Professional Documents
Culture Documents
A Changing Market Composition Points To A Lower Corporate Default Rate On The Horizon In Europe
Primary Credit Analyst: Paul Watters, CFA, London (44) 20-7176-3542; paul.watters@standardandpoors.com Secondary Contact: Alexandra Krief, Paris (33) 1-4420-7308; alexandra.krief@standardandpoors.com
Table Of Contents
A Steady Stream Of Defaulters The Default Rate By Value Falls Back To Q3 2011 Levels The Portfolio Shifts Toward Speculative-Grade Ratings The Default Rate Will Likely Fall To 5.2% By March 2015 Business Services, Retail, And Transportation Head The Default Tally The Credit Quality Of U.K. Companies May Be A Cause For Concern Recovery Rates For Senior Secured Debt Are On the Rise Appendix: Default Study Methodology Related Research
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT
Default Study:
A Changing Market Composition Points To A Lower Corporate Default Rate On The Horizon In Europe
Gradually improving economies and investors' continued appetite for corporate credit in the bond markets on attractive terms is helping to stabilize credit quality for European nonfinancial corporate issuers somewhat. Nonetheless, there is further work to be done in dealing with vulnerable, highly leveraged pre-2008 vintage credits that will maintain pressure on defaults in CLO portfolios. Taking into account the growing proportion of new speculative-grade issuers in our portfolio (that is, those we rate 'BB+' and below), which generally have better credit quality than was previously the case, we anticipate that the overall default rate (including for private companies) could decline to 5.2% by the end of March 2015 from 5.9% at the end of 2013. However, we would likely raise our default expectations if we see signs of overheating in the high-yield market. Overview Eleven corporate issuers defaulted in the fourth quarter of 2013, taking the full-year total to 42. As a result, the speculative-grade default rate declined to 5.9% for the full year from 7.2% in 2012. The default rate by value of defaulted debt dropped sharply in 2013, to 2.7% from 4.3% in 2012. The amount of outstanding debt held by defaulting issuers to which we assign private credit estimates fell in 2013 to 10.4 billion--the lowest annual figure since 2007. We anticipate a steady stream of defaults through the remainder of this year as 2007-2008 vintage CLOs finally exit their reinvestment periods, overleveraged 2006-2008 loan issuers struggle to refinance, and banks prepare their balance sheets ahead of the European Central Bank's Asset Quality Review.
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT
Default Study: A Changing Market Composition Points To A Lower Corporate Default Rate On The Horizon In Europe
Table 1
*Number in database at start of period. TTM--Trailing 12 months. Europe--EU-28 + Iceland, Norway, and Switzerland. Source: Standard & Poor's.
Looking at the composition of defaults, there were five defaults on publicly rated companies in the fourth quarter, taking the full-year default total to 15, generating a public speculative-grade default rate of 4.7%. This compares with nine defaults in 2012 for a default rate of 3.6% under our newly revised methodology (see sidebar below for an explanation of our revised methodology for calculating defaults). On the credit estimates side, there were six defaults in the fourth quarter of 2013, resulting in a full-year total of 27 and a 12-month trailing default rate of 6.9% (see chart 1). This is somewhat below the full-year 2012 levels of 42 defaults and our revised 9.2% default rate.
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT
Default Study: A Changing Market Composition Points To A Lower Corporate Default Rate On The Horizon In Europe
Our Revised Default Calculation Methodology To improve consistency with our CreditPro default statistics, we've revised the calculation of the denominator we use to derive the default rates in this study. From now on, we will take the initial number of rated nonfinancial speculative-grade corporates and credit estimates in our portfolio at the start of the year rather than take the average over the year. This will mean that the methodology for calculating our 12-month trailing default rate will be consistent with other default data that Standard & Poor's derives from CreditPro using our static pool methodology. The overall effect on the European nonfinancial corporate default rate for 2013 was insignificant because the lower implied default rate for credit estimates (using a higher start-of-year count as the denominator) was almost exactly offset by the higher implied default rate for our rated speculative-grade companies (using a lower start-of-year count as the denominator).
Chart 1
According to our revised methodology, the average European default rate for nonfinancial corporates over the past five years (since the start of 2009) is 7.4%--exactly the same as under our prior average period method. This average rate combines both the heavy, albeit rapidly declining, weight of the private credit estimates pool, where the average
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT
Default Study: A Changing Market Composition Points To A Lower Corporate Default Rate On The Horizon In Europe
default rate was 8.5% (versus 9.0% under our previous method) and the 4.6% average default rate for rated corporates (versus 4.3% under our previous method).
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT
Default Study: A Changing Market Composition Points To A Lower Corporate Default Rate On The Horizon In Europe
Table 2
*Europe = EU-28 + Iceland, Norway, and Switzerland. TTM--Trailing 12 months. Source: Standard & Poor's.
