Where risk is settling post-tightening
Key take-aways
- Macro stabilisation has reduced systemic stress, but not structural fragility. Inflation has eased and policy rates have peaked, lowering immediate refinancing pressure across Southern Europe. Yet growth remains uneven and investment subdued, leaving corporate balance-sheet repair incomplete and credit resilience dependent on firm-level fundamentals rather than macro momentum.
- Default risk is converging across public and private borrowers, but structural gaps persist. Public and private PDs have retreated from 2022–23 highs and are now moving closer across Spain, Italy and Portugal. However, Italian corporates continue to screen structurally riskier than Spanish peers, reflecting persistent differences in leverage, productivity and sovereign-linked sensitivity rather than cyclical divergence.
- Balance-sheet structure, not the macro-credit cycle, now determines credit outcomes. As monetary tightening fades, leverage, short-term funding intensity and liquidity buffers are driving non-linear credit differentiation. The real estate sector illustrates this clearly: Italian issuers’ thinner equity cushions, heavier short-term funding reliance and limited liquidity coverage translate into materially higher baseline PDs and greater tail risk than Spanish peers, despite similar macro conditions.
FIGURE 1 Public and private company credit risk is converging
Data source: Moody’s EDF-X platform as of Jan 2026
Southern Europe
Southern Europe has stabilised, but growth and credit dynamics remain structurally divergent
Southern Europe entered 2026 in a markedly more stable macro-financial position than at any point since the global financial crisis. Inflation pressures receded across Spain, Italy and Portugal, allowing the European Central Bank to move policy rates back toward a less restrictive stance as price dynamics converged toward the 2% target. This shift materially reduced near-term refinancing risk for corporates, particularly in bank-dependent economies, and alleviated debt-service pressure following the 2022–23 tightening cycle.1
At the same time, the past year underscored why macro stabilisation should not be mistaken for uniformly improving credit fundamentals. Growth across Southern Europe in 2025 has been driven primarily by consumption rather than investment, supported by resilient labour markets and rising real wages, while private capital formation has remained cautious amid global trade uncertainty and structural competitiveness constraints. This distinction matters for credit risk: consumption-led growth stabilises revenues but does little to improve long-term margin resilience or balance-sheet strength, increasing the importance of firm-level differentiation.2 Despite this shared stabilisation, Figure 2 shows that post-pandemic growth trajectories across Southern Europe have diverged materially, reinforcing that macro normalisation has not necessarily translated into a uniform improvement in corporate operating environments or credit risk dynamics.
FIGURE 2 GDP stabilisation without convergence in Southern Europe
Source: IMF3, Real GDP Growth
Similarly, corporate credit risk in Southern Europe continues to be shaped more by national structural characteristics than by purely cyclical forces. As shown in Figure 3, Spain's default risk has remained fairly steady, and improvements in financing conditions have been more quickly reflected as policy rates ease. In contrast, Portugal initially experienced more gradual deterioration before starting to improve in 2025 alongside strengthening macro-financial stability. Italy’s PD, meanwhile, broadly tracks Spain’s but at a consistently higher risk level, reflecting more persistent structural credit pressures associated with slower trend growth and longstanding economic constraints.
FIGURE 3 PD levels have improved; Italy’s default risk remains elevated while Spain and Portugal’s have converged
Spain
Spain combines strong growth with rising cost pressures and episodic operational shocks
Spain has been the clearest cyclical outperformer within the region. Economic growth in 2025 remained significantly above the euro-area, with GDP growth of 2.9% compared to 1.2%, underpinned by strong household spending, robust job creation and resilient services exports. The OECD projects Spain to outperform most core euro-area peers in 2025, reflecting both post-pandemic catch-up dynamics and sustained labour market momentum.2 Tourism has continued to provide a powerful external tailwind, with international arrivals and spending close to record levels, while non-tourism services have also contributed positively to growth.4
However, Spain’s 2025 experience also illustrates the limits of a purely cyclical interpretation. Labour market improvements coexist with persistent structural rigidities, including elevated unemployment relative to peers and weak productivity growth. Wage growth in labour-intensive sectors has increasingly outpaced productivity gains, keeping services inflation relatively sticky and compressing margins for firms with limited pricing power. As a result, corporate profitability has become more sensitive to cost control and pricing flexibility than to volume growth4. Figure 4 illustrates how elevated unit labour cost growth has coincided with persistent services inflation, limiting margin resilience despite Spain’s strong post-pandemic growth.
