Key Takeaways
- We expect the European trailing-12-month speculative-grade corporate default rate to be 3.5% by December 2024, the same level as in December 2023, indicating a relative stabilization of the default rate by year-end after its expected rise to slightly higher levels over the summer.
- A prolonged growth slowdown (or recession), particularly if triggered by any meaningful deterioration in regional conflicts spilling over to Europe, could push the default rate higher--to 5% in our pessimistic case.
- Higher interest rate burdens still lie ahead for many businesses and households despite recent market optimism and a fall in fixed-rate yields. Upcoming fixed-rate maturities this year and next will force issuers to contend with market rates still roughly 2% higher than those on existing debt.
- We think that similar to 2023, consumer-reliant sectors such as consumer products and media and entertainment will likely lead the default tally in 2024. The chemicals and health care sectors may also see high relative defaults because these sectors have many issuers with negative cash flow and high proportions of 'CCC/CC' ratings.
Our Base Case Incorporates Generally Stable Credit Quality
Baseline: S&P Global Ratings Credit Research & Insights expects the European trailing-12-month speculative-grade corporate default rate to level out to 3.5% by December 2024 – essentially unchanged from December 2023 (see chart 1). Over fourth-quarter 2023, credit quality was largely stable outside of an increase in defaults during December. Meanwhile, market sentiment has turned more positive, as slowing inflation appears to support rate cuts by the European Central Bank (ECB) later this year. Though overall economic growth in Europe slowed in 2023, it remained relatively resilient with only Germany seeing a slight contraction.
Our expectations for 2024 center on a soft-landing economic scenario supported by wage growth and disinflation. In addition, the speculative-grade bond and loan markets have opened up in recent months, allowing firms to reprice and refinance existing debt. That said, expectations for more growth-oriented uses of debt such as mergers and acquisitions (M&A) and capital expenditures remain muted for now, reflecting a still selective investor environment and restrictive interest rates.
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% this year. Economic resilience would need to continue or even expand beyond S&P Global economists' base case. Current market pricing appears supportive but would need to be sustained longer, with lenders becoming more open to loans to the still large number of 'CCC/C' issuers. Headline inflation readings at both the consumer and producer levels have been declining consistently. If inflation were to continue falling at the current pace, it could give central banks room to cut rates sooner than our base-case assumption for the second half of 2024, though time is running short on this possibility. Near-term refinancing needs are manageable, particularly after recent stronger issuance, but comparably large amounts of 'CCC'-rated instruments are coming due in 2025.
Pessimistic scenario: We forecast the default rate could rise to 5%. Our growth expectations for most of Europe next year point to some strengthening, but still subpar growth. Along with rising real rates, speculative-grade issuers are vulnerable to a downturn. In a scenario of even slower economic growth or a recession, or if interest rates stay high throughout 2024, the default rate could rise to 5%.
Slowing earnings for several quarters in a row leave less room to maneuver amid elevated interest rates. Issuers are dealing with refinancing needs, but at a higher cost. The continuing Russia-Ukraine conflict remains a factor for further uncertainty, which could lead to more acute stress as winter approaches. In addition, the latest Israel-Hamas war carries the risk of spilling over to become a larger, regional conflict, further stressing regional trade and financial market sentiment.
Defaults Spiked In December, While Leading Indicators Are Mixed
Defaults increased over the course of 2023, culminating in December with the largest single-month increase in the default rate, taking the speculative-grade default rate to 3.5% from only 2.8% through November. Meanwhile, many leading indicators of defaults ahead have seen little movement or have even declined, such as bond spreads (see table 1).
This summary table generally supports our baseline projection for a stable default rate by year-end 2024, though market measures could indicate a decline. That said, we note that market measures tend to factor in loss given default as well as default probability and that in 2023, distressed exchanges accounted for roughly two-thirds of all European defaults. This is in keeping with the general trend of increased representation of distressed exchanges in recent years, which we expect to continue in 2024.
