FOREWORD 3 CORPORATE OUTLOOK CORPORATE CAPEX SURVEY 10 BORROWING AND ISSUANCE 12 DEFAULTS & RECOVERY 14 RATINGS TRENDS 20

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2 Standard & Poor's Ratings Services European Corporate Credit Outlook CONTENTS FOREWORD CORPORATE OUTLOOK CORPORATE CAPEX SURVEY BORROWING AND ISSUANCE DEFAULTS & RECOVERY RATINGS TRENDS INDUSTRY CREDIT OUTLOOK AEROSPACE & DEFENCE AUTOS BUSINESS & CONSUMER SERVICES CAPITAL GOODS CHEMICALS CONSTRUCTION MATERIALS CONSUMER DURABLES CONSUMER NON-DURABLES HEALTHCARE HOTELS, RESTAURANTS & LEISURE MEDIA METALS & MINING OIL & GAS PAPER & PACKAGING REAL ESTATE RETAILING TECHNOLOGY TELECOMMUNICATIONS TRANSPORTATION UTILITIES KEY CONTACTS CreditResearch December

3 Standard & Poor's Ratings Services European Corporate Credit Outlook FOREWORD Dear Reader Five years on from the start of the financial crisis, we are starting to see an upturn in credit conditions for European corporates. There is a sense that a storm has been weathered. The region s economies have moved out of technical recession, confidence has improved and leading indicators are rising, although they remain sub-par. Encouragingly, debt capital markets have been able to offer attractive funding alternatives as Europe s banks go through a period of retrenchment and contracting loan books. A combination of tight financial discipline and a stabilization of the operating environment has contributed to an upturn in ratings upgrades through the year and a lessening of the net pessimism in ratings outlooks. is likely to bring a different set of risks. We don t believe that Europe is generating enough growth to leave recessionary conditions decisively behind. The US Federal Reserve is expected to rein in a period of unprecedented monetary stimulus. At the same time, the buoyancy in financial markets is intensifying pressures for companies to deploy carefully conserved cash. Leveraged markets have started to make greater use of hybrids and dividend re-capitalizations, but covenant-lite borrowing remains scarce in Europe still compared to the US. Deflationary risks jostle with capital market buoyancy. This is an environment where visibility remains poor and where close vigilance remains essential. In this report, S&P s European Corporate team examine the outlook for European companies in, focusing on key trends and risks. It draws upon the essential intelligence offered by our extensive sources of data, our economists and our ratings analysts who offer an enormous depth and breadth of understanding of corporate trends. Our conclusions are mixed. We expect the economic news to continue to improve, but think that Europe will have to endure another year of sub-par growth. Our analysis suggests that hopes for a global investment-led recovery are likely to be disappointed. We suspect that this will be an environment when companies will remain relatively cautious with respect to financial policy. All this speaks to a continued, gradual improvement in credit quality. Yours Sincerely Blaise Ganguin Managing Director Head of Corporate Ratings, EMEA Standard & Poor's Ratings Services Rue de Courcelles, Paris T + ()...9 CreditResearch December

4 Standard & Poor's Ratings Services European Corporate Credit Outlook CORPORATE OUTLOOK PRIMARY CREDIT ANALYSTS: Paul Watters, CFA, London,+, Gareth Williams, London,+, GENERAL CONTACTS: Blaise Ganguin, Paris () --9; Alexandra Dimitrijevic, London,+, OVERVIEW Recent months have brought an upturn in credit conditions for European corporates with an end to recession, rising confidence and unhindered access to capital markets bolstering liquidity and reducing effective interest rates. This has been reflected in our net ratings outlook bias moving from -% to -% over the last year. Nevertheless, this remains a sub par recovery. Europe's north-south divide remains acute and there is little tangible sign that high unemployment, contracting investment and poor returns on capital in the south will reverse. The UK is showing marked improvement but questions about its resilience remain given that it is based on recovering asset-prices. Global capital expenditure is shrinking with the fading of the commodity cycle and European companies remain relatively constrained by weak cash flow. Hopes for an investment-led recovery are misplaced in our view. Our latest analysis suggests that global capex expenditure will fall by % and that in European by % in in (real terms). Access to bank funding is likely to remain difficult from SMEs, with the ECB's Asset Quality Review sustaining the focus on core ratios over lending. In this context, high cash balances appear more cautionary than indulgent. Similarly, 's record bond issuance largely reflects a desire to refinance on attractive terms, rather than a sign of over-exuberance. We do not expect the operating environment to improve enough in for companies to be able to relax their relatively conservative financial policies. Improving but still weak economic growth for most of Europe implies positive but still low revenue and operating cash flow growth and limited margin improvement. This combination of positive but weak growth and continued caution with respect to financial policy means that credit quality is likely to continue to improve through the year. We anticipate a moderate reduction in the overall default rate for public and private ratings from.% currently to.% by the end of. TURNING A CORNER The credit outlook for European companies has taken a positive turn in the last six months, with an exit from technical recession, rising leading indicators, an easing of systemic stress in the eurozone and relatively unhindered access to liquidity from financial markets on attractive terms. At the same time, an undeniably difficult operating environment characterized by falling revenues, rising costs and pressure on cash flow has helped keep in place the fiscal conservatism of last five years. Capital expenditure has been cut, cash accumulated and M&A activity restrained. The net effect has been a slow improvement in credit quality over recent months. We expect to pose similar but subtly different challenges. Continuing signs of improvement in the global economy will intensify pressures to deploy cash and invest for the medium and longer term. However, we do not see enough growth or confidence in Europe especially - to usher in a phase of rising profitability, renewed investment, renewed hiring and an upturn in M&A that one might normally expect to see at this stage of the cycle. Earnings visibility remains poor, exacerbated by uncertainty around the health of the banking sector, limited funding channels for smaller companies and the uncertain impact of the likely removal of unprecedented and unconventional monetary support measures in the US. Despite these concerns, the implications for credit quality are likely to be beneficial in the short term. A slowly improving global economy should help business risk profiles, particularly for companies with high operational gearing or those that have undertaken major restructuring efforts. At the same time, the fragility of the recovery is likely to lead companies to retain a relatively cautious financial policy. We suspect cash balances will remain relatively high and mainstream mergers and acquisition activity subdued. This ought to underpin corporate liquidity positions and support financial risk profiles. There are various reasons that underpin our thinking. These include: CreditResearch December

