Baseline: S&P Global Ratings Credit Research & Insights expects the European trailing-12-month speculative-grade corporate default rate will fall to 4.25% by September 2025.  This would be down slightly from the 4.7% for the 12 months through September 2024, but remain elevated historically (see chart 1).

Stubbornly high market rates are making it more difficult for weaker issuers to service their debt. While we expect the European Central Bank (ECB) to continue cutting interest rates into next year, this will only result in higher terminal rates than before the COVID-19 pandemic. As an offset, we expect economic growth to accelerate somewhat in 2024 for the eurozone (0.8%) and more importantly the U.K. (1.0%), home to the largest share of our speculative-grade issuers. However, downside risks prevail, keeping our current projection above the historical average of 3.1% with a very slow downward trajectory.

Chart 1

Optimistic scenario: We forecast that the default rate could fall to 2.25% by next September.  Economic growth in Europe would need to expand beyond what our economists expect in their base case; and importantly, interest rates would need to fall more than forecast to ease pressure on the lowest-rated issuers.

Current debt market pricing appears supportive, and there has been a record amount of issuance used for refinancing by 'BB' and 'B' rated issuers in the year to date. A stronger resumption of 'CCC/C' rated debt issuance would offer needed support as these companies' maturities get closer. This would offer an alternative to debt restructurings and maturity extensions.

Pessimistic scenario: We forecast that the default rate could rise to 6%.  Growth in Europe could prove precarious amid the conflict in Ukraine, combined with the prospect of higher tariffs from the U.S. toward year-end 2025. For now, our economists' assumptions for growth next year are largely contingent on increased consumer spending as inflation cools and interest rates decline. These stressors (war and tariffs) could pose serious headwinds to sentiment and spending patterns. Market access for issuers rated 'CCC+' or lower remains effectively closed, forcing many to extend maturities or restructure debt--sometimes aggressively. If the reputational risk and associated business implications for issuers using these tactics subsides, we could see even more distressed exchanges.

Defaults Have Exceeded Fundamentals

We have arguably seen a higher-than-expected default rate in Europe during 2024, which we expect to continue in the near term. Given current macroeconomic fundamentals, some activity would be expected, but the current 4.7% default rate includes an additional layer of debt restructurings initiated to avoid more traditional default events involving otherwise lower recovery levels (see chart 2). These restructurings are likely to continue amid elevated interest rates, which even with near-term cuts will still be higher than the period after the financial crisis and before 2022's hike cycle.

Chart 2

Given the high percentage of distressed exchanges and increasing number of repeat defaulters, the higher-than-typical overall default rate is being driven by the 'CCC/C' category (see chart 3). All other rating levels have default rates similar to long-term trends, with the exception of 'BB' after one default in the prior 12 months (Atos SE). This concentrated default rate among the weakest issuers demonstrates that today's overall elevated levels do not reflect widespread credit stress in Europe.

Chart 3

A Strong 2024 For Issuance Outside 'CCC/C'

We've seen strong momentum in combined high-yield bond and leveraged loan issuance through October (see chart 4). Through the first 10 months of the year, this totaled €239 billion--the second-highest level since 2021's record €289 billion. Refinancing drove much of the total, helping to reduce companies' near-term liquidity risk.

That said, the surge mostly excluded the 'CCC/C' category, which has only seen €1.98 billion of new bond issuance since February 2022. Of this meager total, most was from U.K.-based brokerages, leaving nonfinancial corporates with few options to deal with upcoming maturities other than debt restructurings or extensions. Even private lenders appear quite wary of supporting issuers with vulnerable financial risk profiles.

Chart 4

Speculative-grade issuance (both bonds and loans) has been very strong so far in 2024, with volumes more than doubling over the past two years through end-October. Refinancing activity has been an important driver of rated issuance, significantly reducing near-term refinancing risk. As a result, near-term maturities seem rather manageable outside the 'CCC/C' category. However, for the latter, outstanding debt due in 2025 and 2026 has actually increased since the start of the year--to €33.7 billion as of Oct. 1, from €30.4 billion. Some of this increase is due to downgrades through the year, but the total also remains high because of the relative lack of new issuance for the 'CCC/C' category in 2024.

Chart 5

Despite mitigating factors, issuers face higher costs of refinancing now--on average--than when they first issued debt maturing over the near term. Sectors with high amounts of speculative-grade and floating-rate debt also constitute pockets of risk. Consumer products, health care, and media and entertainment are among the five sectors with the highest debt amounts reaching maturity through 2028. They also all have a share of floating-rate debt above 70%, emphasizing their vulnerability should interest rates remain higher for longer.