FIGURE 4 In Spain, cost pressure constrains margin flexibility
Source: ECB5, Eurostat6
Policy responses to external shocks have played a visible role. In April 2025, the Spanish government announced a €15.7 billion support package aimed at cushioning companies and households from the impact of newly imposed US trade tariffs. According to Reuters, the measures were designed to stabilise corporate cash flows and consumer purchasing power amid heightened trade uncertainty.7 From a credit perspective, this intervention reduced near-term downside risk for exposed sectors and limited the likelihood of abrupt earnings deterioration, particularly for smaller firms with thin margins.
At the same time, Spain was affected by a series of acute operational disruptions with direct credit relevance. Record heatwaves and wildfires during 2025 disrupted agricultural output, tourism activity and logistics networks, increasing cost volatility and working-capital strain in affected sectors. In April, a major power blackout across large parts of the Iberian Peninsula disrupted production and services in both Spain and Portugal, exposing vulnerabilities in grid infrastructure and operational resilience. While these events did not trigger systemic stress, they materially affected earnings volatility, insurance costs and contingency planning for corporates, particularly in energy-intensive and infrastructure-dependent industries.8
The policy response, including commitments to accelerate grid investment and resilience measures, is credit-positive over the medium term but introduces near-term execution and financing considerations for utilities and regulated sectors. Spain’s macro narrative in 2025 is therefore best understood as growth resilience supported by policy buffers, occurring alongside episodic shocks that raise operational and cash-flow volatility, rather than as a uniformly credit-positive expansion.
This is also reflected in the evolution of Spain’s public and private company credit risk. As shown in Figure 5 private company PD has generally remained above that of public firms, consistent with structurally tighter margins and more limited financial flexibility, but the differential narrowed markedly into 2025 as public company PD increased and eventually broke above private PD levels.
FIGURE 5 Spain’s average public company PD has increased to converge with private company risk
Source: Moody’s EDF-X platform as of Jan 2026
Spanish companies have seen a slight decrease in their average credit risk over the past year with varying sectoral outcomes. As illustrated in Figure 6, sixteen sectors have reported year-on-year decreases in the average probability of default, while three sectors have recorded increases. The energy sector experienced the largest YoY increase in average credit risk. Heightened macroeconomic and policy uncertainty in 2025 dampened investment confidence and slowed industrial investment decisions, reducing future revenue expectations and weakening debt servicing capacity in capital-intensive sectors9.
FIGURE 6 The majority of Spanish industry sectors have experienced a decline in default risk
Source: Moody’s EDF-X platform as of Jan 2026
The increase in Spain’s average public company PD over the past year aligns with an upward trend in the proportion of firms exhibiting severe Early Warning Signals (EWS). When factoring in companies with high EWS, this segment consistently comprises less than 20% of Spain’s public companies (Figure 7) – which is below the corresponding proportions observed for Italy and Portugal, and reflects Spain’s relatively lower public company PD.
FIGURE 7 The proportion of Spanish public companies with high and severe EWS has remained consistently below 20%
Source: Moody’s EDF-X platform as of Jan 2026
Italy
Italy faces structurally constrained growth and persistent sovereign-linked credit sensitivity
Italy presents a structurally different macro-credit configuration. Growth in 2025 has remained weak relative to Spain and some other euro-area peers, reflecting long-standing productivity challenges, subdued private investment and adverse demographic trends. As shown in Figure 8, Italy continues to lag peers on GDP per hour worked, underscoring the persistence of low productivity growth that has constrained potential output for more than a decade. Broader euro-area forecasts from the European Commission and OECD continue to highlight Italy’s limited potential growth and investment responsiveness, even as monetary conditions ease.2 10
While easing financial conditions have reduced immediate refinancing stress, they have not translated into a meaningful rebound in private investment or business confidence. Consumption growth has been modest, constrained by weaker real income dynamics, and the corporate sector remains heavily exposed to domestic demand conditions. Productivity growth remains weak, reinforcing a low-growth equilibrium in which monetary easing primarily prevents deterioration rather than enabling expansion.11 12
FIGURE 8 Italy; Persistent productivity gap (GDP per hour worked) versus Euro-area peers13
Source: OECD14
Policy and regulatory developments in 2025 have reinforced this cautious environment. Italy revised its “golden power” investment screening framework following criticism at the European level, altering the regulatory landscape for strategic sectors including infrastructure, finance and cross-border M&A. As reported by Reuters, the revisions were intended to align Italy’s framework more closely with EU norms but introduced additional uncertainty for firms reliant on foreign capital or strategic transactions.15 For corporate credit, this uncertainty affects investment timing and ownership structures rather than near-term financial metrics, but it weighs on longer-term strategic flexibility.