5 Standard & Poor's Ratings Services European Corporate Credit Outlook. EUROPE'S ECONOMY SUB ZERO TO SUB PAR While the global growth outlook is improving, Europe's recovery remains painfully slow and likely to drive only a modest recovery in revenues (see Chart ). CHART EUROPEAN SALES GROWTH (S&P RATED NON- FINANCIAL CORPORATES) AND EURO AREA GDP GROWTH Euroarea - GDP Growth (YOY%) [RHS] F'cast Source: S&P Capital IQ, Eurostat, S&P Global Economics, S&P Ratings. Sales growth figures for are for last twelve months (LTM) Unemployment rates are expected to remain high (see Table ) and disposable income growth weak. We are doubtful that corporate investment will be a significant driver of growth over the next year (see pages - for more). Significant downside risks remain, particularly in relation to disinflationary pressures and economic imbalances between northern and southern Europe. TABLE GDP GROWTH AND UNEMPLOYMENT FORECASTS FOR SELECTED EUROPEAN COUNTRIES Real GDP Baseline forecast Unemployment Baseline forecast (%) f f f f f f France Germany Italy Netherlands Spain Eurozone Switzerland U.K Source: S&P Global Economics Europe - Sales Growth (YOY%). PROLONGED BALANCE SHEET ADJUSTMENT A weak economic environment is not conducive to deleveraging balance sheets through strong earnings growth. In aggregate, further corporate balance sheet adjustment to reduce debt is still necessary, particularly for businesses more dependent on the weaker economies, as debt levels for eurozone and UK companies Unless stated otherwise, Europe refers to the European Economic Area (EEA) plus Croatia. This includes all EU and EFTA member countries remain % and % above pre-financial crisis levels respectively in terms of total debt as a multiple of gross operating surpluses (Chart ). CHART EUROZONE AND UK NFC TOTAL DEBT TO PROFIT RATIO % % % % % % UK Debt: Profit Euroarea Debt:Profit 99- Av - Av % Source: ONS, ECB and S&P Ratings calculations. NFC refers to private non-financial corporation Debt to Profit = Total Debt / Gross Operating Surplus Access to bank finance is likely to remain an issue, particularly for SMEs. Over the last two years, net loan growth has been negative for Europe's largest banks as measured by risk-weighted assets, with boosting tier ratios taking precedence (see Chart ). The European Central Bank's Asset Quality Review is likely to sustain this focus on the rebuilding asset ratios rather boosting lending. CHART TIER ONE CAPITAL RATIO AND NET LOAN GROWTH FOR EUROPE'S LARGEST BANKS Net Loan Growth (YOY%) Tier Capital Ratio (%) [RHS] LTM for Banks - Source: S&P Capital IQ, S&P Ratings. Calculations show figures for Europe's largest Banks as determined by ranking of latest annual risk-adjusted assets. Figures for are based on a subset of banks for whom figures are available for the last twelve months.. PRESSURES ON RETURNS AND CASHFLOW European rated companies' aggregate return on capital employed has slipped back to.% (see Chart ) - a return not much higher than the nadir seen in 9 of.%. More stable sectors such as healthcare and consumer non- CreditResearch December

6 Standard & Poor's Ratings Services European Corporate Credit Outlook durables are holding up well, but the more cyclical and capital intensive sectors are struggling to maintain returns on capital. The growth outlook suggests little respite from this pressure and, consequently, continuing caution with respect to financial policy. CHART EUROPEAN NON-FINANCIAL RATED CORPORATES RETURN ON CAPITAL 9. Source: S&P Capital IQ, S&P Ratings. S&P rated non-financial corporates only. Figures for are for the last twelve months Moreover, Europe's rated companies have less cashflow headroom than one might expect. Operating cash flow has yet to sustainably exceed 's peak level and, over the last three years, has barely covered its principal uses capex, dividends, acquisitions and share buybacks (see Chart ). Indeed, over the last twelve months, companies have returned to being net disposers of assets. CHART EUROPEAN CASH / TOTAL ASSETS S&P RATED NON FINANCIAL CORPORATES Bn, Europe - Return On Capital (%) Capex Net Acquisitions Operating CF Dividends Share Buybacks In this context, we believe that a large share of the billion increase in short term cash balances since the end of ( billion for eurozone non-financial corporates [NFC] and billion for UK private NFCs in the UK) has been precautionary to provide relatively cheap selfinsurance against any further bank turmoil. The outsized increase in cash balances held by GIIPS domiciled companies from.% of total assets in to 9.% over the last twelve months attests to this (see chart ). CHART EUROPEAN CASH / TOTAL ASSETS S&P RATED NON FINANCIAL CORPORATES 9 Source: S&P Capital IQ, S&P Ratings. S&P rated non-financial corporates only. Figures for are for the last twelve months In any event, notwithstanding the wide variation between sectors and regions, we do not view the level of cash balances as excessive. Relative to total assets cash balances of.% have only risen to the high end of the historical range seen over the last years (see chart ). CHART EUROPEAN CASH / TOTAL ASSETS S&P RATED NON FINANCIAL CORPORATES Northern Europe - Cash & Equivalents/Total Assets (%) Southern Europe - Cash & Equivalents/Total Assets (%) Europe - Cash & Equivalents/Total Assets (%) LTM Source: S&P Capital IQ, S&P Ratings. S&P rated non-financial corporates only. Figures for are for the last twelve months Source: S&P Capital IQ, S&P Ratings. S&P rated non-financial corporates only. Figures for are for the last twelve months. CONTINUING CASH PRESERVATION. M&A CAUTION, IPO POTENTIAL Economic uncertainty and limited visibility over future earnings has engendered a cautious approach to debt funded acquisitions by management. While this continues we expect European companies to further strengthen core competencies via small bolt on acquisitions, usually with no impact on ratings. If favorable equity market conditions persist we see opportunities for companies to sell off non-core businesses, perhaps even CreditResearch December

