The Economy

Euro Zone 2013: Zero Growth, More Defaults

Standard &spamp; Poor’s cuts its euro-zone GDP forecast for this year and next, and says robust high-yield issuance won’t stop corporate defaults f...
Andrew SawersSeptember 26, 2012

If you were looking for a euro-zone recovery in 2013, forget about it, says ratings agency Standard & Poor’s. Its previous forecast of 0.3% growth in gross domestic product has been cut to exactly zero. Moreover, 2012 is now looking worse, with euro-zone economic activity expected to contract 0.8%, a slightly bigger reduction than S&P’s previous estimate of 0.7%.

Cuts in S&P’s macroeconomic forecasts in the wake of the recent European Central Bank’s announcement to prop up the sovereign bond market seem likely to raise concerns that the agency could downgrade the debt of euro-zone member states as a result. A spokeswoman for S&P says, “[GDP growth] is one of the inputs that’s factored into our ratings not only for sovereigns but also for corporates and banks, but [this is] not a rating action and it doesn’t directly lead to any rating actions.”

S&P’s forecasts are worse than those of the European Central Bank. The midpoints in the ECB’s forecasts, published earlier this month, are for a decline of 0.4% this year but a 0.5% expansion in 2013. S&P’s estimates are also more pessimistic than those of rival agency Moody’s Investors Service, which has penciled in a decline of 0.3% this year but a small pick-up of 1.0% next year.

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S&P acknowledges in its research note that the ECB’s new policy of buying the bonds of the region’s troubled countries, known as outright monetary transactions (OMT), could “ease financial conditions for the member states concerned” but adds that there are still “fundamental issues . . . about exit strategies out of recession.”

Other forecasters were not surprised by S&P’s lower economic-growth forecast. Marie Diron, director of macro forecasting at Oxford Economics, says her firm has been expecting no euro-zone growth for a while. “We are very much on the same page,” she says.

Bank of America Merrill Lynch’s most recent 2013 forecast is a gloomy 0.7% decline, compared with its estimate of analysts’ consensus outlook of 0.2% expansion. It says the reduction will have an effect on the fiscal adjustments made by member states: “We expect the additional tightening to be greater in France, Spain, Italy and the Netherlands,” the bank said in a client note.

Bond Defaults on the Ascent
Whatever the exact GDP numbers turn out to be, it’s clear that the economic backdrop has a direct impact on European companies, as default rates have been increasing. A separate S&P report revealed that among a portfolio of speculative-grade companies (rated BB+ or below), the default rate rose to 5.3% at the end of the second quarter, up from 4.7% three months previously. S&P blamed economic and political uncertainty, a deteriorating growth outlook spreading through the core European Union countries, and “a raft of highly vulnerable [leveraged buyouts] approaching debt maturity.”

By the end of June 2013, S&P expects the default rate to rise further, to 6.3%, even though the ECB’s OMT strategy is expected to “support market liquidity and limit the extent of the rise in defaults.” There are other, counterbalancing catalysts, however, that “could result in a more severe and protracted recession in the euro zone and, consequently, a much higher default rate of more than 8%,” says the S&P report.

Paul Watters, head of European corporate research at S&P, agrees that there are implications for Europe’s CFOs. They need to pay ever closer attention to the financial position of key customers and suppliers, he says. On a positive note, some companies have been able to refinance despite a rising default environment. Since the ECB unveiled its OMT strategy on September 6, “the high-yield market has been very much open for business.” There has been some €6 billion of issuance in this market in the past three weeks, a figure that, for Europe, is “substantial,” says Watters. “The ECB may have taken the tail risk off the table and created greater stability in financial markets, so investors have been more willing to put money to work in the high-yield market,” he explains.

However, much of the issuance has been refinancing “legacy” leveraged buyouts, transactions from 2006 to 2008 that were entirely bank-funded. Watters notes that many weaker companies in that bracket “don’t have the credit profile to be able to go to the debt capital markets to refinance their bank debts. It remains the case that those companies are still vulnerable to restructuring as their debt falls due over the next year or two.”

Andrew Sawers is editor of CFO European Briefing, a CFO online publication.