Credit Strategy

EUROPE CREDIT STRATEGYUK Credit Review & Outlook

20 AUGUST 2O24

Cycle Bottom May Be Taking Shape for UK
Corporate Credit Risk

CONTACTSDavid Hamilton
Head of Research & Analytics
Predictive Analytics+1 914 356 6427
David.Hamilton@moodys.com
Joanna Su
Computational Journalist
Predictive Analytics+1 212 553 0300
Joanna.Su@moodys.com
Steve Kidd
Director
Predictive Analytics+44 (207) 772-8674
Steve.Kidd@moodys.com
Hanna Sundqvist
Director
Predictive Analytics+44 (203) 314-2217
Hanna.Sundqvist@moodys.com

But the path to sustained lower credit risk may not be direct
or smooth
Key Take-Aways:•

The outlook for UK corporate credit risk is cautiously optimistic, but the yearahead outlook does not indicate a peak or sustained easing of credit risk
until the latter part of 2025, as headwinds to improvement remain.

•

Credit risk for UK private companies edged down in the first half of 2024,with the average probability of default easing to 2.7% as of July from 3% inDecember 2023. For public companies, the average PD was 2.8% as of July,
within its range since mid-2023.

•

The realized default rate for Moody’s-rated UK companies may trend
down towards 1% over the next year from its current 1.3%.

•

Seven industry sectors saw their credit risk fall over the past 12 months
compared to 13 that deteriorated, indicating a broad-based improvement incredit risk for public companies in the UK has yet to take hold. In a positive
sign for UK credit risk, the share of firms with high or severe early warning
signals has fallen since the fourth quarter 2023.

FIGURE 1 After a technical recession in the last half of 2023, UK
corporate credit risk may be showing signs of topping out
Average 1-year probability of default (PD), monthly

ABOUT
This article is a product of Moody’s
Analytics, a division of Moody’s Corp.
separate from Moody’s Ratings. The
analysis and viewpoints expressedherein are solely those of Moody’s
Analytics.

Data source: Moody’s EDF-X platform.

Credit Strategy

Cautious Optimism – Emphasis on the Caution
The credit risk of UK companies appears to be showing signs of plateauing, but Moody’s year-ahead forecast does not yet
indicate a sustained easing of credit risk until the latter part of 2025. Credit risk measures came in mixed in the first sevenmonths of 2024, with the average probability of default for UK public and private companies moving in opposite directions.
Figure 1 shows the average one-year ahead probability of default (PD) for UK private and public companies from 2019 to July
2024.1 These time series plot expectations for the average level of corporate credit risk over the next twelve months, notrealized default rates. Credit risk for private companies edged down to 2.6% as of July from 3% in December 2023. For publiccompanies, credit risk has been range-bound between 2.8% and 3.1% since May of 2023. The average PD for publiccompanies was 2.9% as of July 2024.
The data in Figure 1 shows that UK-based companies weathered the technical recession in the latter half of 2023 reasonably
well. The average risk of default for both public and private firms was virtually unchanged in the last two quarters of 2023,
despite GDP growth registering -0.1% in Q3 and -0.3% in Q4. Yet, the first quarter 2024’s stronger than expected +0.6% GDP
print – the strongest growth since Q4 2021 – has also failed so far to materially bend the trajectory of credit risk across allcompanies. Private companies seem to have benefited most from the recent show of economic resilience, and althoughcredit risk for public companies did not rally in sympathy, it has nonetheless been stable. To put these figures into context, theone-year probability of default for UK corporates has averaged about 2.8% since 2004. So while credit risk for publiccompanies remains somewhat elevated relative to the levels just prior to and immediately after the pandemic shock, it has
been hovering in the range of its historical average since early 2023.
Changes in the average PD of public companies historically tends to lead changes in private company credit risk. This leading
relationship is visually apparent in Figure 1. Moody’s PD measures for both private and public companies incorporate forwardlooking market information, but the metric for public companies, which tend to be larger and have traded equity and debt,
responds to changes in expected credit risk faster. If that leading relationship holds up, we may see the average PD for private
firms tick back up again in the coming months, or move sideways until the average PD of public companies begins to show adownward trend.
FIGURE 2 Credit risk for public companies across the UK, the US, and Europe has converged
Average 1-year probability of default (PD) for public companies, monthly

The UK’s strong 1Q
GDP growth has so
far not materiallybent the trajectory ofcorporate credit risk.

