Europe: Corporate Defaults Will Jump in 2012

Econintersect:  Robin Wigglesworth reports in the Financial Times that analysts have greatly increased their 2012 default forecasts for European companies rated below investment grade, or junk.  There are fears that the problem could rival what occurred during the height of the financial crisis.  The situation has arisen because both loan demand decline and credit underwriting standards increases have made big moves in the second half of 2011 and appear to be continuing if not accelerating in the first quarter of the new year.  As a whole, Wigglesworth says, things do not look bad; however some smaller companies are experiencing increases in debt to earnings ratios not seen since the recession in the early 1990s.

Details of just what is going on can be found in a report release last week by the ECB (European Central Bank.  The report covers a comprehensive survey of bank lending practices for the past couple of years and bank expectations for early 2012.

From the January 2012 ECB Bank Lending Survey:

According to the January 2012 bank lending survey (BLS), the net tightening of credit standards by euroarea banks surged in the fourth quarter of 2011 for credit standards on both loans to non-financialcorporations (35% in net terms, up from 16% in  the preceding quarter) and loans to households for house purchase (29%, up from 18% in the preceding quarter), and to a lesser extent on consumer credit (13%, up from 10% in the preceding quarter). Looking ahead, euro area banks expect a further net tightening of credit standards, albeit at a slower pace than in the fourth quarter of 2011.

The first graph shows that the results in 2011 produced far more contraction in bank lending activity than had been expected.  The tightening of underwriting (credit standards) was greatest for large firms and for long-term loans.  Corporate size effects will be discussed further later in the article.

Chart 1. Changes in credit standards applied to the approval of loans or credit lines to enterprises

The single largest concern in reduction of lending is lower economic activity, followed by industry or firm specific factors.  But bank liquidity and access to market financing are also constraining concerns for more than 25% of the banks.  See the following graphic.

Chart 2a. Factors affecting credit standards applied to the approval of loans or credit lines to enterprises

(net percentages of banks contributing to tightening standards)

It is interesting to note in the following graphic that, although the defaults are expected to fall most heavily on small and medium sized corporations with below investment grade credit ratings, the curtailment in new lending has fallen more extensively on large coorporations.

Chart 6. Expected credit standards for the approval of loans or credit lines to enterprises

(net percentages of banks contributing to tightening standards)

Not only are banks tightening standards for loans, demand for loans has contracted sharply across the board for the Eurozone in the second half of 2011.  The following are the percentages of banks reporting declines in lending activity:  15-20% activity down for loans to enterprises of all sizes; more than 25% of banks report less home mortgages; and about 15% report less activity for consumer credit and other lending.  The outlook going into 2012 is for lending activity declines to be variable.  For example, while decline in lending activity in general is expected to moderate according to the ECB report quotation earlier, over 40% of banks expect a further decline in home purchase mortgage lending in 1Q/2012.

Sources:

• Corporate defaults set to jump on Europe (Robin Wigglesworth, Financial Times, 6 February 2012)

• The Euro Area Bank Lending Survey (European Central Bank report, 1 February 2012)

• News article found on Econintersect Europe newspaper page