European Corporate Finance: So Much Credit, So Little Need
The combination of attractive rates in global bond markets and motivated lending by major banks last year created an extremely favourable funding environment for the largest companies in Europe that has persisted into 2011, according to Greenwich Associates.
Throughout 2010 banks ranging from global providers to local players competed aggressively for loan business among blue-chip credits in the FT 500. Especially motivated were major banks working to win back corporate clients lost or ceded due to the bank balance sheet crises in 2008-2009. This competition was great news for companies in need of bank financing, which throughout the year was widely available to FT 500 companies at attractive prices. Approximately 85% of FT 500 companies say they have unimpeded or nearly unimpeded access to bank credit, up from 72% in 2009. Only 7% of FT 500 companies report any difficulties in accessing bank credit, down from 12% last year.
At the same time, many of Europe’s biggest companies have taken advantage of the historically low rates available in European and US bond markets to add to already sizable cash cushions built up as protective measures during the global financial crisis. Big cash positions and a general lack of conviction about the economic recovery have combined to moderate corporate demand to the point at which – for these large companies, at least – the supply of available bank credit probably now exceeds corporate demand.
“The 683 participants of the FT 500 in our 2011 European Large Corporate Banking Study report declining demand for bank credit overall, and for any type of financing used to fund capital expenditures,” said Greenwich Associates consultant Markus Ohlig. “These findings reflect two things: first, big European companies are not entirely confident about near-term business prospects and are not yet ready to make large-scale growth investments; and second, when they are making investments in their businesses, companies are increasingly funding them from their large pools of cash on hand.”
Cash Drag
FT 500 companies expect to earn an average of only 1.1% on their cash investments in 2011. That level of return would guarantee that the enormous cash positions currently held by large European companies will act as a significant drag on corporate returns on equity this year.
As recently as the 3Q08, FT 500 companies predicted that their cash investments would generate average returns of 3.6% in the following year. As Greenwich Associates consultant Tobias Miarka explained, companies were caught off guard when actual returns for 2009 came in at only 1.6%. “At the start of 2009 there was widespread belief that a recovery was taking hold and that rates would soon begin to rise from crisis-level lows,” he said. “Instead, the global recession proved much deeper and intractable than expected, and interest rates generally stayed at their low levels as opposed to going higher.”
In fact, returns on corporate cash investments have now been so low for so long that some FT 500 companies are abandoning longer-term liquidity solutions altogether. In 2008, 62% of these companies were using an external asset manager for short/medium-term investments. That share dropped to 47% in 2009 and fell again to 46% in 2010. “The opportunities for active managers to add value in the current interest-rate environment are just so minimal that companies are deciding that it’s not worth the cost and effort,” said Ohlig. “As a result, actual returns on cash holdings in 2011 could fall further without a meaningful move in interest rates, placing even more of a drag on ROE [return on equity].”
“There is one clear message in these data,” said Miarka. “Large European companies are not being held back from expanding or hiring by a lack of available funding. To the contrary, they have ample access to capital, but see few attractive investment propositions in the current economic environment.”
Bond Boom for Financials
Forty-eight percent of FT 500 companies issued euro-currency bonds in 2010 – a share that is down slightly from the 51% that issued euro denominated debt in 2009 but remains far above historic norms.
Although bond issuance has been heavy among all types of European companies for the past two years, financials have been especially active. Three-quarters of FT 500 financial service companies issued euro-currency bonds in 2009; in 2010 that share increased to 81%. “Many banks have limited flexibility in their funding schedules,” explained Greenwich Associates consultant John Colon. “After spending 2009 building equity capital, European banks now face significant amounts of maturing debt that must be rolled over – a process that will continue into 2011 and 2012. At the same time other financial institutions will continue taking advantage of low rates to refinance existing debt.”
Corporates issuing euro-denominated bonds topped out at 46% in 2009 and dipped to 39% in 2010 as companies facing an uncertain economy started hitting the limits of their demand and bouts of volatility associated with the sovereign bond crisis gave both issuers and investors pause for brief stretches of time. Across Europe expectations are bullish for euro-currency bond issuance in the coming year. With costs of funding near all-time lows for many investment-grade companies, 39% of FT 500 companies overall have plans to issue euro-currency bonds in 2011. That average includes about one-third of all FT 500 corporates and two-thirds of FT 500 financials.