Relative Stability Preserves Our Base Case

Baseline: S&P Global Ratings Credit Research & Insights expects the European trailing-12-month speculative-grade corporate default rate to rise to 3.75% by September 2024 from 3.1% in September 2023 (see chart 1).  Credit quality and market trends in Europe have largely been stable over the last quarter, but defaults did pick up, largely because of activity in August. The pace of defaults has been falling since, with the year-to-date default rate (through October) likely hitting 2.8%. Strong labor markets should help the region avoid a recession, but growth is still slowing, and for European firms, cash interest paid has risen roughly 25% from a year earlier. Producer prices continue to fall quickly, offering some reprieve from the high inflation of 2022, but wages this year, particularly in the U.K., have been surging. Ultimately, this mix of factors should produce more defaults in the future, but not at an elevated pace.

Chart 1

Optimistic scenario: We forecast that the default rate could fall to 2%.  In a best-case scenario, we think the default rate could decline to about 2% through next September. Economic resilience would need to persist, and current market pricing appears roughly aligned with this expectation. Headline inflation readings at both the consumer and producer levels have been declining consistently so far, with recent figures suggesting that inflation is coming in considerably for most sectors. It would require inflation to continue falling at the current pace to provide scope for central banks to cut interest rates sooner than we assume in our base case (the second half of 2024). Near-term refinancing needs are manageable, but they will increase in the second half of 2024.

Pessimistic scenario: We forecast that the default rate could rise to 5.5%.  We already expect that growth will be precarious for most of Europe next year, and we anticipate rising real rates, so the current speculative-grade population is vulnerable to a further downturn. The default rate could rise past 5% if economic growth is slower than we expect or if there's a recession; it could also push above 5% if interest rates stay at current higher levels throughout 2024. Slowing earnings for several quarters in a row are leaving firms less room to maneuver amid elevated interest rates. Any further increase in risk aversion arising, for instance, from any escalation in either the Russia-Ukraine conflict or the war between Israel and Hamas could render refinancing even more challenging and expensive than it already is.

Issuance Remains Ahead Of Last Year's Pace, Supporting Refinancing Needs In The Near Term

Combined high-yield bond and leveraged loan issuance in Europe has remained subdued this year relative to typical levels, even though it has been, since May, slightly outpacing 2022 issuance (see chart 2). High-yield bond issuance this year has been significantly outpacing leveraged loan issuance, and much of that funding has been used to pay down existing debt, helping to reduce refinancing risk in the near term. It's unlikely that interest rates will subside in the near future, so issuance in primary markets will likely remain well below even 2020 levels.

Chart 2

Even if markets fall off in the second half, upcoming maturities in 2024 will remain very manageable (see chart 3). We estimate that a total of €71.1 billion in speculative-grade debt will come due in Europe next year--with only €5.7 billion of that in the 'CCC'/'C' category. But the amount of maturing speculative-grade debt will jump in 2025, when €152.7 billion will come due. Depending on the economic and interest rate environments in the next 12 months, these maturities could prove challenging to refinance.

Chart 3

Risk Sentiment Improves, But Debt Costs Rise

In the euro area, banks' credit standards for loans to companies tightened from the previous quarter, more than the banks had anticipated (see chart 4). Nevertheless, the pace of tightening did slow down. Banks' risk perceptions were the main driver for the tightening in the third quarter, followed by lower risk tolerance and liquidity positions. Banks expect further tightening in the fourth quarter, but to a lesser extent. Still, the cumulative tightening of credit standards since the start of 2022 has been substantial.

Chart 4

The relative risk pricing of both bonds and loans (via spreads) reflects markets' declining risk perceptions (see chart 5). High-yield corporate bond spreads in Europe finished October at 483 basis points (bps), just 15 bps below where they began the year. Meanwhile, the spread-to-maturity for the European Leveraged Loan Index (ELLI) has fallen 97 bps this year through Oct. 31, to 522 bps.

The relative risk of holding corporate debt can be a major indicator of future defaults because companies face pressure if they're unable to refinance maturing debt or service existing debt. In broad terms, speculative-grade spreads have been good indicators of future defaults based on a roughly one-year lead time. Given current spreads, our baseline European default rate forecast of 3.75% is above what the historical trend would suggest. However, while spreads are narrowing, yields are continuing to rise, increasing the all-in costs of debt that issuers must contend with regardless of the risk perceptions. While the ELLI spread has declined 97 bps in the first 10 months of this year, the ELLI yield-to-maturity has increased 81 bps, to 9.4%. And that increase is just part of a broader uptrend: The yield-to-maturity has risen by roughly 550 bps since the start of 2022.

