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Press Release Source: Standard & Poor's
S&P Comments on Credit Trends in Europe for 2002/2003
Monday December 16, 7:17 am ET
LONDON--(BUSINESS WIRE)--Standard & Poor's--Dec. 16, 2002--The creditworthiness of European companies and institutional borrowers will remain weak in 2003, despite signs that the most severe phase of the credit cycle may be over, Standard & Poor's Ratings Services said today.
Releasing its annual review of credit trends in Europe, the Middle East, and Africa, Standard & Poor's confirmed that 2002 had been a grim year for bond markets in the region, with issuance volumes down, defaults at record levels, and rating downgrades sharply up. Although the number of defaults and downgrades are expected to decline next year, this would represent a slowdown in the deterioration of corporate credit quality, not a recovery.
According to the research study:
There were 27 defaults among rated corporates and financial institutions in the 11 months to Nov. 30, 2002, sharply up from 14 in the whole of 2001 -- the highest level of defaults in Europe since Standard & Poor's began rating European debt in the late 1970s. Problems related to companies that issued speculative-grade debt in the mid-to-late 1990s are now easing, however. Most defaults by speculative-grade issuers occur in the first three-to-four years after the bond issue, and speculative-grade issuance has declined substantially since 2000.
A broad recovery in corporate creditworthiness remains some way off, despite improvements in certain sectors such as investment-grade telecommunications. This is highlighted by the ratio of rating downgrades to upgrades, which for all European issuers (excluding structured finance) was 3.1 to 1 for the 11 months to Nov. 30, 2002, compared to 2.9 to 1 in 2001. For western European corporates, the ratio is 3.8 to 1. For a stable credit environment, the ratio would normally have to be about 1.0 to 1.
The high proportion of issuers assigned a negative outlook does not bode well for 2003. At Nov. 30, 2002, there were 95 corporate issuers assigned a negative outlook -- representing 17% of all rated companies in the region -- while only 39 were assigned a positive outlook. Similarly, 114 rated insurance entities (40% of all interactive ratings in the sector) were assigned a negative outlook, compared with just 7 assigned a positive outlook. In the banking sector, 78 rated entities (17% of the sector total) were assigned a negative outlook, compared with 23 assigned a positive outlook. This suggests further significant downgrades in these sectors in the coming months.
"European companies are clearly working hard to reduce debt and improve cash flow, but their house-cleaning may yet bring some unpleasant surprises," said Barbara Ridpath, Standard & Poor's Chief Credit Officer for Europe. "Although we may be past the most vicious stage of this cycle, we do not expect the gloom to lift much in 2003. Companies in many sectors, including banks, insurers, and utilities, are facing a very tough market -- and any external shock such as war with Iraq will only make it worse."
Ms. Ridpath noted that although problems related to original speculative-grade issuers had now largely been resolved through defaults or restructurings, there was a new generation of "fallen angels" (that is, major issuers that have dropped from investment-grade to speculative-grade after a sharp decline in their credit quality). At Nov. 30, 2002, there were 17 such companies in Europe, compared with three at the end of 2001 -- Marconi PLC (CC/Negative/C), Railtrack PLC, and British Airways PLC (BBB-/Negative/--).
Although the number of defaults is expected to decline in 2003, the aggregate value of defaults is likely to remain high. The average size of default has ballooned because of the much larger volumes of debt in the public domain. The aggregate value of defaulted debt in Europe in the first 11 months of 2002 was $14.8 billion, compared with $4.1 billion in the whole of 2001.
Standard & Poor's believes the creditworthiness of European banks will remain negative in 2003. Although downgrades on bank ratings exceeded upgrades by 2.1 to 1 in 2002, against 1.6 to 1 for full-year 2001, this was a relatively favorable outcome given the poor credit environment for corporate lending. This suggests that banks had successfully offloaded much of their risk via underwritings, collateralized loan obligations, and credit default swaps. Nevertheless, many banks remain beset by deteriorating credit quality, weak investment banking fee income, and excessive cost bases.
"For 2003, we expect pressure on bank ratings will continue," said Ms. Ridpath. "We will see an increasing differentiation of bank credit quality in Europe, largely based on the ability of banks to deliver on cost cutting and restore earnings and capital. In particular, Germany still looks vulnerable, as do those banks with significant insurance operations. In addition, the key unknown in the U.K. is the duration of the boom in house prices."
The insurance industry in Europe also remains fragile. There were a record 150 downgrades on insurance entities (representing 82 groups) this year -- double the level of 2001 -- with most actions concentrated in the U.K., Germany, France, and Italy. To maintain existing ratings, insurers will need to exercise sustained discipline in underwriting, as their flexibility is limited by the absence of significant contributions from investment income, together with impaired capital.
In the corporates sector, the picture remains bleak, with only a few bright spots. The average long-term corporate credit rating in Europe this year fell from 'BBB+' to 'BBB', while 6% of Standard & Poor's corporate ratings are placed on CreditWatch with negative implications and 17% are assigned a negative outlook.
Capital intensive and cyclical industries such as capital goods, chemicals, building materials, and airlines will continue to be under pressure. In particular, the ratings on companies that rely on improving cash flows to restore their balance sheets may be affected if the economy is slow to pick up next year. Furthermore, Standard & Poor's expects further credit deterioration in the power sector -- especially in the U.K., where utilities and power projects exposed to unregulated generation will continue to feel the pressure of low prices coupled with high leverage.
In contrast, the European investment-grade telecoms sector is expected to recover its poise after the turmoil of the last few years. The telecoms operators' focus on restoring balance sheets and maximizing margins and cash flows on existing assets, rather than chasing growth, has helped to stabilize credit quality for these issuers.
Three additional uncertainties remain, however. First, companies may fail to disclose credit triggers until they are activated, creating potential serious -- and sudden -- credit problems (as in the recent case of Cable & Wireless PLC). Second, there is the growing hole in certain European corporates' pension plans, which Standard & Poor's will continue to monitor closely in 2003. Third, liquidity and the ability of firms to refinance financial debt, including convertible debt that was issued in the past few years that will not be easily converted to equity given current equity prices.
The research, entitled "Review of Credit Trends in Europe, Middle East, and Africa in 2002," is available on RatingsDirect, Standard & Poor's Web-based credit analysis system. For a copy of the full study, contact the Standard & Poor's Press Office in London at (44) 20-7826-3605/3504.
ANALYTICAL E-MAIL ADDRESSES
barbara_ridpath@standardandpoors.com
agnes_depetigny@standardandpoors.com
Copyright 2002, Standard & Poor's Ratings Services
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