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Credit quality of European corporates is on a downward spiral

Publication Date: 30 Jul 2019 - By Gaurav Sharma (Editor ReachX) By Gaurav Sharma (Editor ReachX)
Actionable
Differentiated

Equity Fundamental Equity EU ex-UK MENA UK

Corporate credit quality remains under pressure in Europe and is on a downward trend, according to a leading rating agency.

In its recent EMEA ['Europe, Middle East and Africa'] midyear corporate credit outlook and industry trends report, S&P Global Ratings said the risk trend for global trade has taken a turn for the worse as the US moves to target key strategic industries in China and systemic risks surface in Europe.

“While Europe is not (yet) directly involved in this bilateral negotiation, the threat of US auto tariffs, deferred for six months, would have serious financial repercussions for the auto industry in Europe if deployed,” it added.

But in light of economic headwinds, and with global growth stuttering, there has been a clear switch in monetary policy direction from the US Federal Reserve and European Central Bank, said S&P Global Ratings Senior Director Gareth Williams.

"For the non-financial corporate sector, this environment has remained relatively comfortable given ample and cheap liquidity that has helped keep default rates historically low. Signs of financial excess have crept in the form of eroded covenants and less stringent documentation. Systemic fragilities and ebbing corporate credit quality give us cause for concern," Williams added.

For instance, global manufacturing purchasing manager indices are deteriorating rapidly. In part reflecting these risks, S&P Global Ratings' global net outlook bias for non-financial corporates has “turned lower in the second half of 2019.”

The rating agency said that while growth remains positive in the majority of sectors, European corporate credit quality is on a downward trend.

Inevitably, many of the concerns relate to the political situation, both in terms of trade tensions and regional developments. “The risks to European automakers of higher tariffs being imposed by the US remains a particular credit concern. Event risk surrounding Brexit and the deteriorating political cohesion apparent across Europe is also a major concern.” 

A key structural concern remains Italy, where fiscal imbalances and political differences with the EU present a potent risk that could escalate further if the economic slowdown gains traction.

However, monetary policy switches are likely to prevent a full-blown recession in Europe, as central banks have once again “signalled a return to the tried and tested analgesic of monetary stimulus.”

“Our base case remains that stimulus will avert recession, but systemic fragilities and ebbing corporate credit quality give cause for concern,” S&P Global Ratings concluded.

 

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