(Editor's Note: Our "Risky Credits" series focuses on European corporate issuers rated 'CCC+' and lower. Because many defaults are of companies in those categories, ratings with negative outlooks or on CreditWatch negative are even more important to monitor.)
Key Takeaways
- Downgrades of European risky credits increased by 13% to 54 in the fourth quarter of 2022, more than 1.5x higher than the pre-pandemic level.
- Three sectors--consumer products, media and entertainment, and capital goods--account for a material 47% of all risky credits by number, while the U.K. has the highest volume of risky debt, around 46% as of Dec. 31, 2022.
- Of the risky credits, 57% had negative outlooks at the end of 2022, meaning we can expect more defaults in 2023. This is due to persistent inflation, slower growth, tighter financing conditions, and continuing geopolitical tensions.
- In our base-case scenario, we expect the European speculative-grade default rate to rise toward the long-term average of 3.25% by September 2023.
The rise in downgrades in the fourth quarter of 2022 was the highest since the start of the pandemic in 2020. Operational challenges and inflationary headwinds remained the key factors in downgrades to the 'CCC' rating category in the fourth quarter of 2022. However, refinancing concerns and market liquidity risks rose materially, reflecting tightening financing conditions and investor risk aversion. Fifteen additions (mostly downgrades) and six removals from the category since Sept. 30, 2022, led to an increase in issuers rated 'CCC+' and lower as of year-end 2022 (see charts 1 and 2). Four sectors were responsible for 60% of the downgrades: media and entertainment (three issuers), consumer products (two), capital goods (two), and health care (two). In contrast, we upgraded three issuers from the 'CCC' rating category on improved operational performance and deleveraging, one in the retail sector and two in media and entertainment.
Chart 1
Chart 2
The pressure on lower-rated issuers is likely to prevail in 2023. At year-end 2022, around 57% of the issuers rated 'CCC+' and lower had a negative outlook or CreditWatch status, signifying mounting downward pressure and potential default risk in the rating category. In our base-case scenario, we expect the European speculative-grade default rate to rise toward 3.25% by September 2023, up from 1.6% in November 2022, as weakening consumer sentiment and higher energy prices, inflation, and global economic tensions cloud the region's growth outlook (see "The European Speculative-Grade Corporate Default Rate Could Rise To 3.25% By September 2023 As Downside Risks Rise," published Nov. 17, 2022).
The rise in downgrades of more than one notch might be an additional sign of a sharp deterioration. Downgrades to both the 'B-' and 'CCC+' and lower rating categories reached 75 in 2022 compared to only 28 in 2021, with 33 occurring in the fourth quarter. This was the highest quarterly downgrade tally since the second quarter of 2020, when there were 78 downgrades. While most downgrades in the fourth quarter were of one notch, the number of downgrades of two or more notches also picked up, to eight issuers (see chart 3). These multi-notch downgrades were for several reasons, such as refinancing risk, slowing economic growth, and operational headwinds, including deteriorating profit margins (see chart 4).
Chart 3
Chart 4
Consumer products and media and entertainment led the European risky credits in 2022. By sector, consumer products and media and entertainment had the most issuers rated 'CCC+' and lower in the fourth quarter of 2022, with ten and nine issuers, respectively (see chart 5). Broadening input cost pressures, rising funding costs, and potential contractions in demand will weigh increasingly on earnings, particularly in more competitive sectors that lack pricing power. Retail, media and entertainment, capital goods, and consumer products have the most exposure in this regard. In addition, consumer products has the highest number of issuers with a negative outlook or CreditWatch status, at six, followed by capital goods and media and entertainment, with five and four, respectively (see chart 6).