Chart 6

Market Conditions Improve, Despite Rising Defaults

Credit conditions for bank loans have also improved, notably on the back of recent interest rate cuts. For the first time since third-quarter 2021, the ECB's bank lending survey does not indicate tightening of credit standards for firms. Over third-quarter 2024, the evolution of credit standards was neutral, with as many banks tightening as easing (see chart 7). In another multi-year first, firms' net demand for loans rose as well, largely driven by falling interest rates.

Chart 7

The relative risk pricing of both bonds and loans (via spreads) reflects markets' declining credit risk perceptions (see chart 8). The relative risk of holding corporate debt can be a strong indicator of future defaults because companies face pressure if they're unable to refinance maturities or service existing debt. In broad terms, speculative-grade spreads have been a good gauge of future defaults based on a roughly one-year lead time. Given current spreads, our baseline default rate forecast of 4.25% is above what the historical trend suggests.

However, in contrast to spreads, current yields remain comparably elevated, particularly on loans. This increases the all-in costs of debt for issuers, regardless of relative risk perceptions. In our view, since the start of the current rate-hiking cycle in 2022, the default trend has been more similar to that of yields than spreads.

Chart 8

Considering broad measures of financial market sentiment, economic activity, and liquidity, the average speculative-grade bond spread in Europe for September was about 245 basis points (bps) below our estimate of 597 bps (see chart 9). The gap between the actual spread and the estimated spread implies that bond markets may be overly optimistic in their current stance. It also supports the argument that yields, rather than spreads, are the better indicator of financial stress in current conditions.

Chart 9

Current rating trends are still far from the credit momentum declines that preceded the 2009 and 2020 default cycles--indications that there are no major spikes ahead. In the 12 months ended September 2024, speculative-grade credit quality continued to marginally improve. Net rating actions stayed positive, with a negative net bias that implies more downgrades ahead, but this measure is still at its lowest level for the past six quarters (see chart 10).

Chart 10

The rate of downgrades and the net negative bias have mostly led movement in the default rate by several quarters. Although credit quality has generally improved since 2021, it hasn't been enough to make up for the declines during 2020. This means that speculative-grade issuers are still much more vulnerable than historically (see chart 11). As mentioned, the 'CCC/C' category has also seen a higher default tally than is typical. Because many of these defaults are distressed exchanges, issuers are often rated in the same category within a short time, keeping the proportion of 'CCC/C' issuers high.

Chart 11

How We Determine Our European Default Rate Forecast

Our European default rate forecast is based on current observations and expectations of the likely path of the European economy and financial markets.   This report covers financial and nonfinancial speculative-grade corporate issuers. The scope and approach are consistent with those of our default and rating transition studies. In this report, our default rate projection incorporates inputs from S&P Global Ratings economists that also inform the analysis of our regional Credit Conditions Committees.

We determine our default rate forecast for speculative-grade European financial and nonfinancial companies based on a variety of quantitative and qualitative factors. The main components of the analysis are credit-related variables (for example, negative ratings bias and ratings distribution), the ECB bank lending survey, market-related variables (corporate credit spreads and the slope of the yield curve), economic variables (the unemployment rate), and financial variables (corporate profits). For example, increases in the negative ratings bias and the unemployment rate positively correlate with the speculative-grade default rate. As the proportion of issuers with negative outlooks or ratings on CreditWatch with negative implications increases, or the unemployment rate rises, the default rate usually increases.

This report covers issuers incorporated in the 31 countries of the European Economic Area, Switzerland, and certain other territories, such as the Channel Islands. The full list of included countries is: Austria, Belgium, the British Virgin Islands, Bulgaria, Croatia, Cyprus, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Gibraltar, Greece, Guernsey, Hungary, Iceland, Ireland, the Isle of Man, Italy, Jersey, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Monaco, Montenegro, the Netherlands, Norway, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, Switzerland, and the U.K.

Related Research

• Risky Credits: Defaults Have Driven A Decline In European Risky Credits, Oct. 30, 2024
• CreditWeek: What Are The Credit Risks Of The Escalating And Expanding Middle East Conflict?, Oct. 10, 2024
• Credit Conditions Europe Q4 2024: Turn In Credit Cycle Won't Be Plain Sailing, Sept. 25, 2024
• Economic Research: Economic Outlook Eurozone Q4 2024: Consumer Spending To The Rescue, Sept. 24, 2024
• U.K. Economic Outlook Q4 2024: Disinflation And Rate Cuts Will Stimulate Growth, Sept. 23, 2024