7 Standard & Poor's Ratings Services European Corporate Credit Outlook through public listings. Private equity firms could be active on both sides - acquiring mid-sized companies as well as taking advantage of better exit opportunities as the IPO market reopens.. RISK OF LONG-TERM RELATIVE DECLINE While the short term trend in credit quality is likely to be positive in our view, we are increasingly concerned that Europe is at risk of a decline in its competitive position in the medium to longer term, particularly relative to North American peers. Two factors point in this direction. Firstly, continuing slow growth in Europe appears to be structural rather than cyclical. The implication is that there is limited appetite or incentive for European corporates to innovate and invest in new technology and more efficient plant and equipment. The contrast with the US is stark. In Europe s share of global capex was % ahead of the US at %, but today Europe s share has fallen to %, as much as % behind the US (see Chart ). Our second concern relates to the lack of a coordinated public policy response within Europe to the challenge of cheap energy in the US. The growing differential in energy costs in Europe relative to the US (see Chart 9) is starting to affect competitiveness of industry (see Chart ) through various channels. High and rising electricity costs in Europe have a direct effect across most industries to varying degrees but petrochemical and related commodity industries face particular challenges as a result of cost differentials for (mostly ethylene derived) feedstock. Energy affordability has also become increasingly contentious for European electorates with rising costs joining austerity measures in exerting pressures on disposable incomes. There are signs that a backlash is developing with regard to the cost implications of developing environmentally-friendly energy sources. From a European sector perspective, the main impact at this stage is on utilities, oil and gas, chemicals and packaging. Utilities: The industry finds itself in an increasingly difficult position with rising costs, growing political resistance to passing these costs on and intensifying pressure to undertake substantial new investments to help ensure long-term energy security. Chemicals: EMEA petrochemicals producers are suffering from a weak position on the global cost curve that is very likely to deteriorate further as substantial new productive capacity is developed in the US capitalizing on cheap shale gas derived feedstock. However, long lead times for building new plants mean that this is likely to play out over the next to years. Packaging: Rising energy costs are an issue for European packaging companies that trade internationally, as they are very difficult to pass on. This is leading to companies aggressively cutting operating costs or considering relocating production abroad. CHART WESTERN EUROPE V US - SHARE OF GLOBAL NON-FINANCIAL CORPORATE CAPEX Western Europe Share Of Global Capex (%) Source: S&P Capital IQ, S&P Ratings. Universe is Global Capex CHART 9 EUROPE V US NATURAL GAS PRICES Source: Platts North America 9 /9 / / / / CHART EUROPEAN V NORTH AMERICAN EBITDA PROFIT MARGINS UK Natural Gas - NBP (USD/MMBTU) US Natural Gas - Henry Hub (USD/MMBTU) North America Source: Thomson Reuters Datastream, Worldscope Europe CreditResearch December

8 Standard & Poor's Ratings Services European Corporate Credit Outlook. INTEREST RATE RISKS REMAIN MODEST Interest rate concerns might seem premature at this point, but are likely to become more pertinent through the year. While we do not anticipate any rise in US policy rates until, the bond markets will inevitably have to come to terms with the removal in some form of the extensive and unprecedented monetary stimulus currently provided by the Federal Reserve. The market risk this represents is substantial and is a major source of uncertainty for (see "Credit Conditions: Europe Sees a Slight Improvement. But Structural Weaknesses Persist", 9 Dec ). However, the absence of inflationary pressures particularly in Europe - is a crucial offset and suggests that a 99 style bond crash is unlikely in. There is also non-negligible risk of policy rate rises in certain markets such as the UK given that rising house prices have played a major part in its burgeoning recovery and emerging markets where inflation risks are more endemic. We see less risk for the eurozone given still-weak growth, low inflation and the fact that the ECB remains committed to keeping policy rates very low and supplying unlimited liquidity to the banks until at least. For non-financial corporates, there are some grounds for concern over interest rates given that our rated universe has been increasing its overall indebtedness. Looking at the broadest measure of leverage total debt to total assets (see chart ) shows that the last twelve months has seen overall leverage continue to rise. This reflects both increased debt issuance but also significant write-downs of asset values. CHART EUROPEAN TOTAL DEBT / TOTAL ASSETS S&P RATED NON-FINANCIAL CORPORATES 9 Europe - Total Debt / Total Assets (%) 9 LTM Source: S&P Capital IQ, S&P Ratings. S&P rated non-financial corporates only. Figures for are for the last twelve months We have also seen a further weakening of interest cover. Two years of negative EBITDA growth have contributed to EBITDA-to-interest cover falling back from its most recent peak of.9x in to.x based on available figures for the last twelve months (see Chart ). This is now below the ten-year average of.x. CHART EUROPEAN EBITDA / INTEREST EXPENSE S&P RATED NON-FINANCIAL CORPORATES 9 Europe - EBITDA/Interest Expense (x) Source: S&P Capital IQ, S&P Ratings. S&P rated non-financial corporates only. Figures for are for the last twelve months However, companies have been able to use strong capital market conditions to refinance debt at lower rates, helping ameliorate the pressure from a weak operating environment. One illustration of this can be seen in the trends in the fixed versus variable rate debt structure (see Chart ). This is only a partial picture - as not all debt is split out in this way - and far more complex in reality given extensive use of swap markets. Nevertheless, it shows how the European corporate sector has been able to move away from a peak level of reliance on floating rate bank debt in to a post high in the share of fixed rate debt. Companies have capitalized on the attractive refinancing opportunities presented by the bond market. CHART PROPORTIONS OF FIXED AND VARIABLE RATE DEBT - S&P RATED NON FINANCIAL CORPORATES Source: S&P Capital IQ, S&P Ratings. S&P rated non-financial corporates only. Figures for are for the last twelve months. Data show relative proportions of debt where classification available as to being on a fixed or variable rate basis.. 9 LTM Europe - Variable Rate Debt (% of Identifiable Total) Europe - Fixed Rate Debt (% of Identifiable Total) % 9% % % % % % % % % % 9 LTM CreditResearch December