Chart 5
Chart 6
The oil and gas sector still has the highest debt exposure, with €9.4 billion. Of this debt, 89% has a negative outlook or is on CreditWatch negative (see chart 7). This year's elevated oil prices have not benefited all issuers in the sector, particularly the service providers to oil and gas companies. Some companies have thin liquidity, remain highly leveraged, or have a poor track record of cash generation. We expect supply in the European gas and power markets to remain tight for several years. This situation will prevail until additional energy capacity in the form of either renewables or liquid natural gas comes on stream, providing the necessary supply to stabilize prices at much lower levels than in the third quarter of 2022. Until then, energy prices could rise even higher in certain circumstances, such as a colder-than-average winter and further constraints on Russian gas supply due to the G7's oil price cap (see "Global Credit Conditions Downside Scenario: Inflation, Geopolitics Are Twin Threats To Our Base Case," published Dec. 8, 2022).
Chart 7
Debt exposure remains elevated for U.K. corporates. U.K. corporates continue to hold the largest portion of European debt rated 'CCC+' and lower, with 46% or €21.2 billion. Of this debt, 74% has a negative outlook or CreditWatch status (see chart 8). U.K. corporates continue to confront risks arising from declining consumer confidence and household spending, higher inflation, and less favorable financing conditions (see "Economic Outlook U.K. Q1 2023: A Moderate Yet Painful Recession," published Nov. 29, 2022).
Chart 8
Low liquidity is gradually becoming a more pronounced risk for issuers rated 'CCC+' and lower due to the subdued primary markets. If primary activity stays subdued or deteriorates even further, this could staunch new issuance and make it more challenging to refinance existing debt. The three sector groups with the highest amount of debt rated 'CCC' or lower and maturing through 2024 are retail and restaurants; chemicals, packaging, and environmental services; and telecommunications, followed by media and entertainment and consumer products.
The median debt-to-EBITDA and interest coverage ratios of the issuers present in European CLOs remains broadly comparable to the previous quarter, at 11.3x and 1.7x, respectively (see chart 9). Twenty-six of these issuers had maturities due in 2023 or 2024. At the time of publication, two have successfully addressed these. Two others have announced engagement with lenders in order to restructure their debt (see "CLO Pulse Q3 2022: Sector Averages Of Reinvesting European CLO Assets," published Jan. 26, 2023).
Chart 9
Chart 10
Table 1
| Median Gross Leverage By Rating On Issuer | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Business risk profile | Rating | Number | Debt to EBITDA | Interest coverage | % of total number | |||||||
| Fair | CCC+ | 5 | 12.6x | 2.1x | 10% | |||||||
| CCC | 1 | 8.7x | 1.7x | 2% | ||||||||
| CCC- | 0 | N/A | N/A | 0% | ||||||||
| Weak | CCC+ | 32 | 12.2x | 1.8x | 62% | |||||||
| CCC | 5 | 8.6x | 0.5x | 10% | ||||||||
| CCC- | 3 | 7.3x | 2.3x | 6% | ||||||||
| Vulnerable | CCC+ | 6 | 10.6x | 1.7x | 12% | |||||||
| Total | N/A | 52 | 11.3x | 1.7x | N/A | |||||||
| Data as of Jan. 15, 2023. N/A--Not applicable. Source: S&P Global Ratings Research. | ||||||||||||
Related Research
- This Month In Credit: Risk Remains For Weaker Borrowers Despite Cooling Inflation, Jan 27, 2023
- Global Credit Markets Update Q1 2023: Standing On Thin Liquidity, Jan. 25, 2023
- Gaps Open As Global Corporate Defaults Increase By 15% In 2022, Jan. 18, 2023
