With Europe’s economic outlook brightening and investor demand for corporate credit through the bond market soaring, Standard & Poor’s Rating Services expects the corporate default rate to fall to 5.2 percent by March 2015.
The default rate for speculative grade credits – rated BB+ or lower – fell from 7.2 percent in 2012 to 5.9 percent in 2013, according to S&P’s latest default study. The number of European defaults also fell from 51 in 2012 to 42 in 2013, according to the study.
“While we anticipate that the overall default rate will remain above the historical average of 4.7% over the next two years, the changing composition of the leverage finance market toward higher quality and more recently rated issuers should, in our view, enable the default rate to fall back toward more normal levels (all else being equal),” according to the study.
The improved forecast takes into account gradual economic improvements throughout the Eurozone, particularly in Germany in the UK. Although the cost of corporate financing has continued to plague companies seeking fresh capital, it has been partially mitigated by improvements to the banking sector’s liquidity position and the emergence of non-bank lenders.
Furthermore, banks’ underwriting capacity has improved alongside economic outlooks and the return of the primary CLO market.
As default rates fell last year, so did the the combined default rate in terms of value of outstanding balances. European corporates defaulted on 2.7 percent of total outstanding balances last year, compared to more than 4 percent in 2012.
The recovery is fall from over, however, and S&P indicated that it would raise its default expectations should it see signs of high yield markets overheating.
“In a more pessimistic downside scenario–which might correspond with growing issuance from more aggressively financed issuers or smaller businesses with weaker business risk profiles, or with a weaker, more disinflationary economic environment–we could envisage the default rate remaining elevated, at about 6.7 percent,” according to the study.