THE SOVEREIGN DEBT CRISIS affecting much of Europe continued to impact the economic stability of the entire continent in 2013, contributing to the downward pressure on European companies – especially in the financial sector.
In total, 16 companies rated by Standard & Poor’s (S&P) defaulted on their debt, affecting issuance worth $17.8bn (£10.5bn). This is up from the nine corporate defaults in 2012, and is the highest number since 2009. Nevertheless, there is evidence of greater stability taking hold across Europe: the percentage of unchanged ratings increased to 72.04%, which is a notable improvement from 62.08% in 2012.
Currently, one of the greatest obstacles to the stability of the European economy remains the financial sector. Four times as many financial institutions were downgraded last year than upgraded, which we believe is linked to the financial challenges certain sovereign credit profiles continue to face.
Growing stability in Europe
All told, the figures suggest that despite the sharp hike in default numbers, the majority of companies are managing to maintain stable levels of creditworthiness. For instance, the downgrade-to-upgrade ratio across all European companies was 1.47% last year, which is markedly lower than the 3.25% ratio in 2012.
And even if the total number of defaults has increased, the volume of debt affected by defaults has decreased. In 2013 it totalled $17.8bn, down from $19.7bn in 2012 – a considerable improvement from the $38.7bn in 2009.
The non-financial sector, in particular, saw a growing proportion of rating upgrades. Some 12% of European non-financial companies were upgraded last year, only marginally outstripped by the 13% that were downgraded. By contrast, there was continued downward pressure on the financial sector, with 16% of European financial institutions being downgraded compared to 4% that were upgraded.
Continuing downward trend in the financial sector
Indeed, 2013’s relative ratings stability can mainly be attributed to non-financial companies. In total, S&P saw eight rising stars, which are corporate entities that have been upgraded to investment grade from speculative grade – all of which are from the non-financial sector. We also saw eight fallen angels, which are entities downgraded to speculative grade, four of which were financials.
Without a single rising star, it is clear issues remain with Europe’s financial sector. Typically, financial institutions are more leveraged – making them more vulnerable to sovereign and macro-related problems than non-financial companies. At S&P, we believe it is the continuing weak credit profiles of some key European sovereigns that contributed to the elevated downgrade activity in the financial sector in 2013.
Correlation of S&P ratings and corporate defaults
The reason ratings adjustments vary may be related to overall shifts in the economy or business environment, or more narrowly focused circumstances affecting a specific industry, entity or individual debt issue. We would expect that the higher the issuer rating, the lower the observed frequency of default, and vice versa.
Indeed, in 2013, no investment grade entities rated by S&P defaulted, demonstrating that credit ratings continue to serve as effective indicators of credit risk. All but two of the 2013 European defaulters were initially rated BB+ or lower: Norway-based Norske Skogindustrier ASA was initially rated BBB in 2001, while Ireland-based Irish Bank Resolution Corp. Ltd. was initially rated ‘A’ in 2007. S&P downgraded both to speculative-grade ratings several years before they defaulted in 2013 – Norske Skog was downgraded to BB+ from BBB- in November 2006 and Irish Bank to B from BBB in November 2010.
The sovereign debt crisis continues to be felt
The growing number of upgrades of non-financial companies in 2013 demonstrates that the European economy is at least stabilising. But the weaker credit performance of the financial sector remains a concern.
Indeed, the simultaneous downgrade of several sovereigns, continuous downward trend in the ratings of financial institutions, and the elevated level of defaults are consistent with our belief that the sovereign debt crisis has strongly influenced, and will continue to influence, the credit rating performance of European corporates.
Diane Vazza is head of global fixed-income research at Standard & Poor’s Ratings Services
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