Fitch: Rising debt levels boost default prospects in Europe, Middle East, Africa

By Angela McDaniels

Seattle, March 20 - Fitch Ratings said that while the existence of liquidity and the extent of high-grade issuance might ameliorate any immediate credit concerns about a significant increase in defaults in Europe, the Middle East and Africa in 2007, there is mounting evidence to suggest that the market's resolve will be tested more thoroughly from 2008.

A higher amount of lower-rated bonds are due to mature from next year, coinciding with what the agency anticipates will be a period in which increases in interest rates will take greater effect and more risk reflective pricing will be employed.

Current growth in industrial bonds rated BBB or below is close to 30% per year, with those in the B category around double that rate, thus providing scope for an increase in negative rating actions, if not defaults, should the credit markets turn, Fitch said.

"Of note is the extent of speculative grade-rated bonds outstanding within some of the more volatile or cyclical sectors," Jonathan Cornish, a senior director in Fitch's credit policy group, said in an agency report.

"Bond maturities in 2007 are quite negligible, but in aggregate some €3.4 billion of bonds from these sectors alone will mature in 2008, with another €2.8 billion falling due in 2009. Of course, in the coming few years a great deal more loans also fall due for some of the less creditworthy borrowers."

The corporate bond market in Europe, the Middle East and Africa has maintained double-digit pace throughout the decade, the agency said. At the end of 2006, there was €5.914 billion of Fitch-rated bonds outstanding, which represents an increase of €1.221 billion, or 26%, from the end of 2005, though less than the 34% average growth rate since 2000.

The agency said it recognizes the growth in speculative-grade bonds as being from a relatively low base and, by maintaining such a pace, it will not materially alter their percentage contribution to total bonds outstanding, given the market's overall growth levels.

Speculative-grade bonds represent only a modest percentage of the market, Fitch said - currently, around 98% of bonds outstanding at the end of 2006 were rated BBB or higher, with most bonds in the AAA or AA categories.

Meanwhile, $1.706 billion of syndicated and leveraged loans were added in 2006, following the $1.531 billion written in 2005.

The agency said competition in recent years between the loan and debt capital markets - particularly at the speculative-grade and low investment-grade levels - had relaxed attitudes toward risk pricing and covenant protection. Although the recent market volatility has, if anything, reminded creditors of the need to remain vigilant in managing their exposures, as and when the credit cycle turns any further relaxation of risk tolerance now could later see a boost in absolute levels of defaults and, importantly, also the loss severity on such instruments, Fitch predicted.

"A contraction in the amount of additional capital available to the more vulnerable entities is expected to provide the impetus for a hike in defaulting borrowers. In previous instances of heightened and sustained volatility and/or less favorable operating conditions, lenders have tended to find solace among higher-grade credits, which typically means reduced levels of funding on offer to riskier credits," Cornish said in the report.

Fitch further predicted that any pronounced deterioration in credit conditions in Europe, the Middle East and Africa would likely have wider reaching implications in the future than in previous instances because unprecedented levels of liquidity and investor desire to capitalize on the sustained run of favorable operating conditions have been the catalysts for robust corporate debt issuance throughout the region.

The agency noted that investment-grade bonds and bonds form the banking and finance, insurance and supranational sectors currently account for 98% and 86%, respectively, of the total value outstanding in the European, Middle Eastern and African corporate bond market, compared with 82% and 49%, respectively, in the U.S. corporate bond market, where industrial issuance is far more meaningful in the context of the overall market.

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