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT
Default Study: A Changing Market Composition Points To A Lower Corporate Default Rate On The Horizon In Europe
Chart 2
Table 3
Public ratings Credit estimates Combined Public ratings Credit estimates Combined 0.6 1.9 3.8 6.0 21.7 0.6 2.1 4.3 6.7 23.4 0.8 2.4 5.1 8.2 26.9 0.9 2.6 5.5 8.9 28.6
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT
Default Study: A Changing Market Composition Points To A Lower Corporate Default Rate On The Horizon In Europe An ongoing gradual economic improvement in the eurozone (European Economic and Monetary Union), with Germany and the U.K. taking the lead and the periphery and France following in their trail, with a lag. Our expectation that the ECB official policy rates are unlikely to increase until late 2015 at the earliest, while the U.K. might initiate modest increases earlier in 2015. This would provide significant support for companies' debt service capacity. While the cost of corporate financing remains an issue across the eurozone, the combination of an improving liquidity position for the major banks and the increasing private nonbank provision of debt finance will continue to erode the higher risk premiums required for peripheral borrowers. Modest signs of improving liquidity in the loan market. Banks' underwriting capacity is benefiting from the return of the primary CLO market, older CLOs exiting reinvestment now being past their peak, as well as growing confidence in the broader economic environment and the banks' improving capital positions. As a consequence, after applying slightly lower one-year default stress assumptions than for our previous default forecast in December 2013(see "European Defaults Remain Elevated As Legacy Transactions Take Their Toll," published Dec. 10, 2013, on RatingsDirect) and reflecting the shifting weight in our speculative-grade portfolio away from private credit estimates, we envisage that the combined default rate will fall to 5.2% by the end of March 2015, from our previous baseline forecast of 6.0% for year-end 2014. In a more pessimistic downside scenario--which might correspond with growing issuance from more aggressively financed issuers or smaller businesses with weaker business risk profiles, or with a weaker, more disinflationary economic environment--we could envisage the default rate remaining elevated, at about 6.7%.
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT
Default Study: A Changing Market Composition Points To A Lower Corporate Default Rate On The Horizon In Europe
Table 4
*Data combines rated entities and private credit estimates. Europe = EU-28 + Iceland, Norway, and Switzerland. Source: Standard & Poor's.
However, it's revealing to compare the recent default experience with issuer characteristics in the high-yield market since the start of 2009, when activity in that market started to pick up. Prior to 2009, the most indebted companies looking to raise financing in the high-yield market were in the telecommunications, metals and mining, and paper and forest products sectors. In our view, this reflected a variety of factors, not least the capital intensity of the respective sectors, their degree of industry concentration, and the risk that high debt exposure represented to relationship banks. Since 2009, the picture has evolved. The three sectors with the most outstanding debt held by newly rated speculative-grade companies are now retail and restaurants, media and entertainment, and transportation, and these are three of the four sectors that experienced the highest default rates in 2013. Much of the new issuance for companies in these sectors represents loan-for-bond refinancing, which raises some interesting questions: What are the relationship banks doing to encourage these companies to diversify their funding? And are investors' risk assessments properly accounting for the default experience at the sector level? Of course, investors would need to consider many other elements to make a proper judgment of risk, including the security package and other investor protections provided in the various financing documents.
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT
Default Study: A Changing Market Composition Points To A Lower Corporate Default Rate On The Horizon In Europe
Chart 3
However, the default experience to date likely masks the location of future weaknesses, from our perspective. First, notwithstanding the high level of non-performing loans monitored by the Bank of Italy and the Bank of Spain, the number of Italian and Spanish speculative-grade corporates that we track is low representing just over 11% of our portfolio, of which about one-third have credit quality of 'B-' or lower. Of greater concern to us is the credit quality of U.K. speculative-grade companies that comprise almost 23% of our portfolio, of which 8% have highly leveraged financial risk profiles in the 'B-/CCC' categories. Most of them are LBOs originated prior to the financial crisis. By comparison, the ratings distribution for French and German companies poses less of a prospective credit concern because we assess a little less than 5% of companies in both of these countries at the 'B-/CCC' level.
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT
Default Study: A Changing Market Composition Points To A Lower Corporate Default Rate On The Horizon In Europe
For more information on recovery rates, see table 5 and observations in our recent report titled "Standard & Poor's European Recovery Rating Performance--A Six Year Study," published Feb. 25, 2014. This study analyses the recoveries for a (somewhat limited) sample of 27 European rated companies that have emerged from default since 2007 where recovery ratings had been assigned to the various debt instruments.
Table 5
Year 2007 2008 2009 2010 2011 2012 2013 Total Weighted average*
Exited 2 0 11 6 3 4 1 27
83%
37%
36%
11%
*Weighted average by number of companies, using mid-point of mean recovery range. Source: Standard & Poor's.
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT
Default Study: A Changing Market Composition Points To A Lower Corporate Default Rate On The Horizon In Europe
Chart 4
For companies with a private credit estimate (see chart 5), the process is not quite so straightforward. Where a coupon or principal payment is not paid on time we then consider that the default occurs on that date. However, in the case of a debt restructuring, we recognize that a default has occurred either on the date a restructuring plan is implemented (if payments remain current) or on the date of the first missed payment, whichever occurs first.
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT
Default Study: A Changing Market Composition Points To A Lower Corporate Default Rate On The Horizon In Europe
Chart 5
Due to the time lag involved in receiving information relating to restructurings for private unrated companies, or to companies that defaulted after their ratings were withdrawn, it is not uncommon to revise default rates over time.
Related Research
The articles listed below are available on RatingsDirect unless otherwise stated.
Standard & Poor's European Recovery Rating Performance--A Six Year Study, Feb. 25, 2014 European Defaults Remain Elevated As Legacy Transactions Take Their Toll, Dec. 10, 2013 Proceed With Caution: European Corporate Credit Outlook 2014, Dec. 11, 2013. For more details, access https://ratings.standardandpoors.com/economic-research/europe-middle-east-and-africa/The-Outlook-For-Europe-in-2014.htm Under Standard & Poor's policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Rating or Rating Outlook.
Additional Contact:
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT
Default Study: A Changing Market Composition Points To A Lower Corporate Default Rate On The Horizon In Europe
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT
Copyright 2014 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription) and www.spcapitaliq.com (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT