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Credit Trends: Risky Credits: European Downgrades To 'CCC' Increase As Refinancing And Inflation Risks Bite

(Editor's Note: Our "Risky Credits" series focuses on corporate issuers rated in the 'CCC' category. Because many defaults are from these companies, those with negative outlooks or ratings on CreditWatch negative are important to monitor.)

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The number of European corporate issuers rated 'CCC+' or lower by S&P Global Ratings dropped in the second quarter, but downgrades into the 'CCC' rating category have increased.  The tally of issuers rated 'CCC+' or lower decreased to 52 as of June 30, 2022, from 59 as of March 31 due to several downgrades and ultimately rating withdrawals for entities affected by the imposition of sanctions related to the Russia-Ukraine conflict. Apart from these conflict-related withdrawals, two issuers, French rental car company Europcar Mobility Group S.A. and German carbon and graphite producer SGL Carbon SE, were also removed from the tally due to upgrades, after they were able to improve their capital structures given stronger-than-expected operating performance.

Despite this fall in the number of issuers rated 'CCC+' and below, downward pressure on European corporate issuers is increasing: Five issuers were downgraded into the 'CCC' rating category in the second quarter, compared with four in the first quarter, due to a mix of liquidity and refinancing risk, along with slower-than-expected market recovery and increasing inflationary pressures. The five downgraded companies were:

  • Luxembourg-based real estate asset manager Corestate;
  • Germany-based autobody sealant producer Standard Profil;
  • Luxembourg-incorporated, Berlin-headquartered residential real estate holding company Adler Group S.A.;
  • U.K.-based specialty retailer L1R HB Finance Ltd.; and
  • Aeroengine partmaker F-Brasile SpA.

Chart 1

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The speculative-grade ratings distribution remains far weaker than before the pandemic, with the percentage of issuers rated 'CCC+' or lower in Europe elevated at 8.7% (see chart 2).  This comes at a time when financing conditions have tightened for many lower-rated issuers and the European Central Bank has begun to hike rates with the objective of curbing persistently high inflation. While a sharp downturn in growth is inevitable, the likelihood of a full recession is only 30%-43% (see "A Eurozone Slowdown Is For Sure; Recession Is Less Certain," July 19, 2022).

Chart 2

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Seven out of 10 issuers have less than adequate or weak liquidity,  indicating that the sources of funding available to them within the next 12 months closely match or are under their expected uses of funds. As such, these issuers are highly dependent on operating performance or additional liquidity from external sources, such as access to capital markets, asset disposals, or equity injections by their owners. Average weighted debt-to-EBITDA leverage for the 'CCC' rating category is 10.4x with 1.9x interest coverage, indicating unsustainable capital structures, barring unforeseeable favorable developments on the operating side. Approximately 86% of 'CCC' category issuers have weak or vulnerable business risk profiles, with small scale and limited product or service diversification.

The media and entertainment sector leads in the number of issuers rated 'CCC+' and below in Europe,  with 10--40% of which are either assigned negative outlooks or negative CreditWatch implications. Most of the issuers with this negative bias are U.K.-based, including Vue International Bidco PLC, Cineworld Group PLC, and Comet Bidco Ltd. (see chart 5). Other U.K.-based entities rated 'CCC+' and below include auto manufacturers McLaren Group Ltd. and Aston Martin Lagonda Global Holdings, retailers Holland & Barrett and Matalan, and hotel operator Thame and London Ltd. (Travelodge).

Chart 3

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Chart 4

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Current Gross Leverage Comparison By Type of Owner (Median)

Business risk profile Rating Number Debt to EBITDA (x) Interest coverage (x) % of total
Fair CCC+ 5 8.8 1.4 8
CCC 1 5.2 3.1 2
CCC- 1 7.4 1.6 2
Weak CCC+ 31 8.8 1.7 52
CCC 9 13.5 0.9 15
CCC- 3 9.2 2.0 5
Vulnerable CCC+ 8 10.0 1.1 13
CCC 2 11.4 2.5 3
60 10.5 1.4
Data as of Aug. 1, 2022. Source: S&P Global Ratings Research.

Chart 5

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Defaults picked up in the second quarter, and we expect the default rate to reach 3% by 2023.  There were three defaults in Europe in the second quarter of 2022, bringing the European speculative-grade default rate to 1.1% as of June 30, 2022, from 0.7% as of March 31. Because the European 'CCC+' and below default rate is on average seven times higher than the speculative-grade ('BB+' or lower) default rate, with the number of 'CCC+' and below rated issuers remaining high, we can expect the default rate to rise (see chart 6). In the baseline scenario, the European trailing-12-month speculative-grade corporate default rate rises to 3% by June 2023 from 1.1% as of June 2022 (see "The European Speculative-Grade Corporate Default Rate Could Rise To 3% By June 2023," Aug. 22, 2022).

Two defaults in the second quarter, from Petropavlovsk PLC and EuroChem Group AG, were captured as defaults from the U.K. and Switzerland, respectively, due to the locations of incorporation and corporate headquarters. The ratings on these issuers were subsequently withdrawn as of April 15 because these were considered to be entities with substantial presences in Russia. Note that we do not include Russia in our definition of Europe. If we were to remove these issuers from the count of defaults, the 12-month-trailing default rate ended June 2022 would have been 0.79%, down from the 1.05% reported throughout our forecast. Adjustments of similar magnitude would appear for default rates ended in April and May 2022, as well as for future rates.

Chart 6

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Related Research

This report does not constitute a rating action.

Credit Markets Research:Nicole Serino, New York + 1 (212) 438 1396;
nicole.serino@spglobal.com
Patrick Drury Byrne, Dublin (00353) 1 568 0605;
patrick.drurybyrne@spglobal.com
European Leveraged Finance:Marta Stojanova, London + 44 20 7176 0476;
marta.stojanova@spglobal.com
Research Contributor:Tanya Dias, CRISIL Global Analytical Center, an S&P affiliate, Mumbai

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