Table 1
| Defaults rise in 2023; select leading indicators are mixed | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2022 | 2023 | Change (%) | ||||||
| Default rate | 2.2% | 3.5% | 59.1% | |||||
| Negative bias | 16.5% | 17.5% | 6.1% | |||||
| Negative bias ('B-' & below) | 28.7% | 28.2% | -1.7% | |||||
| Percent 'CCC/C' to speculative-grade | 9.8% | 10.0% | 2.4% | |||||
| High-yield yield | 7.5% | 6.1% | -19.2% | |||||
| ELLI YTM | 8.6% | 9.1% | 5.7% | |||||
| High-yield spread | 5.0% | 4.1% | -18.7% | |||||
| iTraxx-Xover CDX | 4.7% | 3.1% | -34.6% | |||||
| Unemployment rate | 6.7% | 6.4% | -4.3% | |||||
| Sources: ICE Benchmark Administration Ltd. (IBA). ICE BofAML Euro High-Yield Index Option-Adjusted Spread (retrieved from FRED, Federal Reserve Bank of St. Louis). S&P Global Market Intelligence. S&P Global Ratings Credit Research & Insights. | ||||||||
Issuance Was Subdued In 2023 Versus Historical Levels, But Has A Strong Start To 2024
Combined high-yield bond and leveraged loan issuance was subdued in 2023, but still managed to exceed 2022's total by about €15 billion (see chart 2). The pace of bond issuance was by far the stronger of the two debt types, and issuers have used much of the funding for refinancing, helping to reduce near-term liquidity risk. With the improved market sentiment in the fourth quarter, bond yields have come down and issuance picked up in January as well, with high-yield bond issuance up 51% from January 2023.
Chart 2
Even if issuance falls off in the second half of the year, upcoming maturities in 2024 remain very manageable (see chart 3). We estimate €50.8 billion in total speculative-grade debt will come due in 2024, but only €5.5 billion of that is in the 'CCC'/'C' category. However, maturities then total €314 billion through 2026. Depending on the economic and interest rate conditions in the next 12 months, these maturities could prove challenging to refinance, particularly the large €117 billion total of 'B' category debt due in 2026.
Chart 3
Risk Sentiment Improves, But Debt Costs Rise
European banks' credit standards for loans to firms tightened in fourth-quarter 2023 from the previous quarter, though at the most modest pace since the first-quarter 2022 survey (which reflected fourth-quarter 2021; see chart 4). Banks' risk perceptions were the main driver for tightening in the fourth quarter, followed by lower risk tolerance and liquidity positions. In the first quarter of 2024, banks expect tightening to a slightly higher level than in the fourth quarter. Despite the relative decline in net tightening, cumulative tightening since the start of 2022 has been substantial.
Chart 4
Relative risk pricing of both bonds and loans (via spreads) reflect declining risk perceptions on the part of markets (see chart 5). The relative risk of holding corporate debt can be a major indicator of future defaults because companies face pressure if they are 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. At current spreads, our baseline default rate forecast of 3.5% is above what the historical trend suggests.
However in contrast to spreads, current yields continue to rise, increasing the all-in costs of debt that issuers must contend with regardless of risk perceptions. While the ELLI spread may have fallen 117 basis points (bps) over 2023, the ELLI yield-to-maturity has increased 49 bps to 9.05%. In our view, since the start of the current rate hike cycle in 2022, defaults have trended more similarly to yields than spreads.
Chart 5
Considering broad measures of financial market sentiment, economic activity, and liquidity, we estimate that in December, the average speculative-grade bond spread in Europe was about 192 bps below our estimate of 600 bps (see chart 6). The gap between the actual and estimated spread implies that bond markets may be overly optimistic in their current stance. This also supports the argument that yields rather than spreads better indicate financial stress in the current conditions.