9 Standard & Poor's Ratings Services European Corporate Credit Outlook. REGIONAL DISPARITIES REMAIN A CONCERN Regional disparities in Europe in terms of growth, returns and access to capital continue to be a major source of risk. Of particular concern is the continuing divide between effective corporate interest rates across Europe with companies in the southern periphery still reporting access to bank finance as being challenging due to restrictive terms and conditions as well as being expensive. As shown in Chart this remains most acute for SMEs located in these regions with Spanish companies still having to pay more than a % risk premium for smaller loans compared to their German counterparts. This is not sustainable if the more capital intensive Spanish and Italian companies in particular are to become more competitive globally. CHART PERIPHERAL CORPORATES PAYING HIGH RATES NEW NFC LOANS (OVER YEAR) % Italy Germany Spain Jan- Jan- Jan- Jan- Source: ECB. New Loans to non-financial corporations of over year duration and up to million euros in value Funding-cost differentials are part of the explanation for the gap in returns on capital that has opened up since 9 between northern and southern Europe (see Chart ). CHART RETURN ON CAPITAL EMPLOYED NORTHERN V SOUTHERN EUROPE (S&P RATED) Northern Europe - Return On Capital (%) Southern Europe - Return On Capital (%) 9 Source: S&P Capital IQ, S&P Ratings. S&P rated non-financial corporates only. Figures for are for the last twelve months.. recovery and little in our macro-economic forecast to suggest that we should expect this to change. Moreover, the contagion effect is writ large, with the rebound in northern European returns on capital having abruptly reversed since. RISKS TO OUR VIEW We remain vigilant over sources of risk that could undermine the burgeoning recovery. The main concerns that we have over the next year that could trigger a relapse in consumer and business confidence include: Renewed volatility in financial asset markets as the Fed taper begins. Higher long-term US Treasury yields could lead to substantial losses for investors and trigger an exodus from higher yielding, less liquid assets including emerging markets and perhaps the peripheral bond markets in Europe. A flare up of sovereign-related risk cannot be ruled out. Without further significant eurozone rebalancing, we believe periphery economies will find it increasingly difficult to reduce their high external leverage and the eurozone crisis will continue to simmer. The risk that European banks tighten credit lending standards further ahead of the Asset Quality Review to be undertaken by the ECB in. This could be especially harmful for small and medium sized enterprises that remain wholly reliant on bank funding. Its impact would fall disproportionately on SMEs in the weaker economies such as Spain and Italy. Pressures on companies to return cash through buybacks and higher dividends and, in the high-yield and leveraged space, to borrow to fund investor payouts could increase significantly. Higher debt multiples arguably would also make it easier for private equity firms to deploy the significant equity capital that they have to invest by enabling them to hit their return targets despite the relatively high prices of acquisitions. BUT PROCEED WITH CAUTION Over the next year, while we expect the direction of travel for credit quality to be positive, it is in some ways an improvement born of marginal operating gains and continuing financial caution. We expect the European economy to show further improvement but not by enough to overcome the negatives of weak revenue growth and pressures on profitability. We see little scope for a major turnaround in the global capex cycle. Moreover, the uncertainty created by the Federal Reserve's gradual reduction in the scale of unconventional monetary stimulus and continuing uncertainties around bank lending all suggest an understandable need to preserve cash. Europe's corporates are likely to continue to proceed with caution. Returns for companies domiciled in the south have been on a broadly downward trend since, with little sign yet of CreditResearch December 9

10 Standard & Poor's Ratings Services European Corporate Credit Outlook CORPORATE CAPEX SURVEY Our Global Corporate Capital Expenditure Survey suggested that hopes for a recovery in global capex are misplaced. Updating this work reinforces this view and points to a % decline in real terms global corporate capex in. Over the last decade, capex growth has been increasingly reliant on commodity-related sectors. The fading commodity 'supercycle' means capex will remain under pressure. Capex fatigue is also apparent in many emerging markets. Capital expenditure (capex) and its relative absence has been a big theme in and one on which we have written extensively. Hopes remain high that might bring an upsurge in capex given the stabilization of financial markets, ageing capital stocks and plentiful corporate cash balances. Certainly, measures of sentiment (see Chart ) with regard to capex intentions have shown improvement. CHART IFO WORLD ECONOMIC SURVEY - CURRENT AND FUTURE CAPITAL CAPEX IFO World Economic Survey - Capex - Present Situation IFO World Economic Survey - Capex - Next Months Diffusion index ( = % pessimism, 9 = % optimism) Source: IFO, Thomson Reuters Datastream, S&P Ratings Improving Deteriorating 9 Our view remains, however, that capex is likely to disappoint in. While our relatively cautious prognosis for the European economy explains why regional capex might remain subdued, we think it is important to keep in mind the broader context given that Asian and US capex are the key drivers at a global level. We have updated the analysis from our Global Corporate Capital Expenditure Survey, which looked at trends for the the, companies globally that spend the most on capex. We combine consensus estimates with recent guidance from companies themselves to derive forward projections for (real terms) capex growth. Since we published our survey in July, the estimated growth rate for has risen from minus % to positive % (rounded). Rising expenditure from telecoms companies on th generation (G) mobile networks is one factor in this. However, the estimated growth rate for has not changed at all, suggesting that our concern that global capex will fall next year remains warranted. See "Cash, Caution, And Capex Why A Trillion Euro Cash Pile Is Unlikely To Drive A European Capex Boom" (Feb, on Ratings Direct) and "Global Corporate Capital Expenditure Survey ", (July, on Ratings Direct). CHART GLOBAL CAPEX GROWTH - - -, IMF. Universe is Global Capex This is a global phenomenon, All major regions are expected to see real capex decline, with a notably strong negative contribution from Asia Pacific. In the US too, the shale-inspired investment surge of - is ebbing. CHART GLOBAL CAPEX GROWTH - REGIONAL COMPOSTION ANALYSIS - - Non-Financial Capital Expenditure Growth (YOY%, Real, USD) Per cent -, IMF. Universe is Global Capex The fading of the global commodity cycle has led to the major mining companies aggressively cutting back their spending plans and consequent knock-ons in revenues and investment at engineering equipment manufacturers. As we pointed out in our survey, this reversal is extremely important. It represents a change in trend for what has Estimate APAC ex Japan N.America Latam W.Europe EEMEA Japan Global Total Percentage Points - CreditResearch December

11 Standard & Poor's Ratings Services European Corporate Credit Outlook been the single largest driver of capex growth globally over the last decade. Energy and materials together accounted for 9 % of corporate capex from - (Chart 9). CHART 9 SECTOR CONTRIBUTION TO CAPEX GROWTH FROM - Information Technology %, IMF. Universe is Global Capex So in terms of negative contributions to the estimated % fall in global capex in (Chart ), it is not surprising that that the energy and materials sector is by far the largest element. CHART GLOBAL CAPEX GROWTH - REGIONAL CONTRIBUTION ANALYSIS Telecoms % Industrials % Consumer Staples % Utilities % Consumer Healthcare IT & Telecoms Global Percentage Points Consumer Discret'ry % Materials % Energy % Healthcare.% Energy & Materials Industrials Utilities Estimate, IMF. Universe is Global Capex Within Western Europe, non-financial corporate capex growth has held up better than one might expect (Chart ) with close to % real terms growth seen in and. However, this modest recovery owes much to Europe's oil companies who have continued to grow capex. Excluding energy and materials reveals a weaker underlying picture with limited growth from to that has not brought the level of capex back above the peak in real terms. Note that here we are looking at only Western Europe and looking at both rated and unrated companies. CHART WESTERN EUROPEAN CAPEX GROWTH YOY % - -, IMF. Universe is Global Capex There are also some striking differences in trend between northern and southern Europe (see Chart ). The figures are not directly comparable to the work from our Corporate Capex Survey, as they refer to our rated universe only and are calculated in nominal euro terms. Nevertheless, two features emerge. First, capex trends are even worse in southern Europe than for the rest of the region. This clearly illustrates the impact that weak growth, high unemployment and low confidence is having on corporates in that part of Europe. Second, there has been a pronounced deterioration in the north over the last twelve months, partially reflecting contagion from the euro crisis. CHART NORTHERN V SOUTHERN EUROPE CAPEX GROWTH (EUR, NOMINAL, RATED ONLY) Non-Financial Non-financial Ex Energy and Materials Estimated 9 Northern Europe - Capital Expenditure Growth (YOY%) Southern Europe - Capital Expenditure Growth (YOY%) Source: S&P Capital IQ, S&P Ratings. S&P rated non-financial corporates only. Figures for are for the last twelve months In conclusion, while it is valid to point at high cash balances and ageing capital stocks as reasons why there ought to be a turnaround in capex in, we continue to suspect that will be a disappointing year for capex. In Europe, weak operating conditions and pressure on cash flow mean that cash will be used only carefully. Globally, the commodity slowdown will inevitably crimp capex given how pivotal this industry has been to capex growth over the last decade. CreditResearch December

