(Editor's Note: Our "Risky Credits" series focuses on 'CCC' rated corporate issuers. Because the majority of defaults are from companies rated in the 'CCC' category, companies with negative outlooks or ratings on CreditWatch negative are even more important to monitor in this unprecedented downturn and uncertain recovery.)
Key Takeaways
- The recovery of 'CCC' rated issuers in Europe remained stagnant in the third quarter as the number of upgrades out of the 'CCC' rating category slowed compared to the second quarter.
- European 'CCC' and below debt outstanding topped US$100 billion equivalent for the first time in September with the downgrade of Ireland-based Endo International PLC to the 'CCC' rating category from 'B-'.
- French issuers contributed the largest portion of speculative-grade debt outstanding with a negative outlook or CreditWatch placement with negative implications, with nearly US$50 billion.
- Although upgrades are slowing, positive bias among the 'CCC' rated issuers increased through September, signaling the possibility of positive rating momentum in the near term.
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The percentage of 'CCC' and below issuers as a share of the total speculative-grade population in Europe is now higher than in North America for the first time. Europe's recovery continues to lag those of the U.S. and Canada, as companies with high debt burdens and an inability to generate free operating cash flow struggle to improve credit quality despite accommodative debt capital markets, a higher pace of vaccination, and the lifting of COVID-19-related restrictions. The percentage of 'CCC' and below rated issuers in North America has fallen to 10% of the total rated universe from a peak of 18% in May 2020, while Europe has seen a negligible improvement to 11% from 12%.
The number of upgrades in Europe has slowed in the third quarter compared to the second quarter, contributing to the overall slowdown in recovery. In the third quarter, there was only one upgrade and one downgrade. Nonetheless, speculative-grade positive bias (companies with a positive outlook or CreditWatch placement with positive implications) remains at the highest since May 2012, implying a potential upgrade out of the rating category for those issuers in the near term.
By debt amount, European 'CCC' debt reached a historic high of US$100.7 billion in September. The health care sector is the most exposed, with US$34.2 billion in 'CCC' debt, all of which comes from issuers with a negative bias (those with a negative outlook or CreditWatch placement with negative implications). Most of this debt (US$33.5 billion), however, is from one issuer--Endo International PLC, which was downgraded in September, reflecting S&P Global Ratings' expectation that Endo's credit metrics will weaken over the next several years. Endo is headquartered in Ireland and is therefore listed as a European issuer, although 93% of its revenue is generated in the U.S. The issuers with the highest debt exposure with a negative bias excluding Endo International include U.K-based offshore drilling service provider Transocean Ltd. (US$9.7 billion), U.K.-based cinema operator Cineworld Group PLC (US$5.4 billion), and U.K.-based Travel commerce platform Toro Private Holdings I Ltd. (US$3.7 billion).
Around 60% of European 'CCC' and below rated issuers have 'less than adequate' or 'weak' liquidity. This indicates that the sources of funding available to them within the next 12 months are highly dependent upon operating performance improvement or access to funding, via debt capital markets or otherwise. Average weighted debt to EBITDA leverage for the 'CCC' rating category is 11x, with 2x interest cover for the 'CCC+' rated universe. 'CCC' and below rated entities, or approximately 22% of European risky credits, carry leverage of approximately 11.8x, with interest cover of 1.2x on average, suggesting cash flow and liquidity pressures are more pressing. We therefore believe restructuring may be unavoidable for these credits within the next 12 months.
U.K. speculative-grade debt with a negative bias has dropped significantly since June 2021. U.K. speculative-grade debt with a negative bias fell to US$35 billion as of September from US$63 billion in June as we revised many issuers' outlooks to stable from negative. Speculative-grade debt outstanding with a negative bias is now the highest in France, with US$49.3 billion. The largest three contributors are Renault S.A., Casino Guichard - Perrachon S.A., and Accor S.A., with US$23.6 billion, US$12.9 billion, and US$4.4 billion in debt outstanding, respectively.
Despite an elevated number of 'CCC' and below rated issuers, the number of defaults in the region has slowed significantly. Globally, only 16% of 'CCC' rated issuers have defaulted over the prior 12 months, and this trend seems to be consistent with what we are seeing in Europe (see "Why 'CCC' Rated Companies Have Risen And Default Rates Have Not," Oct. 19, 2021). There were only two defaults from the region in the third quarter of 2021, down from three in the second quarter and eight in the first quarter. The Europe 12-month trailing speculative-grade default rate dropped to 3.4% in mid-October, from 5.4% in May 2021 (see "Default, Transition, and Recovery: The U.S. Contributes The Most To Lower Global Corporate Defaults," Oct 14, 2021). We expect the European trailing-12-month speculative-grade corporate default rate to fall to 3.25% by June 2022 (see "The European Speculative-Grade Corporate Default Rate Could Fall To 3.25% By June 2022," Aug 24, 2021).
Spreads inched up in the third quarter, corresponding to government debt spreads widening on the back of market volatility due to rising inflation concerns.. Europe's corporate five-year composite spread increased to 34 as of Sept. 30, from 32 at the end of the second quarter.
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Related Research:
- European Leveraged Finance And Recovery Second-Quarter 2021 Update: Late Cycle Behavior Or A Brave New World?, July 20, 2021
- CLO Pulse Q1 2021: Sector Averages Of Reinvesting European CLO Assets, July 8, 2021
This report does not constitute a rating action.
| Credit Markets Research: | Nicole Serino, New York + 1 (212) 438 1396; nicole.serino@spglobal.com |
| European Leveraged Finance: | Marta Stojanova, London + 44 20 7176 0476; marta.stojanova@spglobal.com |
| Research Contributor: | Shripati Pranshu, CRISIL Global Analytical Center, an S&P affiliate, Mumbai |
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