Chart 6
Economic Resilience Remains Key For Weaker Credits
The current deceleration of consumer price inflation is a key factor supporting household demand. Among our weakest rated issuers (in the 'CCC'/'C' category), 32% are in 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 the potential for very high default risk should a worst-case scenario play out.
Chart 7
Consumer products represent 17.6% of the European 'CCC+' and below rated portfolio, which is the biggest share by sector. To some extent, this is due to the size of this sector, which also makes up nearly 17% of European speculative-grade rated issuers. Within consumer products, issuers rated 'CCC+' and below make up 11% of the sector portfolio, just above the 10% average across sectors. The sector's size in terms of number of issuers also partly explains why consumer products has the second-highest amount of floating-rate debt outstanding and has the third-highest total speculative-grade debt outstanding. Subdued consumer demand remains a key challenge to issuers in the consumer products sector, as inflation expectations remain high despite ongoing disinflation. At the same time, labor markets remain tight, and many consumer-facing businesses have to bear the brunt of higher wages on their margins.
The media and entertainment sector is the second-biggest contributor to European speculative-grade rated issuers. It makes up around 15% of issuers in the 'CCC+' and below category, while 11% of speculative-grade rated issuers in the sector are rated 'CCC+' and below.
The ratings outlook for media issuers rated in the 'B' category and lower remains bleak. Refinancing and elevated financing costs will remain risks. Many media companies addressed capital structure issues and extended maturities in 2023, but there's still a high volume of maturities in 2025-2026.
Similar to other consumer-facing sectors, we expect media and entertainment issuers to suffer from weakening consumer balance sheets. Consumer spending on discretionary media will weaken as savings accumulated during the peak of the COVID-19 pandemic are depleted. Notably, streaming subscriber growth may take a hit.
The third largest sector contributing to 'CCC+' rated European issuers is chemicals, packaging, and environmental services with 10.8%. Within the chemicals sector, headwinds for European producers extend well beyond 2024 due to higher cost positions and competitive pressures, prompting decisions to examine production footprints. Destocking, some troubled key end-markets (such as housing), and slower-than-expected growth in China have hampered demand in the petrochemicals industry. Additionally, the ramp-up of new capacity and limited permanent capacity closures to date have led to industry oversupply. We expect these challenges, which are exacerbating already weak supply and demand fundamentals, to continue in 2024, delaying a recovery in the sector.
Credit Momentum Reflects Modest Improvement
In the 12 months ended December 2023, speculative-grade credit quality continued to show marginal improvement. Net rating actions stayed positive, but with a negative net bias that implies downgrades ahead (see chart 8). That said, current trends are still far from the declines that preceded the 2009 and 2020 default cycles, and credit quality has recently been trending positive.
Chart 8
History shows that the rate of downgrades and net negative bias tend to lead the movement in the default rate by several quarters. Though credit quality has generally shifted positive since 2021, net improvements in credit quality have not been enough to make up for the declines during 2020, leaving speculative-grade issuers still much more vulnerable than they've been historically (see chart 12). Considering that, we think relative default risk is higher than 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
- Global Credit Outlook 2024: New Risks, New Playbook, Dec. 4, 2023
- Credit Conditions Europe Q1 2024: Adapting To New Realities, Nov. 28, 2023
- Economic Outlook Eurozone Q1 2024: Headed For A Soft Landing, Nov. 27, 2023
- U.K. Economic Outlook For 2024 Sees More Stagflation Ahead, Nov. 27, 2023
- Credit Trends: Risky Credits: Europe's Q1 Fall Masks The Full Story, April 28, 2023
This report does not constitute a rating action.
| Credit Research & Insights: | Nick W Kraemer, FRM, New York + 1 (212) 438 1698; nick.kraemer@spglobal.com |
| Paul Watters, CFA, London + 44 20 7176 3542; paul.watters@spglobal.com | |
| Sarah Limbach, Paris + 33 14 420 6708; Sarah.Limbach@spglobal.com |
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