12 Standard & Poor's Ratings Services European Corporate Credit Outlook BORROWING AND ISSUANCE After five years of tight financial control as management teams act to protect against unpredictable external events and as funding conditions in debt capital markets threaten to become exuberant, we believe market liquidity continues to act as a support to credit quality that, on balance, should persist through. BACK TO BASICS Clearing debt remains unfashionable. A legacy of the corporate debt accumulated before the financial crisis is that low growth and free cash flow pressure means that the majority of outstanding (nominal) debt is not repaid at maturity but rolled-over. The hope is that over time inflation will erode the debt burden in real terms. Richard Koo of the Nomura Research Institute has coined the phrase Balance Sheet Recession to explain why the necessary adjustment can, as in the case of Japan, take such a long time. Indeed, as much as % of corporate bank lending originated in Europe between - supported M&A, including leveraged buyouts. A good part of this debt issuance simply replaced existing debt. But a material part essentially financed the control premium required to obtain ownership of the company. Seen in this light, the substantial reduction of corporate bank lending in recent years (Chart ) may not be as damaging to the economy as it may appear at first glance. In fact, refinancing corporate bank debt and lending for general corporate purposes, the lifeblood of corporate existence (using Dealogic transaction data) averaged billion per year between -. The 9- average was billion, a reduction of just over %. By contrast, bank lending to support M&A and LBO activity has fallen % over the same period. DISINTERMEDIATION TO CONTINUE Of course this is not to say that banks have not been refocusing on core business and deleveraging their balance sheets. More onerous lending terms and conditions, as well as the dramatic reduction of risk-free rates in government and most corporate bond markets have encouraged corporates increasingly to replace floating-rate bank-debt. The volumes have been material. For instance, since the start of 9 the bond market has provided % of investment-grade-corporate debt-funding on average compared to only 9% between - (Chart ). The difference amounts to a meaningful billion since the start of 9. The bond market proportion would be much higher if the comparison only took account of funded term bank debt and excluded undrawn revolving credit facilities. The bond market has also become an increasingly viable funding channel for sub-investment grade companies looking to reduce their traditional dependency on the banks. CHART EUROPEAN IG CORPORATE DEBT ISSUANCE bn IG Loan Issuance Bonds % IG IG Bond Issuance % % % CHART EUROPEAN CORPORATE LOAN MARKET ISSUANCE Refinancing GCP Repay Debt Project Financing LBO/MBO Acquisitions bn,, 9 Source: Dealogic. IG Investment Grade % % % % - 9 Chart highlights the renaissance in the leveraged finance market and the growing relative importance of the high yield market in the overall mix. Since the middle of 9 the high yield bond market has provided an average 9% of gross funding compared to only % in earlier years from with the difference amounting to billion since mid-9. Source: Dealogic; S&P Ratings, GCP General Corporate Purposes CreditResearch December

13 Standard & Poor's Ratings Services European Corporate Credit Outlook CHART EUROPEAN SIG CORPORATE DEBT ISSUANCE Lev. Loan Issuance HY Issuance bn Bonds % SIG % % % % % % % % % 9 We think that investors are right to resist this development as the European secondary market is far less liquid than the US market Our second observation, specifically relating to LBOs, is that the level of equity contributions are materially higher in Europe than the US (Chart ). In our view this acts to mitigate the downside risks to credit quality of LBOs in Europe and to some extent reflects the dismal recovery experience of subordinated lenders over the last cycle in Europe. Given the relatively high level of equity valuations and the limitations on leverage we think the level of equity contributions in Europe are likely to only reduce slowly. CHART LBO EQUITY CONTRIBTION EUROPE V US Source: Dealogic. SIG Sub-Investment Grade Equity Contribution US Equity Contribution Europe DOES THIS SPELL TROUBLE? Looking in a little more detail at the leveraged finance market, does the increase in leveraged loan and bond issuance point to a material deterioration in credit quality in for speculative grade issuers? The short answer is that, on balance, we do not think so. Several reasons feed into our judgment. These include: Improved liquidity in financial markets supports weaker companies wishing to refinance, and is particularly beneficial for those diversifying funding away from banks Greater high yield issuance with - year maturities priced at historically low yields is a positive for the liquidity position of corporates While we expect leverage multiples to gradually move higher from current levels of around.x for total debt/ebitda in Europe, they remain well below the peak levels of.x seen in using data from S&P Capital IQ LCD. Furthermore, cash interest cover ratios at about.x in Europe in provide much greater leeway than the trough of.x in given the low level of euribor that will persist for a couple more years at least. Trends in structures present a greater risk for credit quality in our view, although we think these risks are likely to be containable in the European market for a while at least. Two specific aspects relate to covenant provision and the level of equity contributions for LBOs. On covenant provision, one concern is that the trend towards covenant-lite leveraged loan transactions seen in the US will migrate to Europe. Over % of US loan transactions in do not contain any maintenance financial covenants, according to S&P Capital IQ LCD, benefitting borrowers financial flexibility quite significantly. In Europe, to date there have been no purely covenant-lite deals for transactions that only contain euro debt tranches sold to investors in Europe. % % % % % % % Source: S&P Capital IQ LCD. Figures for are for last twelve months Nevertheless, we do have reservations over the small but potentially growing number of recapitalizations undertaken to make payments to shareholders or refinance shareholder loans or preference shares. Absent the ability to exit their investments, increasing leverage moderately where debt levels have been reduced is often quite neutral from a credit perspective, but we would view a more substantial increase in debt levels quite negatively. These opportunistic transactions, in our view, largely reflect the perceived imbalance between supply and demand in the market and play to the interest of shorter term, speculative investors engaged in arbitrage rather than long term institutional investors. More conventional fund raising from corporate borrowers and primary LBOs would likely restore greater equilibrium to the market making it harder to sell the more esoteric instruments such as holdco PIK and PIK toggle transactions. In summary, we view the increasing volumes of bond market issuance as a credit positive for now, and while cognizant of the risks, we think that it is unlikely that technical market conditions will provide a material threat to evolving corporate credit quality in. CreditResearch December

