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European corporate credit quality falters as shallow recession holds, says report


Europe’s persisting economic gloom is leading to a deterioration in credit quality among corporate issuers in the region, says a report by Standard & Poor’s Ratings Services.

Titled "European Corporate Credit Quality Starts To Slip As Economic Growth Eludes The Region," the report finds that downgrades have outpaced upgrades by a factor of 2:1 since the start of April 2012 – the highest rate since the first quarter of 2010. What’s more, the ratio of downgrades to upgrades continues to be materially higher for investment-grade companies than for speculative-grade companies.

The economic outlook remains uneven across Europe, but is deteriorating in most economies that are dominated by deleveraging occurring almost simultaneously in the public, private, and financial sectors. The outlook is compounded in our view by softening demand in emerging markets, which appears more protracted than we initially anticipated, and the uncertain trajectory and timing of policy-making in the eurozone (European Economic and Monetary Union), which is undermining business and consumer confidence.

If the softness in emerging markets persists, negative rating actions could spread to large multinational European corporate entities that have until now benefited from greater penetration in these stronger-growth markets. The report points to early signs of weakness in the metals and mining and technology sectors, for instance.

Under base-case economic growth forecasts for 2012 and 2013, S&P now expects the shallow recession in the eurozone to continue through much of 2013 before a recovery takes hold.

As a result, over the next 12 months S&P expects:

•         Some slowdown in demand from elevated levels in 2011, with new public sector contracts experiencing the greatest contraction.

•         Pressure on margins in competitive manufacturing sectors when capacity utilization starts to fall.

•         The persistence of cautious financial policies. This is restraining growth capital expenditure outside the mining and oil and gas sectors, which have already committed to multiyear investment programs.

•         A slide in free operating cash flow in many sectors. This is mitigated in sectors such as chemicals and oil refining where demand and price pressures ease when working capital is released.

•         Ongoing restricted access to loan financing on reasonable terms, according to mid-market companies that rely heavily on banks.

On the positive side, it expects:

•         Continued commitment of the monetary authorities in Europe to underpin the euro in the face of ongoing fiscal austerity.

•         An improvement in financial market conditions even for high-yield issuers whose domiciles are in the periphery of the eurozone.

On a sector level, S&P has downgraded a meaningful number of companies in the utilities, transportation and telecommunications, and leisure sectors since April 2012. In addition, the number of negative outlook placements on metals and mining and leisure and technology companies has increased significantly in recent months amid volatile industry conditions.

The picture is more positive in the chemicals, media and entertainment, and consumer products sectors, where upgrades have exceeded downgrades since April. Upgrades and downgrades have been more balanced in the auto, healthcare and retail sectors; and companies in the chemicals, auto and healthcare sectors continue to have a well-below-average proportion of negative outlooks.

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