Covid Turmoil Expected to Lead to Increase in European Debt Defaults

It is expected that credit defaults in Europe will increase significantly in 2021, reaching levels that are comparable to the most difficult times of the COVID-19 crisis.

S&P Global Inc. has predicted that the trailing 12-month speculative-grade corporate default rate will increase to 3.25% by September 2023, a rise from the 1.4% rate seen in the previous year.

European companies are facing a multitude of difficulties, such as an energy crisis, high material costs, and customers who are unable to pay. This has led to an expected rise in defaults. Additionally, after central banks around the world raised rates to combat inflation in the past year, refinancing existing debt has become more costly.

Fitch analysts Eric Rosenthal and Joao Gaspar Tovolli noted in a December report that a lack of refinancing options for a growing number of issuers with high debt and principal payments due between 2023 and 2025 has contributed to a rise in the European default rates for 2023 and 2024.

Analysts anticipate that the default rate for European high-yield bonds will increase to 2.5% in 2023, a significant jump from the 0.7% rate seen in the previous year. Additionally, they forecast that the default rate for leveraged loans will climb to 4.5% in the same period, up from the 1.3% rate of the year before.

Moody's Investors Service has predicted that corporate defaults from borrowers who have issued high-risk bonds and leveraged loans will increase to 4.2% in November of this year, compared to 3.1% in November of 2022.

The ratings agencies' predictions are not yet as high as the 6% peak experienced in late 2020-early 2021, when the effects of coronavirus restrictions caused disruption to businesses. However, it is likely that these figures will remain elevated for a while longer, as central banks are not expected to move back to expansive monetary policies in the near future.

The predictions are based on the amount of debt that will come due in the next few years. Bloomberg data shows that in Europe, the Middle East, and Africa, there is approximately €103 billion ($109 billion) of sub-investment grade debt maturing this year, increasing to €154.9 billion in 2021 and €238.9 billion in 2025.The inability to refinance debt that is due will have an effect on default rates.

As the due dates approach, it is likely that more borrowers will attempt to extend the maturity of their loans and agree to pay a higher interest rate at a later date, which would then be considered a default by ratings agencies.

Fitch's analysts have predicted that borrowers who are under financial strain will likely enter into amend-and-extend transactions with their current lenders, which would meet the criteria for a distressed debt exchange. According to Fitch's data, this type of debt was responsible for 56% of defaults in the EMEA region last year.

As more businesses struggle to fulfill their commitments or go through restructuring, banks will also be affected by writedowns. According to S&P Global, credit losses for banks in Western Europe are projected to increase by 20% to $87 billion in 2023, and stay at that level in 2024.

Despite the potential for higher losses, lenders may not be greatly affected. According to a December report from S&P analysts Osman Sattar and Gavin Gunning, the losses should be manageable due to the rise in interest rates, which will benefit net interest margins.

A December study conducted by law firm Weil, Gotshal & Manges revealed that corporate distress is increasing more rapidly in the UK than in other European countries, with Germany coming in second. Fitch's report also indicated that France and Germany are the two countries in Europe with the highest projected default rate for their high-yield and leveraged loan markets in 2023.If you would like to participate in Bloomberg Intelligence's survey of European high yield investors for the first quarter, please click the link provided.

In other areas of the credit market:

On Wednesday, UBS Group AG and Deutsche Bank AG are two of the 24 issuers that are offering bond sales, making it the most active day of bond sales in Europe in the past year, according to individuals with knowledge of the situation. The borrowers are expected to raise at least €20.3 billion ($22 billion), the people added.

On Wednesday, Hong Kong launched green bonds in multiple currencies, joining the global trend of issuers taking advantage of the recent improvement in the debt market.

It looks like it's going to be a hectic week for debt issuance in the United States, with an estimated $40 billion in debt being offered. On Tuesday, 19 issuers, including Commonwealth Edison Co. and Connecticut Light and Power Co., released new deals, making it the most active day since the start of September.