- Global Credit Conditions Downside Scenario: Inflation, Geopolitics Are Twin Threats To Our Base Case, Dec. 8, 2022
- Credit Conditions Europe Q1 2023: Time To Face The Music, Dec. 1, 2022
- Economic Outlook U.K. Q1 2023: A Moderate Yet Painful Recession, Nov. 29, 2022
- The European Speculative-Grade Corporate Default Rate Could Rise To 3.25% By September 2023 As Downside Risks Rise, Nov. 17, 2022
- Credit Trends: Regional Refinancing: Rising Interest Rates And Strengthening Dollar Present Headwinds, Sept. 8, 2022
- Risky Credits: The Respite In Europe May Be Short-Lived, Nov. 3, 2022
- CLO Pulse Q3 2022: Sector Averages Of Reinvesting European CLO Assets, Jan. 26, 2023
Related Rating Actions
- Software Provider Bock Capital Bidco B.V. (Unit4) Downgraded To 'CCC+' On Unsustainable Capital Structure; Otlk Stable, Dec. 28, 2022
- Adler Pelzer Holding GmbH Rating Lowered To 'CCC+' On Free Cash Flow And Refinancing Risks; Outlook Negative, Dec. 23, 2022
- Elevator Component Maker Wittur International Downgraded To 'CCC+' On High Leverage; Outlook Negative, Dec. 21, 2022
- Norican Global A/S Downgraded To 'CCC+' On Its May 2023 Maturity Wall; Ratings Placed On CreditWatch Negative, Dec. 16, 2022
- Castle Intermediate Holding V Ltd. Downgraded To 'CCC+' On Weak Operating Performance; Outlook Negative, Dec. 9, 2022
- Financiere Labeyrie Fine Foods Downgraded To 'CCC+' From 'B-' On Very Weak Credit Metrics; Outlook Stable, Dec. 9, 2022
- Spanish Travel Retailer PAX Midco Spain (Areas) Upgraded To 'B-' From 'CCC+' On Operations Recovery; Outlook Stable, Dec. 9, 2022
- German Real Estate Landlord ESPG AG Downgraded To 'CCC' On Large Upcoming Short-Term Debt Maturities; Outlook Negative, Dec. 6, 2022
- Corestate Capital Holding S.A. Downgraded To 'D' Following Missed Payment And Agreed Bond Restructuring, Nov. 29, 2022
- Technicolor Creative Studios Downgraded To 'CCC+' On Lowered Guidance, Liquidity Risks; Outlook Negative, Nov. 23, 2022
- L1R HB Finance, Holland & Barrett's Parent, Downgraded To 'SD' And Debt To 'D'; Ratings Withdrawn At Issuer's Request, Nov. 16, 2022
- Spain-Based KronosNet Assigned 'B+' Ratings; Outlook Stable, Nov. 9, 2022
- Covis Pharma Lowered To 'CCC+' From 'B' On Rising Interest Rates And Operational Disruptions; Outlook Stable, Nov. 1, 2022
- Richmond UK Holdco Ltd. (PdR) Downgraded To 'CCC+' On Refinancing Risk; Outlook Negative, Oct. 21, 2022
- Venator Materials Downgraded To 'CCC+' On Production Curtailments And Weakening Operating Performance; Outlook Negative, Oct. 21, 2022
- Casper Topco (B&B Hotels) Upgraded To 'B-' On Stronger-Than-Expected Summer Trading; Outlook Stable, Oct. 20, 2022
- Joye Media SLU Upgraded To 'B-' From 'CCC-' On Completed Refinancing And Debt Reduction; Outlook Stable, Oct. 18, 2022
- Schur Flexibles GmbH Upgraded To 'CCC+' From 'SD' ; Outlook Stable, Oct. 12, 2022
- Casino Guichard - Perrachon S.A. To 'CCC+' On Tougher Operating Conditions And Market Headwinds; Outlook Developing, Oct. 7, 2022
- German Health Care Provider GHD Downgraded To 'CCC+' From 'B-' On Unsustainable Capital Structure; Outlook Stable, Oct. 6, 2022
- Label Manufacturer Biscuit Holding Downgraded To 'CCC+' On Persistently Very Weak Credit Metrics; Outlook Negative, Oct. 4, 2022
This report does not constitute a rating action.
| Credit Markets Research: | Ekaterina Tolstova, Dubai +971 (0) 547923598; ekaterina.tolstova@spglobal.com |
| Nicole Serino, New York + 1 (212) 438 1396; nicole.serino@spglobal.com | |
| Patrick Drury Byrne, Dublin (00353) 1 568 0605; patrick.drurybyrne@spglobal.com | |
| Leveraged Finance Europe: | 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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