Our Base Case Incorporates Generally Stable Credit Quality

Baseline: S&P Global Ratings Credit Research & Insights expects the European trailing-12-month speculative-grade corporate default rate will fall to 3.75% by December 2025.   This would be a decline from the 4.5% default rate for the 12 months ended December 2024, but it would still be higher than the long-term average of 3.1% (see chart 1).

We expect policy rates to decline this year through the first half, bringing EU policy rates at least closer to their neutral levels. Despite increased tariff threats from the U.S., for now the potential impact to Europe is expected to be more modest, with economic growth still expected to come in higher than 2023 or 2024 levels.

The default rate is higher than its long-term average, mainly because of an increase in distressed exchanges and other forms of debt restructuring in the last two years. We expect them to remain the leading cause of defaults, but to a lesser extent amid continued refinancing, stronger aggregate growth, and declining interest rates. That said, we believe the decline in the default rate will be a gradual process, and downside risks--which could produce a higher default rate--remain.

Chart 1

Optimistic scenario: We forecast that the default rate could fall to 2.5% by December.  To achieve this scenario, economic growth in Europe would need to expand beyond what our economists expect in their base case, and interest rates would need to fall more than expected to ease financing pressures on the lowest-rated issuers. With the additional potential threat of increased tariffs, this scenario is becoming less likely.

Current debt market pricing appears supportive, and the amount of issuance used year to date for refinancing by 'BB' and 'B' rated issuers has reached record highs. A stronger resumption of 'CCC'/'C' rated debt issuance would provide support as these companies' maturities get closer--offering an alternative to debt restructurings and maturity extensions.

Pessimistic scenario: We forecast that the default rate could rise to 6.25%.  For now, we expect economic growth in Europe and the U.K. to expand beyond the pace of 2023 and 2024, even when including the potential impact of modest tariffs from the U.S. However, we recognize growing uncertainties. Sentiment in Germany remains weak, the Russia-Ukraine conflict continues, and unpredictability surrounding the scope and level of tariffs is high--particularly in light of the recent announcement for reciprocal tariffs as these could be felt more keenly in Europe.

From a credit perspective, market access for issuers rated 'CCC+' or lower remains weak, particularly relative to upcoming maturities. This has forced many to extend maturities or restructure debt--sometimes aggressively so, pushing the default rate for 'CCC'/'C' to 37% in 2024. That said, the stock of upcoming debt maturities over the next three years for 'CCC'/'C' is roughly €25 billion higher than at the start of 2024. However, most of this increase is attributable to two large issuers that were downgraded in 2024.

Defaults Have Been Elevated, Driven By Distressed Exchanges

We have arguably seen a higher-than-expected default rate in Europe during 2024, and we expect this to continue in the near term. Given macro fundamentals, some default activity would be expected, but the current 4.5% default rate includes situation-specific cases of debt restructurings and distressed exchanges to avoid more traditional default events (involving otherwise lower recovery levels). Through the end of 2024, the distressed exchange default rate was 2.9%, almost double the default rate excluding distressed exchanges (see chart 2).

Previous periods where the proportion of distressed exchanges overtook more traditional defaults have been during the latter half of recession-related default cycles when the default rate was declining. Lenders became more agreeable to restructuring debt with the belief that an improving macro backdrop was nearing.

This time around, distressed exchanges have led the default rate upward, in the absence of a recession. This is likely the result of the normalization of interest rates after a prolonged period of very low rates, which have been a headwind for weaker issuers, but not enough to force more traditional defaults considering resilient economic growth and expectations for declining rates.

Chart 2

Of the defaults in 2024 that were classified as distressed exchanges or other debt restructurings, 91% began the year with a rating of 'CCC+' or lower. The 'CCC'/'C' rating category is always the most fertile ground for future defaults, and in the current environment dominated by distressed exchanges, this is even more true. In fact, last year the 'CCC'/'C' default rate was just over 37%, materially higher than the 25% annual average from 1981-2023.

At the start of last year, there was €63.4 billion in outstanding debt in the 'CCC'/'C' category due through the following five years (2024-2028) (see chart 3). This year has started with €102.1 billion due through 2029, easily exceeding the five-year refinancing burden at the start of 2024.

However, some €34 billion is attributable to two organizations downgraded to 'CCC'/'C' in 2024: Altice and Ardagh. This indicates that while the nominal increase in maturing debt among the lower ratings is much higher this year, much of it is concentrated. Still, a sizable pool for more distressed exchanges remains.

Chart 3

The impact of larger issuers on near-term maturities due this year is seen at a sector level (see chart 4). Telecommunications leads this year's speculative-grade total with just over €16 billion due this year--over twice the amount of any other sector. It leads among 'CCC'/'C' maturities as well, largely due to five issuers each with over €2 billion in outstanding debt due this year.