Data source: Moody’s EDF-X platform.

1

The average one-year ahead PDs are calculated from Moody’s EDF-X platform, which includes data on over 75K public and 44M private
entities with detailed financials, 4M with payment data, and 98M inactive entities including those in default, merger/take-over status formore than 200 countries/territories globally. Learn more about EDF-X.
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Credit Strategy

The trend in credit risk for UK public companies has converged with those of other western economies. The
times series of average PDs for the US non-investment grade public company, UK public company, and Western
Europe company portfolios have converged to a level of around 3% as of July, as shown in Figure 2. The
convergence and the level of risk implied by these forward-looking forecasts of credit risk suggests a carefulbalancing of two tidal forces: interest rates that may be seeing their tightening cycle peaks and economic
growth, which has proved resilient but is increasingly seen as at-risk. The Bank of England’s August 1 rate cut
puts it in the club of five central banks that have recently lowered policy rates (that group includes Canada, theEuro Zone, Switzerland, and Sweden). At its most recent meeting, the Fed signaled the potential of a rate cut in
September.
The trailing 12-month default rate for Moody’s-rated UK debt issuers ticked down to 1.3% in July from 1.7% inJanuary. Moody’s Ratings’ default rate is one of the market’s key barometers of corporate credit risk. Although alagging indicator of financial health, the realized default rate is helpful for gauging trend. Figure 3 shows theaverage PD for UK private companies (the same as in Figure 1) and Moody’s Ratings’ trailing 12-month default
rate for rated UK debt issuers. 2 The average PD for private firms shows a strong leading relationship to therealized Moody’s default rate, leading changes by nine to twelve months. In the graph we have shifted theaverage private company PD forward by nine months to emphasize that relationship and highlight the potential
projected path of the Moody’s default rate. Based on the correlation in changes of the two time series, we
project that the UK default rate may drift down to 1.1% by the first quarter of 2025.3
FIGURE 3 Moody’s Ratings’ default rate for UK debt issuers may see further improvement
Average 1-year probability of default (PD) for private companies (shifted) and Moody’s trailing 12-month default rate, monthly

Private firm credit risk
shows a strong
leading relationship to
Moody’s default rate,
pointing toward alevel of 1% over the
next 12 months.

Data source: Moody’s EDF-X platform, Moody’s Ratings.

While the data we have discussed so far give reasons for cautious optimism, our longer-run, scenario-based
projections for corporate credit quality indicate that the path to sustained lower credit risk may not be direct orsmooth. We derive our longer-run forecasts of the average probability of default by conditioning the measureson two economic scenarios.4 The baseline scenario is the most likely expected set of economic conditions,some of whose key assumptions as of the time of this report include GDP growth below potential, a moderate
2

Moody’s Rating’s trailing 12-month default rate is based on counts of issuers, not volume of debt. The average PD for private companies isderived from Moody’s EDF-X platform and includes more than 270,000 UK companies.
3
The projected trend of the Moody’s default rate in Figure 3 is not a forecast made by the ratings agency. It is based only on the correlation
between the average private company probability of default and the realized historical default rate.
4
The full description of Moody’s economic scenarios, as well as other alternative scenarios can be found in Moody’s monthly economic
release “U.S. Macroeconomic Outlook Baseline and Alternative Scenarios.” The conditional average PDs shown in Figure 4 are based on theeconomic scenarios in the July 2024 release.
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Credit Strategy

