This article is written and published by S&P Global Market Intelligence; a division independent from S&P Global Ratings. S&P Global Ratings does not contribute to or participate in the creation of credit scores generated by S&P Global Market Intelligence. Lowercase nomenclature is used to differentiate S&P Global Market Intelligence PD credit model scores from the credit ratings issued by S&P Global Ratings.
In this updated analysis of “Uncertainties Impact Credit Risk in the European Union and the UK” we further examine how companies in the European Union (EU) and the United Kingdom (UK) have fared in the complex pre- and post-pandemic environment which, more recently, have been further impacted by new challenges, ranging from stagflation to geopolitical pressures.
Figure 1 shows historical speculative default rates provided in CreditPro®, our solution that provides rating transition, default and recovery rate analytics. As noted in our previous analysis, we saw a surge in speculative-grade company defaults in 2002 with the tech bubble, and in 2009 following the global financial crisis. We have since witnessed a further spike in 2020, albeit mitigated by numerous government fiscal initiatives and central bank accommodative policies enacted to support businesses.
As countries adjust to the post-pandemic “new normal” and central banks reduce accommodative policies, companies in specific sectors face the challenge of reducing the debt accumulated on their balance sheets and have a higher risk of default.
Figure 1: EU+UK Region and Global Trailing-12-Month Speculative Grade Default Rate
The Probability of Default (PD) Model Fundamentals measures the likelihood of default for public and private companies by assessing their financial and business strength. We calculated the median credit risk using the latest available financials to gain a mid- to long-term view of how the credit risk of different industries in the EU and UK has responded to market conditions.
In Figure 2, we examine the median PDs for the EU+UK region by industry, focusing on a range of industries/sectors that display the highest median PDs, greatest change in PDs, and lowest PDs. Airlines continued to exhibit the highest PD. The sector also exhibited the highest volatility between Q3 2020 and Q1 2022, ranging from a median PD of 8.89% to 11.52%, equivalent to a credit score of ccc+. The volatility across airlines' PD can be attributed to travel restrictions that were lifted and imposed many times during that period. For instance, high vaccination rates by Summer 2021 and lifted travel restrictions led to higher demand for holiday destinations, resulting in extensive air traffic throughout summer 2021, reflected by stable PD. However, as winter came in 2021, the Omicron variant emerged. European governments-imposed new travel restrictions and forced airlines to cancel tens of thousands of flights, reflected by a spike in PD in Q1 2021. As restrictions were lifted once again, PD decreased. However, increasing jet fuel prices with labour shortages led to lower profit margins, which increased business risk, reflecting higher PD levels.
Figure 2: PD Fundamental Evolution in EU+UK by Sector
The hotels, restaurants & leisure sector experienced the biggest increase in their PD, rising from 3.96% to 6.76% (from Q3 2020 to Q1 2022), a 70% increase. Multiple waves of lockdowns, compulsory testing, bans on international travel, and most importantly, two-week quarantine upon arrival at many destinations discouraged people from traveling, severely reducing demand and driving occupancy down to 20-30% of pre-pandemic levels. This also contributed to persistent labour shortages within the UK, as this sector traditionally employs foreign workers, many of which moved abroad during the pandemic.
The retail sector exhibited the second highest PD throughout this period, increasing from 8.11% to 8.50%, driven by supply chain issues and persistent cost inflation. Higher energy prices, shortage of raw materials, and higher freight cost have significantly increased the operating costs of many retailers, thus reducing their profit margins and accelerating business risk. Although the PD increased, the retail sector did relatively well as a result of high spending by consumers and the government measures put in place, such as the Furlough Scheme.
The PD for the energy sector spiked from 6.37% to 7.68% until the first half of 2021 due to the sharp contraction in oil demand during the height of the pandemic. As the global economy recovered throughout 2021, global oil consumption increased, and prices rose consistently, subsequently reducing the PD to 7.47%.
Utilities companies maintained and lowered PD levels from 3% to 2% in 2021, as power prices in Europe rose due to higher electricity demand as the economies recovered from COVID-19. In addition, longer heating seasons in some EU Countries along with Government-imposed tax cuts and subsidies helped the utilities sector to retain strong financial performance. However, at the beginning of 2022, utility companies found themselves vulnerable, with 31 UK energy companies going bankrupt. A reduction in Russian spot sales in late 2021 led to high gas prices in Europe along with a price cap that made it hard to pass high prices onto consumers, which led to lower margins and forced companies to make losses. Therefore, the PD has risen to 3% in Q1 2022.
It would be remiss not to mention the rising uncertainty surrounding the oil and gas supply in 2022 due to geopolitical events. The Russian invasion of Ukraine has led to global, all-time high energy prices, which has negatively impacted businesses within the EU and the UK.
We should also note those sectors that did well in our analysis, such as pharmaceuticals and healthcare, that managed to see a reduction in their PD over this term, related to the successful launch and efficient distribution of COVID-19 vaccines. As the world recovered from the pandemic, the demand for non-COVID-related healthcare services also grew. The financial sector remained stable throughout 2021, with strong consolidation of M&A activities.
The transition of credit risk in the EU and UK
Comparing the fundamental PDs of the same set of public and private companies across the EU+UK and grouping them by credit score (e.g., ‘bbb+’, ‘bbb’, ‘bbb-’, etc.), provides insight into the transition of credit scores from Q4 2021 to Q1 2022 for this sample set. Figure 3 shows that the percentage of companies with ‘aa’ to ‘bb+’ scores decreased in Q1 2022, while with the exception of ‘ccc+’ the percentage of companies with scores commonly classified as speculative grade at ‘bb’ or below increased. The most sizeable shift was at the score level ‘b-’. This implies that, similar to our 2020 analysis, there was a continued weakening in the fundamentals across these companies, and a worsening credit quality, despite post-pandemic recovery and strong consumer spending. Moreover, within this sample of companies, there was an increase in the percentage of companies with lower credit scores by Q1 2022. This negative shift was linked to rising inflation, oil and gas prices, and supply chain issues.
Figure 3: Transition of Credit Scores Q4 2021 – Q1 2022
In this PD Fundamental analysis we looked at how the credit risk of public and private companies headquartered in EU and UK has changed between 2021 and the beginning of 2022. Airlines, hotels & restaurants, and utilities are among the most affected. Other sectors such as materials, pharmaceuticals, finance, consumer durables, and healthcare were either stable or experienced moderate improvement, displaying more resilience to increasing inflation and recent supply chain shocks.
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 S&P Global Ratings does not contribute to or participate in the creation of credit scores generated by S&P Global Market Intelligence. Lowercase nomenclature is used to differentiate S&P Global Market Intelligence PD scores from the credit ratings used by S&P Global Ratings.