlying economic realities,” Paul Watters, senior director, head of corporate research Europe, S&P’s Ratings Services, writes in the report.

“Although the intervention by the European Central Bank (ECB) appears to have averted the crisis by reducing the risk of a disorderly break-up of the euro, the hard grind of adjustment and austerity will remain. As such, Europe’s economy is likely to remain weak and fragile – our baseline forecast is for zero real gross domestic product (GDP) growth for the eurozone in 2013.  In such a difficult operating environment, we consequently expect corporate credit quality to weaken moderately in most sectors in 2013.”

S&P’s base-case European speculative-grade default forecast for 2013 would equate to 49 companies defaulting, up from 46 over the 12 months to end-September 2012. Furthermore, in S&P’s downside scenario, the default rate may reach a high of 8.8%, although that would require a more severe recession in Europe than currently anticipated, accompanied by a more inhospitable financing environment for the more vulnerable, mostly private, credits that S&P monitor.

Greater competition on the back of reduced demand implies that some sectors may lose pricing power and suffer eroding operating margins. Potential issues of structural overcapacity are expected to weigh on credit prospects not only in local sectors such as utilities, refining and motor manufacturing but also in some global sectors, such as shipping and steel, through 2013.

At the same time, corporates based in the ‘GIIIPS countries’ (Greece, Ireland, Italy, Portugal, and Spain) are seeking to protect their businesses from remote euro break-up risk by actively reducing their country risk exposure where feasible. S&P anticipates investors will increasingly differentiate on the basis of how well geographically diversified are companies’ revenues and financing.

On the positive side, some improvement in the US economy (assuming a market neutral accord to address the fiscal cliff), and the stabilisation in the Chinese economy following the recent leadership transition, could limit the deterioration of credit metrics for S&P’s European-rated entities.

Liquidity risks are also expected to ease off in comparison to recent years, as a result of the improvement in corporate balance sheets, and stronger conditions in the debt capital markets. European corporate cash balances, these have increased by 30% in recent years, but at only 8-9% of total assets this is not excessive for the early stages of recovery. Some of the rise reflects companies’ response to the deleveraging of banks and the consequent squeeze on loan growth. It also reflects a strongly precautionary element, concludes S&P.

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