uptick in the unemployment rate, and a gradual easing of the BOE policy rate. The recession scenario (S3), amuch less likely but plausible scenario, envisions a situation where real GDP declines by 0.1% in 2024 and by
3.9% in 2025.
Figure 4 shows the scenario-conditioned average PDs for UK public companies through the end of the fourth
quarter 2025. Moody’s forecasts a 1.3% chance of a recession in the UK over the next twelve months, and underthat scenario the projected average one-year PD for public companies would increase to 4.7% in the second
quarter 2025. That represents a level of expected credit risk exceeding that reached at the peak of thepandemic and not seen since the GFC. However, it is also a level of risk consistent with a garden variety
recession, such as 2001, rather than a catastrophic GFC-level event. The first quarter’s impressive GDP growth
has significantly reduced the likelihood of such a scenario.
Under the baseline economic scenario, the projected average PD peaks at 3.3% in the second quarter of 2025,
then subsides to 3.1% by the end of the fourth quarter 2025. This projection of credit risk is only slightly outside
the range the average PD has trended since the middle of 2023 (as we pointed out above). It also implies thatthe recent easing of credit conditions we see in the recent data (Figures 1, 2, and 3) may not yet signify a bonafide peak, and that the health of the economy and resolution of uncertainty about the future path of interest
rates will be critical for assessing whether credit risk has indeed crested. A higher-for-longer rate path is one of
the strongest headwinds for the improvement of public company credit risk.
FIGURE 4 Economic forecasts imply that credit risk may not top out until Q2 2025
Average 1-year probability of default (PD) for public companies, quarterly

Below potential
economic growth anda higher-for-longer
rate path are thestrongest headwinds
for the improvementof UK public company
credit risk.

Data sources: Moody’s EDF-X platform, Moody’s Economic Scenarios.

Mixed Sector Performance, But Early Warning Signals Show Improvement
The mixed picture for the UK corporate credit risk outlook is also evident at the industry sector level. Moreindustry sectors experienced an increase in forward-looking average credit risk over the past twelve months
than experienced an improvement. Figure 5 charts the average PD levels for the UK public company portfolio
for the most recent quarter, the previous quarter, and the year-ago quarter for 20 industry sectors. The graphalso shows the year-over-year change in PD for each sector on the bar graph on the right. These data points
represent expectations about the one-year ahead risk of default for each of these industry sectors.
Overall, the data in Figure 5 is further evidence that a broad-based improvement in credit risk for publiccompanies in the UK has yet to take hold. Seven industry sectors saw their average credit risk improve over the4Credit Strategy

past twelve months compared to 13 that deteriorated. The sectors exhibiting the most deterioration in thesecond quarter were also the ones where the level of credit risk is also relatively high, and includes Aerospaceand Defense, Natural Resources, and Consumer Non-Durables and Services. Banks and REITS also saw theiraverage PDs move higher on a YoY basis, but given their low PDs small nominal moves translate into potentiallylarge percentage changes. Seven industry sectors experienced a 20% or higher increase in the average PD, thecontinuation of a downward trend in that number that we have observed since the fourth quarter of 2023. On aquarter to quarter change, the balance was more even, with ten sectors improving and 10 deteriorating.
FIGURE 5 More sectors experienced increases in credit risk among UK public companies
Average 1-year-ahead PD levels and annual change by industry sector for UK public companies, quarterly

Data source: Moody’s EDF-X platform.