14 Standard & Poor's Ratings Services European Corporate Credit Outlook DEFAULTS & RECOVERY Weak credit quality among the companies in our private credit estimates portfolio is keeping European default rates elevated. As a consequence, we believe the region's default cycle will extend for a further two years, although we anticipate a moderate reduction in the overall default rate from its current level of.%, to.% by the end of. However, we anticipate a modest rise in the default rate for publicly rated companies to.%, from.% currently. LEGACY TRANSACTIONS AND DEFAULT RATES The extended default rate cycle in Europe continues in part because underperforming legacy transactions that originated just before the financial crisis of -9 are approaching their debt maturity and require refinancing. Meanwhile, we anticipate that ahead of the European Central Bank's (ECB's) bank asset quality review (AQR) next year, the European Banking Authority's (EBA's) new loan forbearance guidelines are likely to encourage lenders to accede to restructurings, notwithstanding the credit support derived from low interest rates in servicing debt. In our view, such restructurings are likely to exert some upward pressure on the default rate over the next year or two. According to our latest default study data, the trailing-- month default rate for speculative-grade companies (that is, those rated 'BB+' and below) in Europe has averaged.% over the past five years (including private credit estimates), only falling below % for one quarter during this period. This contrasts with our experience in the U.S., where, in predominantly a rated market, the public default rate peaked at.% in the third quarter of 9, but has averaged only.% over the past five years. In our view, the ability to refinance stressed companies (at a price), together with the tried and tested Chapter bankruptcy process, have helped the U.S. leveraged finance market to recover quickly. In the months to Sept.,, the combined corporate default rate by number in Europe was.%. This comprised rated defaults, representing a public speculative-grade default rate of.%; and private credit estimate defaults, representing a 9.9% default rate (see table ). The prior year comparison was very similar, with defaults and a combined default rate of.%. TABLE EUROPEAN DEFAULT RATE BY VOLUME Private Credit Estimates Public Ratings Combined No. of Defaults Default No. of Defaults Default Default rate entities* rate (%) entities* rate (%) (%) Q Q Q Q Q... Q Q. 9.. Q Q.9..9 Q... Q Q... Q Q... Q... Q Q. 9.. Q... Q Source: S&P Ratings. *Average number in database over period. TTM-- Trailing months. Europe--EU- + Iceland, Norway, and Switzerland The number of private defaults moderated somewhat in the third quarter of, resulting in the private credit estimate default rate declining to 9.9% from.% at end of the second quarter (see chart ). The continuing stream of private defaults, together with a shrinking credit estimates portfolio, maintains the private default rate at relatively high levels, but over time reduces its weight in the overall default calculation. CreditResearch December

15 Standard & Poor's Ratings Services European Corporate Credit Outlook CHART EU DEFAULT RATE BY VOLUME CHART EU CORPORATE DEFAULT VALUE % % % Combined Private CEs SIG Ratings Q 'f Private CEs Bn Month Value SIG Ratings % % % Q Q9 Q9 Q Q Q Q Q Q Q Source: S&P Ratings However, by value of defaulted debt, the combined default rate at.% at the end of the third quarter (see Table ) moderated slightly from.% at the end of the second quarter and remains below the.% average over the last business cycle. TABLE EUROPEAN DEFAULT RATE BY VALUE Private Credit Estimates Public Ratings Combined No. of defaults Value (, Billion) Default rate (%) No. of defaults Value (, Billion) Default rate (%) Default rate (%) Q Q Q Q Q..... Q Q..... Q Q Q Q Q Q..... Q..... Q..... Q..... Q Q Q..... Source: S&P Ratings. *Average number in database over period. TTM-- Trailing months. Europe--EU- + Iceland, Norway, and Switzerland The volume of outstanding debt owed by defaulting companies remains relatively constant at about billion per quarter (see Chart ) for both the public and private portfolios that we track. This reflects the fewer, but larger, rated defaults compared with the more frequent, but smaller, debt amounts of leveraged loan defaulters. For context, the outstanding debt held by the most vulnerable companies rated 'B-/b-' or lower as of September amounted to. billion. Source: S&P Ratings Unsurprisingly, the great majority of these vulnerable companies originated at the tail end of the last cycle in and when primary volume peaked at. billion and. billion, respectively. Prepayment rates for these two years, taken from S&P Capital IQ LCD's European Loan Index as of October, are relatively low at only % and %, respectively, which implies to us that a material billion (approximately) still needs to be refinanced. Given the weak credit quality of many of these private entities, we expect the default rate to remain elevated over the next two years. SECTOR DEFAULT TRENDS From a sector perspective, transportation and business services have contributed disproportionately to the overall default rate over the past months (see Table ). Transportation defaults reflect tough competition in the global logistics industry and weak conditions in parts of Europe. They also take into account structural challenges within certain segments of the shipping industry where excess capacity has severely depressed charter rates for some business lines, including containers and dry bulk carriers. The relatively high default rate in business services - all leveraged buyouts (LBOs) in the private unrated area - largely reflects the effects of weak growth, rising unemployment, and curbs in government spending, with three businesses in France defaulting between the fourth quarter of and first quarter of. Media and entertainment, with the highest number of companies in our combined portfolio, continues to post a consistently above-average default rate. There are a number of reasons for this. Print publishing, for instance, remains pressured by online media. In the leisure and entertainment segment, revenue growth in businesses with a highly leveraged capital structure remains vulnerable in regions where there has been a toxic combination of weak consumer confidence and declining real household incomes. CreditResearch December