Italy’s sovereign position continues to exert a strong influence on corporate credit conditions. High public debt and limited fiscal space constrain the government’s ability to respond to shocks without affecting market confidence, keeping sovereign spreads a relevant factor in corporate funding costs. In this context, credit risk is driven less by cyclical demand volatility and more by leverage, refinancing profiles and exposure to regulatory and political friction.11
The development of corporate default risk across listed and private firms in Italy follows the same trend as in Figure 9. After a period in which the average credit risk of public companies rose more quickly while private company average credit risk slowly declined, the two converged in early 2025, with public PD peaking before falling back to end slightly below private levels. This temporary convergence seems to capture a phase of market-driven repricing rather than a fundamental shift in underlying credit quality. Average public company PD is also more cyclical reflecting increased sensitivity to changes in financing conditions and market sentiment.
FIGURE 9 Italy; average public and private company credit risk has converged
Italy’s private company credit risk has also improved over the past year. Figure 10 shows that five industry sectors experienced an increase in average credit risk, while fourteen sectors saw improvement. Italian sectors have experienced sharper recoveries and more modest declines compared to Spain resulting in a marginally higher decrease in average PD. As with Spain, Italy’s energy sector faced the largest YoY increase in average PD. While capital intensive industries in Italy have also faced macroeconomic uncertainty and greater price volatility in the last year, the effects have been more reserved.
FIGURE 10 More industry sectors in Italy show improvement than deterioration
Source: Moody’s EDF-X platform as of Jan 2026
Italy’s public companies with high and severe Early Warning Signals have also remained around the 20% mark as seen in Figure 11. This proportion peaked in 2025 before descending slightly towards the year’s end as financial conditions in the country improved. The larger proportion of firms with higher credit risk is in line with Italian corporates broadly screening riskier than their Spanish peers.
FIGURE 11 2025 saw an above-trend proportion of Italian public companies with high and severe EWS
Source: Moody’s EDF-X platform as of Jan 2026
Portugal
Portugal’s fiscal credibility anchors systemic risk despite modest growth
Portugal provides a contrasting case within Southern Europe. Economic growth in 2025 has been moderate rather than strong, but macro-financial stability has been underpinned by declining inflation, a resilient labour market and strong fiscal credibility. Inflation moved closer to target during the year, while unemployment stabilised at historically low levels, supporting domestic demand and corporate revenues.16
Portugal’s fiscal position remains a key differentiator. As shown in Figure 12, the fiscal balance has improved materially from pandemic-era deficits and is now close to balance, while the debt-to-GDP ratio continues on a clear downward trajectory. The government is expected to record a budget surplus in 2025, and the debt-to-GDP ratio continues to decline, reinforcing sovereign credibility and helping to anchor favourable funding conditions for the private sector.17 18 Following the Iberian blackout, Portugal committed to increased investment in grid resilience and energy infrastructure, reducing medium-term operational risk for energy-intensive sectors, albeit with higher capital expenditure requirements.19
FIGURE 12 Portugal; Improving debt dynamics support sovereign credibility
Source: IMF20, ECB21
Despite this supportive backdrop, Portugal’s corporate sector remains dominated by SMEs and concentrated in tourism and other lower value-added activities. Productivity growth remains weak, and sector concentration increases sensitivity to external demand shocks. Macroeconomic stability therefore reduces systemic risk but does not eliminate firm-level vulnerability, reinforcing the importance of granular credit assessment.16 22
This aligns with the changes seen in Portugal’s corporate credit risk. Public company PD, which previously stood materially above private company levels (Figure 13) due to a more concentrated and lower-quality listed universe, declined sharply in 2025 to converge with private company risk. Private company PD, by contrast, has moved only slightly upwards. This convergence seems to be driven by changes in the makeup of the listed sector and modest improvements in macro-conditions.
