Europe’s corporations face rising credit strain as Ukraine crisis continues

The third-quarter 2022 economic and financial outlook for European corporations is looking increasingly bleak, with tighter financing conditions and rising concerns over debt at more vulnerable entities a particular concern, warns credit ratings agency S&P. S&P said that a “rapid deterioration” in global macroeconomic conditions, combined with ongoing geopolitical uncertainty and lingering Covid-19 lockdowns in China, are fuelling persistently high inflation, market volatility and rising yields. This confluence of unwelcome trends poses an “increasingly murky” outlook for credit quality that currently exhibits a degree of resilience built up during the bounceback from Covid-19. The key risks faced by Europe’s corporations are “the outlook for energy and food as supply disruptions linked to Russia’s invasion of Ukraine intensify, a rapid adjustment of central bank policy rates to counter excessive inflationary pressures, stagnant growth weakening the operating environment and financial performance of corporates, tightening financing conditions reawakening fears over fragmentation within the eurozone, and the debt sustainability of more vulnerable entities”, stated the ratings agency. These factors will mean that corporate credit ratings across Europe are likely to come under more pressure into 2023 as supply constraints keep food and energy prices high, households increasingly struggle with falling real incomes, and central banks prioritise tackling inflation over growth. “Tighter financing and operating conditions will refocus business and households on cashflow to protect against a highly uncertain outlook and ultimately solvency for the most vulnerable debtors. We expect default rates to increase to about 3% by year-end and into the first quarter of 2023,” predicted S&P. Non-financial European corporates are facing mounting margin pressures as they face up to a diminishing ability to pass on higher costs to customers as demand moderates, continued S&P. “Even as inflation rates abate next year, such pressure may continue as companies face the renewal of hedging and supplier pricing agreements at new, higher rates. While refinancing needs are not pressing for many, thanks to significant levels of capital raising at low rates in recent years, access to refinancing is more challenging and costly, particularly for weaker borrowers,” it added. The top and worsening risk facing European corporates is further commodity supply shocks and persistent inflation that will extend pricing pressures and weaken earnings, according to S&P. “We see a high risk that the war in Ukraine drags on, sanctions against Russia or Russia’s supply of gas to Europe continue to tighten, putting further upward pressure on energy prices. Oil prices may spike further as the EU embargo on shipped oil and the Western prohibition against insuring Russian oil shipments play out, in combination with strong seasonal demand and a recovery in demand in China. Russian actions to further significantly curtail gas supplies could cause energy prices to spike further if supply restrictions prevented European gas storage replenishment before next winter, leading to gas rationing and a consequent hit to economic activity across Europe,” stated the ratings agency. “Dislocation in the agricultural markets also feeds into food scarcity for certain key staple products, maintaining upward pressure on consumer prices. These factors could result in inflation pressures persisting well into 2023 and, in a slowing growth environment, presenting increasing challenges for companies in certain sectors to maintain margins by continuing to pass through higher input costs to their customers. Should these cost pressures continue to build and demand growth fall steeply, the impact on corporate profits could threaten credit quality,” it added. Another elevated risk for European corporates is cyber, driven by mounting geopolitical tension and accelerated digitalisation, said S&P. “The pace of digitalisation in the global economy exposes corporates and countries to mounting cyber risks… Geopolitical tensions raise the prospect of major cyberattacks. Russia’s use of cyberattacks during its military conflict with Ukraine proves how these moves are becoming a more prevalent means of weaponry, with systemic implications,” it stated.

Europe’s corporations face rising credit strain as Ukraine crisis continues

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