Fundamental credit profiles of European high-yield bond and loan issuers appear set to deteriorate as monetary policy tightening accelerates and the gas crisis results in recession, Fitch Ratings says in its latest European leveraged credit ‘At-Risk’ report. Higher interest expenses from rising benchmark rates on floating-rate borrowers will lead to weaker free cash flow and debt service metrics, while top-line revenue and gross margins remain vulnerable to rising input costs and weaker volumes.
 
In contrast to the role of quantitative easing during previous periods of capital market volatility and deteriorating economic conditions, we expect European and US central bank policies may no longer support fiscal easing to protect households and companies from economic shocks. With liquidity conditions tightening, large-scale fiscal easing in response to gas price and cost of living shocks could push up long-term real interest rates for longer. We will take a conservative approach to refinancing risk on borrowers with maturities approaching in 2024 and 2025.
 
Default rates continue to rise from post-pandemic lows. However, issuers at risk of default remain limited to legacy pandemic-affected credits with near-term maturities and balance-sheet liquidity constraints.
 
We expect net downward rating migration for credits unable to adjust to sharply rising interest expense and cost-input prices. Even performing credits with pricing power and entrenched market positions may require a shift in financial policies towards lower leverage profiles as tighter primary market conditions appear set to endure into 2023.