Changes in average PD are essential measures for monitoring and comparing credit risk across industry
sectors. But when it comes to proactively identifying which exposures represent material risk requiring
immediate attention, credit measures alone are insufficient because they do not tell you when to get worried.
Moody’s Early Warning System (EWS) was designed to identify when a change in a company’s PD becomes asignificant risk. The EWS uses two key measures to identify companies as low, medium, high, or severe risk overthe next 12 months. The two measures are (1) whether a company’s forward-looking PD measure is above anappropriate sector early warning trigger level; and (2) the change in the company’s PD-implied rating. Moody’s
research has shown that public companies with high or severe early
warning signals are 25 times more likely to default over the next year than
In a positive sign forfirms with low early warning signals.
Not all of the increases in average PD across sectors we see in Figure 5
translate into risks triggering an early warning alert. In Figure 6A we graphthe distribution of early warning signals for the same 20 industry sectors
above. The list of sectors in Figure 6A is sorted by the industry sectors
showing the highest percentage of high or severe early warning signals. In
some cases, we do see sectors that exhibited a sharp increase in average

UK credit risk, theshare of firms withhigh or severe early
warning signals has
fallen since 2Q 2023.
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Credit Strategy

credit risk also show a relatively high share of high/severe early warning signals, such as the Energy, Aerospaceand Defense, and Travel, Entertainment and Leisure sectors. Other sectors, such as Medical/Pharmaceuticals,
show up as high on the EWS list, but did not experience as large a change in PD.
FIGURE 6 The number of UK companies with high/severe early warning signals has fallen since Q4 2023
6A EDF-X Early Warning Signals by Industry Sector

6B EDF-X Early Warning Signals for all UK public companies

Data source: Moody’s EDF-X platform.

Company size is strongly correlated with early warning status. Figure 6B shows the early warning signal
distribution for all UK public companies as of July (as well as showing the two dimensions of early warning: PD
vs. trigger on the horizontal axis and change in implied rating on the vertical axis). The size of each bubble in thegraph is proportional to company asset value. Companies falling into the high (orange) and severe (red) EWS
categories are generally smaller than those in the medium (yellow) and low (green) risk categories.
FIGURE 7 More UK public companies transitioned to less risky EWS categories over the past 12 months
EDF-X Early Warning Signals for all UK public companies, July 2023 vs. July 2024

July 2023 EWS
Low
MediumHigh
Severe

Low
70%
65%
45%
20%

July 2024 EWS
Medium
High
26%
0%
25%
2%
0%
23%
0%
30%

Severe
4%
8%
32%
50%

Data source: Moody’s EDF-X platform.

Across all UK public companies, the share of firms with high or severe early warning signals has fallen since thefourth quarter 2023. Moody’s EWS categorized 263 companies as high or severe risk as of July 2024. That
number is down from the fourth quarter 2023 when 320 companies were flagged with the highest early warning
signals. Indeed, a healthy share of UK public companies have transitions to less risky EWS categories over the
past twelve months. The transition matrix depicted in Figure 7 shows movement of UK public companies across6Credit Strategy

the EWS categories over the past year. 65% of Medium, 45% of High, and 50% of Severe flagged UK publiccompanies moved a lower-risk EWS category since the second quarter of 2023.
Summary
The outlook for UK corporate credit risk is cautiously optimistic, though a good amount of emphasis on thecaution part is still warranted. Measures of credit risk for UK companies came in very mixed in the first sevenmonths of the year, showing easing credit risk for private companies but sideways movement for publiccompanies. Given that the forward-looking average probability of default for public companies historically leads
that of private companies, we need to wait for a corroborating signal from the UK public company series todefinitively call a peak. Nevertheless, based on the correlation between the average PD for private firms andMoody’s realized trailing 12-month default rate for UK issuers, we may see a reduction on the number of rated
defaults over the next year.
Credit risk projections conditioned on macroeconomic scenarios also indicate that we may not see a peak in
UK corporate credit risk until the first half of 2025. Despite a cracking first quarter GDP reading, UK economic
growth is expected to remain below potential, while the BOE is expected to lower its policy rate only gradually
going forward. That relatively more UK public companies transitioned to less risky EWS categories thantransitioned to higher EWS categories is another positive sign for the trend in credit risk. While there arepositive signs that the cycle may be beginning to bottom, the overall credit outlook remains cautious, and closemonitoring of both public and private company risk indicators will be essential in the coming months.

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