Chart 5

Considering broad measures of financial market sentiment, economic activity, and liquidity, we estimate that at the end of September, the speculative-grade bond spread in Europe was about 294 bps below our estimate of 739 bps (see chart 6). The gap between the actual spread and the estimated spread implies that bond markets may be overly optimistic in their perception and pricing of risk.

Chart 6

Economic Resilience Remains Key For Weaker Credits

The softening of consumer price inflation is starting to be a key factor supporting household demand in Europe. Of the region's lowest-rated issuers--those rated in the 'CCC'/'C' category--29% are from consumer-facing sectors: consumer products and media and entertainment (see chart 7). The default rate for 'CCC'/'C' rated entities reached nearly 50% during the peak of the pandemic in late 2020, implying that there's the potential for very high default risk if the worst-case scenario were to pan out. In addition, of all the sectors we track, the consumer products sector accounts for the most weakest links (issuers rated 'B-' or below with a negative outlook or on CreditWatch with negative implications).

Two other sectors--the chemicals, packaging, and environmental services sector and the capital goods sector--together represent another 20% of the 'CCC'/'C' population. All four sectors combined account for over 50% of the weakest issuers in this rating category that have negative cash flow-to-debt ratios. These four sectors are characterized by the highest levels of low-rated, loan-based debt, which has been the most subject to rising rates thus far. There have also been additional stressors for the capital goods and chemicals, packaging, and environmental services sectors as a result of slowing international trade, slowing growth in China, and increasing environmental regulation in Europe.

Chart 7

Of the 49 European issuers that were on our weakest links list on Sept. 30, just over half (51%) were from the consumer products; media and entertainment; capital goods; and chemicals, packaging, and environmental services sectors.

Credit Momentum Eases

In the 12 months ended September, there was marginal movement in European speculative-grade credit quality: Net rating actions were still positive, but a negative net bias implied that downgrades were ahead (see chart 8). That said, the current trends are still far from the declines in speculative-grade credit quality that preceded the 2009 and 2020 default cycles.

Chart 8

History shows that both the rate of downgrades and the net negative bias tend to lead movement in the default rate by several quarters. Recent net improvements in credit quality have been very modest and haven't been enough to make up for the declines during 2020, signaling that speculative-grade issuers are still much more vulnerable than they have been historically (see chart 9). And so relative default risk could be higher than what aggregate downgrades imply on their own.

Chart 9

How We Determine Our European Default Rate Forecast

Our European default rate forecast is based on current observations and expectations of the likely path of the European economy and financial markets. 

This report covers financial and nonfinancial speculative-grade corporate issuers. The scope and approach are consistent with those of our default and rating transition studies. In this report, our default rate projection incorporates inputs from S&P Global Ratings economists that also inform the analysis of our regional Credit Conditions Committees.

We determine our default rate forecast for speculative-grade European financial and nonfinancial companies based on a variety of quantitative and qualitative factors. The main components of the analysis are credit-related variables (for example, negative ratings bias and ratings distribution), the ECB bank lending survey, market-related variables (corporate credit spreads and the slope of the yield curve), economic variables (the unemployment rate), and financial variables (corporate profits). For example, increases in the negative ratings bias and the unemployment rate positively correlate with the speculative-grade default rate. As the proportion of issuers with negative outlooks or ratings on CreditWatch with negative implications increases, or the unemployment rate rises, the default rate usually increases.

This report covers issuers incorporated in the 31 countries of the European Economic Area, Switzerland, and certain other territories, such as the Channel Islands. The full list of included countries is: Austria, Belgium, the British Virgin Islands, Bulgaria, Croatia, Cyprus, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Gibraltar, Greece, Guernsey, Hungary, Iceland, Ireland, the Isle of Man, Italy, Jersey, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Monaco, Montenegro, the Netherlands, Norway, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, Switzerland, and the U.K.

Related Research

• Credit Trends: Europe's Risky Credits: Liquidity And Refinancing Risks Start To Bite, Nov. 1, 2023
• Global Credit Conditions Q4 2023: Resilience Under Pressure, Sept. 28, 2023
• Credit Conditions Europe Q4 2023: Resilience Under Pressure Amid Tighter Financial Conditions, Sept. 26, 2023
• Economic Research: Economic Outlook Eurozone Q4 2023: Slower Growth, Faster Tightening, Sept. 25, 2023
• Economic Outlook U.K. Q4 2023: High Rates Keep Growth Muted, Sept. 25, 2023