FIGURE 13 Portugal’s average public company PD has fallen sharply to converge with its private company risk
Source: Moody’s EDF-X platform as of Jan 2026
Across industry sectors, Portugal’s average company credit risk has generally fallen YoY, with modest deterioration in three sectors an fifteen have showing meaningful improvements, as shown in the data in Figure 14. The broad improvements in credit risk across sectors are supported by structural resilience, declining inflation, a robust labour market and modest economic growth.
FIGURE 14 Portugal’s industry sectors have exhibited significant YoY improvements
Source: Moody’s EDF-X platform as of Jan 2026
Portugal has a distinct public-company PD profile. Its listed company population is relatively smaller, more concentrated across sectors, and has been of lower average credit quality than that of its other Southern European peers, resulting in materially higher PD levels prior to 2025. The sharp decline in PD observed during 2025 coincides with changes in the composition of the listed universe, and while the delistings did not mechanically remove the most distressed firms, the surviving population appears, on average, to exhibit stronger financial profiles. The proportion of firms with high or severe EWS, previously about 40%, has dropped significantly to 20%, matching the levels seen in Spain and Italy (Figure 15).
FIGURE 15 The share of Portugal’s public companies with high and severe EWS fell sharply over 2025
Source: Moody’s EDF-X platform as of Jan 2026
Real estate: structural balance-sheet drivers of default risk
The real estate sector provides a particularly clear illustration of how corporate credit risk in Southern Europe has become increasingly shaped by balance-sheet structure and funding design rather than by cyclical demand conditions or near-term operating performance. As shown in Figure 16, Italian real estate firms continue to exhibit materially higher probabilities of default than Spanish peers, despite operating within a broadly similar macroeconomic and monetary environment.
On average, the Italian peer group exhibits a one-year probability of default approximately 25 basis points higher than the Spanish peer group. While a 25-basis-point differential may appear modest in absolute terms, its implications become materially more significant when mapped onto letter-grade implied ratings.
Within the Italian cohort, observed PDs range from 0.37% at the low end, consistent with an implied Baa2, to 0.71% at the upper end, corresponding to a Ba1 equivalent. This dispersion is not trivial. The upper bound of the Italian distribution falls below investment grade into High Yield, introducing a discrete shift in financing dynamics rather than a marginal change in credit risk.
Crossing the investment-grade threshold can have non-linear consequences for issuers, affecting access to capital markets, investor eligibility constraints, funding costs, and covenant structures. In this context, the average PD gap between the Italian and Spanish peer groups masks a more meaningful structural divergence: while Spanish peers remain more tightly clustered within investment-grade-consistent risk levels (a low of 0.19% or A3 and a high of 0.38% or Baa2), the Italian peer group spans both sides of the Investment Grade / High Yield boundary.
As a result, the headline 25-basis-point difference should be interpreted not as incremental noise, but as an indicator of greater downside tail risk within the Italian group.
FIGURE 16 One-Year Median PD Comparison Across Italian and Spanish Real Estate Peer Groups
Source: Moody’s EDF-X
This divergence is not explained by differences in growth exposure or near-term earnings performance, but instead aligns closely with persistent differences in leverage, refinancing profiles and liquidity resilience as shown in Figure 17.
FIGURE 17 Leverage, Short-Term Funding, and Liquidity Coverage by Peer Group
Note: Leverage is measured as total liabilities relative to total shareholders’ equity. Short-term funding intensity is proxied by current liabilities as a share of total liabilities. Liquidity buffer versus refinancing is measured as total cash and short-term investments relative to loans and short-term debt. Reported figures represent median values across firms. All data are as of 31 December 2024 and are sourced from Orbis.
