Standard & Poor's Ratings Services believes credit quality for European nonfinancial companies is showing signs of stabilization and we expect a further gradual improvement over the next 12 months. Under our base-case scenario, we anticipate a moderate reduction in the annual default rate to 6% by year-end 2014, which compares with the latest actual default rate of 6.8% at end-September 2013. (See "Related Research" below for details of the applicable reports--our European Corporate Credit Outlook and latest Default study.)

"This is not a typical cyclical recovery, where an improving economy translates into materially stronger credit performance," said Paul Watters, senior corporate credit analyst at Standard & Poor's. "Rather, it's the result of a weak growth environment maintaining pressure on revenues, profitability, and cash flow, with the onus remaining on tight financial management."

We do not believe that Europe is in a position to generate sufficient growth momentum to translate to a material rise in corporate profitability, renewed investment, a pick-up in hiring, and the broader corporate upturn that we might normally expect at this stage of the cycle. Contributing to this subpar recovery is the north-south divide in Europe. This divide remains acute, with little near-term prospect that the relatively high levels of unemployment, contracting investment, and poor returns on capital in the south will reverse.

"In the medium to longer term, we have increasing reservations about the ability of companies to maintain their competitiveness against their U.S. peers, given relatively subdued investment and materially higher energy costs," added Mr. Watters.

Standard & Poor's does not expect the operating environment to improve enough in 2014 for European corporates to be able to relax their relatively conservative financial policies. Our view remains that global capital expenditure (capex) will continue to disappoint in 2014, and we expect a 5% decline in global capex in real terms, with a 3% decline in Europe. However, accumulated cash balances are likely to remain elevated, supporting financial flexibility and credit quality.

"Global capex is shrinking with the fading commodity super cycle, and European companies remain relatively constrained by weak cash flow," said Gareth Williams, Standard & Poor's corporate economist. "We believe that hopes for an investment-led European recovery are misplaced and, on top of uncertain bank lending conditions, high cash balances appear to us more cautionary than indulgent."

Standard & Poor's Ratings Services, part of McGraw Hill Financial (NYSE: MHFI), is the world's leading provider of independent credit risk research and benchmarks. We publish more than a million credit ratings on debt issued by sovereign, municipal, corporate and financial sector entities. With over 1,400 credit analysts in 23 countries, and more than 150 years' experience of assessing credit risk, we offer a unique combination of global coverage and local insight. Our research and opinions about relative credit risk provide market participants with information and independent benchmarks that help to support the growth of transparent, liquid debt markets worldwide.

Copyright © 2013 by Standard & Poor’s Financial Services LLC. All rights reserved.

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