16 Standard & Poor's Ratings Services European Corporate Credit Outlook Several gaming and travel companies in the periphery of the Eurozone have suffered of late. Spain-based Codere S.A., for example, defaulted for a second time this year in the third quarter after missing an interest payment. However, Codere's financial difficulties do not arise purely from adverse developments in Europe (including higher taxes in Italy); they partly stem from a smoking ban in Argentina and the temporary closure of gaming halls in Mexico. At the other end of the industry default spectrum there has been a sharp reduction in defaults in the consumer products industry. We believe was an exceptional year as consumer product companies were caught between rising commodity prices on the one hand, and falling disposable incomes squeezing consumer demand on the other. This year, the sector, which we consider to have low industry risk, appears to be stabilizing. TABLE EUROPEAN DEFAULT RATE BY VALUE Default Rate* (%) No. of Entities 9 Q Transportation Business services Media and entertainment Retail/restaurants Homebuilders/real estate Chemicals, pckg.,envir Utilities Telecommunications Capital goods Health care Forest products Automotive Consumer products Oil and gas Source: S&P Ratings * Data combine public and private ratings. Europe-- EU- + Iceland, Norway, and Switzerland PRESSURE ON THE PERIPHERY Breaking down defaults by number for major European countries reveals some notable trends. The -month default rate has remained high in Spain (.%) and Italy (.%), similar to, although we would caution that the number of companies that we keep under review in these countries is fairly limited at about and, respectively. The depressed economic environment and difficult banking climate are important factors that contribute to these elevated default rates, in our view. Of greater interest is that the default rate in France has continued to pick up, reaching.% at the end of September from.% at the end of December, with defaults materializing over the past months in our combined portfolios. Notably, of these defaults were triggered by missed interest or principal payments, and two larger transactions with widely syndicated debt of more than billion were restructured. Market participants consider the two debt restructurings, for Saur and Terreal, as groundbreaking because the lender-led groups managed to achieve unanimous consent from all stakeholders to put the capital structure on a more sustainable footing. CHART 9 EU DEFAULT RATE BY COUNTRY % Spain Italy U.K. Source: S&P Ratings EBA GUIDANCE AND RESTRUCTURING France The Netherlands Germany 9 Q This requirement to achieve unanimous consent in France highlights the difficulties of proactively addressing credit problems before companies become insolvent. Ahead of the ECB's bank AQR next year, the EBA is collecting information from across the eurozone to promote a more consistent, standard approach for identifying amend-toextend, or forborne, transactions and assessing whether they are properly provisioned. In France, for instance, it's accepted practice for banks to classify assets on the banking book as performing as long as no loss of principal is incurred. Looking ahead, we believe the EBA will expect banks and their local regulators to systematically review and report on transactions where a concession to the debtor has been agreed. The EBA defines a concession to encompass either: A modification of terms and conditions of a contract with which a debtor is unable to comply due to financial difficulty, in order to allow for sufficient debt service; or A total or partial refinancing of a troubled debt contract that would not have been granted had the debtor not been in financial difficulties. A concession expressed in these terms encompasses our definition of a distressed exchange, which we view as an event of default under our criteria. The two specific conditions we look for are i) where investors will receive less value than the promise of the original debt instrument; and ii) where we view the transaction as distressed rather than purely opportunistic (see "Rating Implications Of Exchange Offers And Similar Restructurings, Update," published May, 9). From our perspective, the EBA's definition of forborne exposures for debtors in financial difficulties is likely to lead CreditResearch December

17 Standard & Poor's Ratings Services European Corporate Credit Outlook to a more realistic and timely approach to dealing with legacy borrowers that will never be able to fully repay their debt. This is important, because we expect that banks will be required to publicly detail these exposures in their reporting statements. As a consequence, it is our belief that this will lead lenders to restructure many of the vulnerable legacy transactions still to be refinanced over the next two years. CLO REFINANCING AND THE BOND MARKET Chart details how the legacy leveraged loan portfolio is changing. Since 9, many larger LBOs with leveraged loans held by institutional lenders--mainly collateralized loan obligations (CLOs)--have refinanced bank debt in the bond market. But this has typically only been feasible for those companies at 'B/b' or higher. There has been some downward migration in credit quality, usually due to tightening covenant headroom warranting a more cautious assessment of the liquidity position of the company. Meanwhile, companies such as Numericable and Kion have either undertaken IPOs or been sold to trade buyers. Again, these actions apply most often to stronger companies. Other loans have been sold out of CLO portfolios. These include cases where senior noteholders have voted to liquidate the financing vehicle at the end of its reinvestment period. Some of these assets, however, have been parceled into European CLO. transactions (that is, European CLOs issued in ). The net result is fewer private credit estimates, but with just over % (or -plus companies) still heavily clustered in the 'b-' and 'ccc' categories (see chart ). CHART EU CREDIT ESTIMATE DISTRIBUTION CCC/CC B- B B+ BB- BB BB+ Number 9 Q Source: S&P Ratings In contrast with our private portfolio, the credit quality of our rated high-yield portfolio is materially stronger. As of Sept.,, % of speculative-grade issuers were rated in the 'BB' category, % were rated 'B+', and % were rated 'B'. The latter being the fastest-growing category for new ratings (see chart ). CHART EU SIG CORPORATE RATINGS DISTRIBUTION CCC/CC B- B B+ BB- BB BB+ Number 9 Q Source: S&P Ratings. SIG Sub-Investment Grade DEFAULT RATE TO MODERATE IN What does this all mean for European corporate defaults over the next year? In summary, under our base-case stress scenario we anticipate a moderate reduction in the combined default rate to.% by year-end, lower than our most recent forecast of.% for the end of September. This compares with the latest actual default rate of.% at end-september. This is in line with our forecast for the end of made back in December. Our assessment takes into account the following assumptions: A continued subpar recovery in the eurozone, with countries in the periphery and the soft core lagging behind Germany and the U.K. Continuing very low official policy rates, which significantly improve companies' ability to service debt. That said, financial fragmentation across the eurozone means that risk premiums remain disadvantageous for borrowers located in the peripheral countries. Vulnerable credit risk profiles for a majority of companies within our private credit portfolio, mostly LBOs originated in - that have delayed refinancing ahead of maturities falling due in the next two years. These include a substantial number of companies that have previously defaulted, but for whom leverage remains excessive. A bifurcated debt market, where debt capital markets are highly liquid for stable and growing businesses with appropriate capital structures. Meanwhile, the bank market continues to retrench mainly for regulatory reasons and the lending capacity of the European CLO market shrinks on a net basis as mature vehicles exit reinvestment. Somewhat related, and as discussed above, we anticipate that the ECB's AQR will renew the focus on restoring confidence in the quality of banks' balance sheets, and the CreditResearch December