At a headline level, Italian real estate firms operate with significantly thinner equity buffers. Total liabilities relative to shareholders’ equity are materially higher in Italy than in Spain, indicating a structurally more levered capital base. While leverage is an inherent feature of property-intensive business models, its credit implications depend critically on how liabilities are funded and how much flexibility firms retain to absorb refinancing shocks.
In this respect, the contrast between Italy and Spain is stark. Italian firms rely far more heavily on short-term funding, as captured by the share of current liabilities in total liabilities. Short-term funding intensity in Italy is substantially higher than in Spain, signalling a structural dependence on frequent refinancing. In a higher-for-longer rate environment, this funding profile mechanically increases sensitivity to changes in financing conditions, even in the absence of earnings deterioration or asset-level stress. Refinancing risk therefore becomes a primary transmission channel through which monetary tightening and market volatility translate into higher default risk.
Liquidity metrics reinforce this interpretation. Spanish real estate firms maintain substantial cash and short-term investment buffers relative to near-term funding needs, providing meaningful insulation against refinancing risk and valuation volatility. By contrast, Italian firms’ liquidity coverage of short-term obligations is extremely limited. With cash buffers covering only a small fraction of near-term liabilities, Italian firms have little margin to absorb funding shocks, leaving them structurally exposed to changes in credit conditions and investor risk appetite.
These balance-sheet characteristics are directly reflected in observed PD levels. Italian real estate firms screen with significantly higher baseline probabilities of default than Spanish peers, and this differential persists even as macro-financial conditions stabilise. The persistence of the gap suggests that it is not driven by temporary stress or sector-specific shocks, but by funding structures that systematically amplify exposure to refinancing and liquidity risk. In effect, Italian firms sit structurally closer to the default boundary, while Spanish firms retain greater distance even when market volatility rises.
Importantly, this pattern does not imply that Italian real estate firms are uniformly distressed, nor that Spanish firms are less prone to adverse shocks. Rather, it highlights a difference in baseline resilience. Spanish firms remain exposed to valuation swings and equity-market volatility, but strong liquidity buffers and limited short-term funding dependence prevent these fluctuations from translating into persistently elevated default risk. Italian firms, by contrast, face a structural amplification mechanism whereby funding composition and weak liquidity coverage cause changes in market conditions to have a disproportionate effect on PDs.
From an investor and lender perspective, these distinctions are central to credit decision-making. A structurally higher PD backdrop in Italian real estate implies reduced underwriting headroom, greater reliance on covenant protection and heightened sensitivity to refinancing risk, even when macro indicators appear supportive. Conversely, lower PDs in Spain should not be interpreted as an absence of risk, but as evidence that balance-sheet structures allow firms to absorb funding and valuation shocks without approaching default thresholds.
Taken together, the real estate sector reinforces the broader conclusion of this paper. As macro-financial conditions normalise across Southern Europe, credit differentiation is increasingly driven by leverage, funding maturity profiles and liquidity resilience rather than by the business cycle alone. In this environment, granular analysis of balance-sheet structure is essential to distinguish firms that are merely exposed to volatility from those that are structurally vulnerable to adverse credit outcomes.
Summary
Southern Europe enters 2026 in a more stable macro-financial position than at any point since the global financial crisis. Inflation has eased, policy rates have peaked, and near-term refinancing pressure has moderated across Spain, Italy and Portugal. Yet this stabilisation has not translated into a uniform improvement in corporate credit fundamentals. Growth remains uneven, investment subdued, and balance-sheet repair incomplete, leaving firm-level differentiation firmly in focus.
Credit risk has improved in aggregate, but convergence has stalled. Both public and private company probabilities of default have retreated from 2022–23 highs, yet persistent cross-country gaps remain. Italian corporates continue to screen structurally riskier than Spanish peers, a pattern that has proven resilient even as macro conditions normalise. Portugal, while benefiting from strong fiscal credibility and declining sovereign risk, remains characterised by firm-level vulnerability driven by scale, sector concentration and productivity constraints.