Despite the high levels of low-rated debt, telecommunications has one of the lowest rates of distressed exchanges as a proportion of total defaults since 2022 (33%), showing that high credit risk is not necessarily the only factor driving the use of distressed exchanges.

Chart 4

Market Appetite Has Been Strong For Most Speculative-Grade Debt

In Europe, combined high-yield bond and leveraged loan issuance in 2024 reached its second-highest annual total after a record haul in 2021 (see chart 5). Combined bond and loan issuance totaled €275 billion, largely because of refinancing activity and strong market demand, as reflected in tightening spreads.

That said, most of this increase excludes the 'CCC'/'C' category, which has seen just €2.7 billion in total new bond issuance since February 2022. And of this meager total, almost all was from U.K.-based brokerages, leaving nonfinancial corporates with few options to deal with upcoming maturities other than debt restructurings, maturity extensions, or approaching private lenders.

By comparison, bond issuance at the 'B-' level reached €9.5 billion--the second-highest annual total in the last five years, indicating investors may be searching for yield, but they remain selective.

Chart 5

The relative risk pricing of both bonds and loans (via spreads) reflects markets' declining credit risk perceptions (see chart 6). 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 maturing debt or service existing debt. In broad terms, speculative-grade spreads have been good indicators of future defaults based on a roughly one-year lead time. Given current spreads, our baseline default rate forecast of 3.75% is above what the historical trend suggests.

However, in contrast to spreads, current yields remain elevated (particularly on loans), increasing the all-in costs of debt that issuers must contend with, regardless of relative risk perceptions. In our view, since the start of the current rate-hiking cycle in 2022, the trend in defaults has been more similar to the trend in yields rather than spreads.

Chart 6

Considering broad measures of financial market sentiment, economic activity, and liquidity, the average speculative-grade bond spread in Europe was about 285 base points (bps) in December, below our estimate of 594 bps (see chart 7). The gap between the actual spread and the estimated spread implies that bond markets may be overly optimistic. It also supports the argument that yields, rather than spreads, are the better indicator of financial stress in current conditions.

Chart 7

Credit Momentum Remains Stable

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 in defaults ahead. In the 12 months ended December 2024, speculative-grade credit quality continued to improve slightly. Net rating actions stayed positive. Negative net bias implied more downgrades ahead, but it was at its lowest level in the last seven quarters (see chart 8). (Net bias is the positive bias minus the negative bias.)

Chart 8

The rate of downgrades and the net negative bias have tended to lead movement in the default rate by several quarters. Although credit quality among speculative-grade issuers has generally improved since 2021, that hasn't been enough to make up for the declines during 2020, meaning that speculative-grade issuers are still much more vulnerable than they've been historically (see chart 9).

As mentioned earlier, the 'CCC'/'C' category has experienced higher defaults than is typical, historically. And because many of these defaults are distressed exchanges, issuers reemerging from such transactions typically receive a subsequent rating in this category within a short time, keeping the proportion of 'CCC'/'C' issuers high.

Chart 9

While nearly one-third of the speculative-grade population remains at 'B-' and lower rating levels at the start of this year, a smaller percentage (roughly 7%) is weakest links--issuers rated 'B-' and below with negative outlooks or on CreditWatch negative. We track these issuers regularly since they have the highest risk of default given their low ratings and negative outlooks.

At the start of this year, more than one-third of these issuers belonged to just three sectors: chemicals, packaging, and environmental services; consumer products; and media and entertainment. The latter two sectors led the default tally since 2022 (see chart 10).

Weakest links in the chemicals, packaging, and environmental services sector are vulnerable now via trade disruptions--driven by geopolitical conflicts, trade tensions, and tariffs--which are a major risk to the sector, over and above headwinds from high energy costs in Europe. This adds to a slowdown in projected global growth and demand. Notably, weaker demand from end markets for chemical products including automobiles, construction, electronics, and agriculture might negatively affect issuers in this sector and increase the default risk of most vulnerable issuers.

Lower global demand also weighs on European consumer producers, despite a projected recovery in European economic growth amid easing inflation and resilient labor markets. Strong inflation over the past years led to high prices, resulting in producers of discretionary consumer products to experience volume pressures and try to cut costs to improve margins.

Half of the weakest links in the media and entertainment sector are in the 'CCC'/'C' rating category. Weaker economic growth and high inflation also weigh on issuers in this sector.

On one hand, because high past inflation weighs on purchasing power and inflation expectations remain elevated, consumers are wary of big-ticket discretionary leisure spending. On the other hand, companies face increased operating and labor costs, pressuring their margins. Similarly, both streaming as well as legacy media are exposed to subdued consumer spending, affecting streaming subscription growth and advertising.

Chart 10

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.

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