18 Standard & Poor's Ratings Services European Corporate Credit Outlook EBA's guidance on forbearance will prompt investors to show a greater willingness to restructure weak corporate balance sheets. CHART RECOVERY RATES BY INSTRUMENT - Median Average # Instruments (rhs) TABLE EU CORPORATE DEFAULT PROJECTIONS TO DEC % % Ratings / Credit Estimates Base Case Default Assumptions Downside Case (% per annum) Public Credit Public Credit Ratings Estimates Combined Ratings Estimates Combined >B B+.... B....9 B CCC / CC.... Default Rates Percentage No. of Defaults Source: S&P Ratings % % % Source: S&P Ratings Note: % Bank debt (st Lien) Snr dec. notes Snr unsec. notes Bank debt (nd lien) Unsec. sub. notes Bank debt (mezz.) RECOVERY RATES LOOK SET TO SLIP Recovery prospects for subordinated lenders look poised to slip as a supply-demand imbalance in the leveraged finance market causes capital structures to become more aggressive and less creditor-friendly. Aggressive central bank actions that target any and all transmission channels to stimulate the real economy only serve to encourage this slippage, in our view.. EBA Final Draft ITS on supervisory reporting of forbearance and non-performing exposures under Art. 99() of Regulation (EU) No. /. That said, institutional investors are now more aware of the downside risks attached to potential investments, particularly in terms of seniority and legal risks. The recovery experience achieved by the bulk of second-lien and mezzanine lenders over the last business cycle has been particularly poor (see chart ). Positively, we note that as much as % of high-yield issuance has provided senior security for lenders. More controversial is the growing prospect that, following developments in the U.S., covenant-lite leveraged loans will become accepted in Europe even for wholly European deals. To date, European investors have only been exposed to noncovenanted loan transactions on cross-border deals such as Oxea S.a.r.L that have been sold into both the U.S. and European markets. Although our research has not been able to point to any hard evidence that covenant-lite transactions lead to lower ultimate recoveries, we concur with the argument of investors that there needs to be a trade-off between the ability of senior lenders to take control of an underperforming business and the ability to trade out of an asset before maturity. The real risk that we see is that in a tougher market environment secondary market liquidity will dry up, locking lenders into a transaction without any way of protecting themselves outside of buying credit protection (assuming that it is available). CreditResearch December

19 Standard & Poor's Ratings Services European Corporate Credit Outlook DEFAULT STUDY METHODOLOGY Our default study covers the broadest investable universe for European institutional investors by including leveraged loans and high-yield bonds. Our universe comprises speculativegrade nonfinancial companies (that is, those with a public rating of 'BB+' or private credit estimate of 'bb+' or lower) domiciled in Europe (EU- plus Norway, Switzerland, and Iceland). The calculation of the denominator used to determine the default rates is the average number of companies in the respective rated and private unrated portfolios over the - month period. This methodology is different to that applied by Standard & Poor's Global Fixed Income Research (GFIR). GFIR only tracks rated corporate defaults including financial institutions and insurance companies using the number of speculative grade companies at the start of the year as the denominator. STANDARD & POOR'S DEFINITION OF DEFAULT For publicly rated companies, we record a default when we see that a company fails to make a scheduled payment of principal or interest on any financial obligation, files for bankruptcy, or completes the restructuring of a financial obligation involving what we consider to be a distressed exchange offer. We recognize defaults on the date that we assign a 'D' (Default) or 'SD' (Selective Default) classification to the company. For private companies, the process is not quite so straightforward. Where a coupon or principal payment is not paid on time (after any relevant grace period elapses) we then consider that the default occurs on that date. However, in the case of a debt restructuring, we recognize that a default has occurred either on the date a restructuring plan is implemented (if payments remain current) or on the date of the first missed payment, whichever occurs first. Due to the time lag involved in receiving information relating to restructurings for private unrated companies, or to companies that defaulted after their ratings were withdrawn, it is not uncommon to revise default rates over time. CreditResearch December 9

20 Standard & Poor's Ratings Services European Corporate Credit Outlook RATINGS TRENDS Credit quality for European rated corporates is showing signs of stabilization. The net outlook bias remains modestly negative at -%, but a marked improvement compared with the -% reading at the start of the year. Sovereign-related downgrades in the fourth quarter have undermined the more positive trend seen in recent quarters. Nevertheless, under our base-case economic scenario we expect further gradual improvement through. CORPORATE CREDIT-QUALITY IMPROVING SLOWLY We have seen a gradual improvement in ratings activity for European corporates in recent quarters, with investment grade seeing a notable reduction in downgrades (see Chart ). For sub investment grade, the ratings revisions balance has seen a steadily improving trend, with upgrades exceeding downgrades for the first time for years in the third quarter (see Chart ). CHART EUROPEAN INVESTMENT GRADE RATINGS UPGRADES, DOWNGRADES AND NET CHANGE Number Upgrades Downgrades Net However, the fourth quarter saw a sharp correction in this trend mainly as a result of recent sovereign downgrades in France and The Netherlands that have affected government related entities such as SNCF (AA-/stable) and GasTerra B.V. (AA/stable). There have also been downgrades linked to the downturn in the commodity sector. This has affected metals and mining companies directly but also had a knock-on effect on capital goods companies that provide investment-related goods to the commodity industries. CHART EUROPEAN RATINGS OUTLOOK DISTRIBUTION WatchPos % Positive % Stable % Negative % WatchNeg % Source: S&P Ratings. * Calculated as of December,. CHART EUROPEAN SUB-INVESTMENT GRADE RATINGS UPGRADES, DOWNGRADES AND NET CHANGE Number Upgrades Downgrades Net Source: S&P Ratings. * Calculated as of December,. Source: S&P Ratings. Calculated as of December,. Even so, it would be fair to characterize recent trends as reflecting a slow but broad improvement. This is reflected in the net negative ratings outlook bias of our corporate ratings which has declined from minus % at the end of to minus % currently. However, it still remains more negative than in the US where the outlook distribution is almost in balance with a net % negative outlook bias. This reflects the still challenging business outlook for the region that is limiting the ability of many rated companies to materially improve their financial performance and reduce debt. Sentiment is showing signs of improvement in the stabilization of our cross-sector survey of the business outlook. This is shown in Chart, which illustrates the results of our quarterly Corporate Credit Conditions Survey. This forms part of the analytical input into the S&P Credit Conditions Committee. The -month business outlook diffusion index which indicates the relative proportions of analytical teams CreditResearch December

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