As the cycle turns, credit outcomes across Southern Europe are increasingly shaped less by the business cycle and more by structural features such as leverage, funding maturity profiles and liquidity buffers. The implication for investors and lenders is clear; macroeconomic normalisation reduces systemic stress, but it does not eliminate downside risk. For private credit investors and lenders, this implies that risk is now transmitted primarily through refinancing channels rather than earnings volatility. Small differences in baseline probability of default can therefore lead to non-linear outcomes around underwriting headroom and covenant protection. In this environment, granular balance-sheet analysis and an explicit focus on funding resilience are central to credit selection, portfolio construction and downside risk management across the region.
References
1European Central Bank (2025) Economic Bulletin. Frankfurt am Main: European Central Bank. Available at: https://www.ecb.europa.eu/press/economic-bulletin/html/index.en.html
2Organisation for Economic Co-operation and Development (2025) OECD Economic Outlook. Paris: OECD. Available at: https://www.oecd.org/en/topics/economic-outlook.html
3International Monetary Fund (2025) World Economic Outlook Database: Real GDP growth (annual percent change). Washington, DC: IMF. Available at: https://www.imf.org/external/datamapper/NGDP_RPCH@WEO
4Moody’s Analytics (2025) Spain: Country Précis, September 2025. London: Moody’s Analytics. Available to subscribers.
5European Central Bank (2025) National accounts: Unit labour cost growth, Spain. ECB Statistical Data Warehouse. Frankfurt am Main: ECB. Available at: https://data.ecb.europa.eu/data/datasets/MNA
6Eurostat (2025) Harmonised Index of Consumer Prices (HICP). Luxembourg: European Commission. Available at: https://ec.europa.eu/eurostat/web/hicp
7Reuters (2025) Spain unveils €15.7bn support package to offset impact of US tariffs. Reuters, April 2025. Available at: https://www.reuters.com
8European Commission (2025) Climate monitoring and extreme weather impacts in Europe. Brussels: European Commission. Available at: https://climate.ec.europa.eu
9ECB (2025) Financial Stability Review, May 2025: Available at: https://www.ecb.europa.eu/press/financial-stability-publications/fsr/html/ecb.fsr202505~0cde5244f6.en.html
10European Commission (2025) European Economic Forecast: Autumn 2025. Brussels: European Commission. Available at: https://economy-finance.ec.europa.eu/economic-forecast-and-surveys/economic-forecasts_en
11Moody’s Analytics (2025) Italy: Country Précis, September 2025. London: Moody’s Analytics. Available to subscribers.
12Moody’s Investors Service (2025) Government of Italy – Credit Opinion, November 2025. New York: Moody’s Investors Service. Available to subscribers.
13Productivity measured over pre-pandemic trend periods to avoid pandemic-related composition effects
14Organisation for Economic Co-operation and Development (2025) GDP per hour worked. OECD Data Indicators. Paris: OECD. Available at: https://www.oecd.org/en/data/indicators/gdp-per-hour-worked.html
15Reuters (2025) Italy revises “golden power” rules following EU criticism. Reuters, December 2025. Available at: https://www.reuters.com
16Banco de Portugal (2025) Economic Bulletin. Lisbon: Banco de Portugal. Available at: https://www.bportugal.pt
17Moody’s Analytics (2025) Portugal: Country Précis, September 2025. London: Moody’s Analytics. Available to subscribers.
18Moody’s Investors Service (2025) Government of Portugal – Credit Opinion, November 2025. New York: Moody’s Investors Service. Available to subscribers.
19European Commission (2025) Energy system resilience and infrastructure investment following the Iberian power disruption. Brussels: European Commission
20International Monetary Fund (2025) World Economic Outlook Database: General government gross debt (% of GDP), Portugal. Washington, DC: IMF. Available at: https://www.imf.org/external/datamapper/GGXCNL_NGDP@WEO/PRT
21European Central Bank (2025) Government Finance Statistics: General government net lending/borrowing (% of GDP), Portugal. Frankfurt am Main: ECB. Available at: https://data.ecb.europa.eu/data/datasets/GFS
22Banco de Portugal (2025) Economic Analysis and Outlook. Lisbon: Banco de Portugal. Available at: https://www.bportugal.pt
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This article is a product of Moody’s Asset Management Research team, part of Moody’s Analytics (“Moody’s”), a division of Moody’s Corp. separate from Moody’s Ratings. The analysis and viewpoints expressed herein are solely those of Moody’s Asset Management Research team.
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