The end of the era of cheap money sabotages dozens of corporate bonds

Dozens of corporate bond trades have not floated in recent months as the end of central bank stimulus leaves firms bereft of cheap funds.

It is generally rare for companies to end bond transactions once bankers actively attempt to sell the debt to investors. But in June, deals withdrawn or postponed in the Europe, Middle East and Africa region more than tripled from May, according to Bloomberg data.

Records of write-offs are sparse, but “there have probably been more deals taken off the market in the last three months than in the last three years,” according to Mark Lynagh, co-head of debt markets for Europe. at BNP Paribas.

Now that benchmark interest rates are set to rise and Ukraine-fueled inflation has proven persistent, fund managers are demanding much higher returns in return for their investments. But companies are balking at that higher price after years of largesse, especially with a potential recession ahead. Bankers say that ultimately companies will have to learn to live with more expensive debt.

“Before, it was child’s play: you would put a deal there, the European Central Bank would come in with a massive order and everyone would pile in,” said one banker.

“Now it is much more difficult. The market is already grappling with inflation and interest rates. Then there is the war in Ukraine, the Bank of England wanting to sell its corporate bond portfolio and the ECB’s asset purchase program coming to an end. This is the worst possible time for all of these things to happen together.

Central banks have kept interest rates close to, or in the case of the ECB, below zero percent since the 2008 financial crisis, with support rising when the coronavirus pandemic hit. Through its asset purchase programs, the ECB held 345 billion euros in corporate debt at the end of June, up from 195 billion euros at the start of the pandemic, often buying debt on the so-called market. primary on its first issue.

Companies have been gorging themselves on this opportunity to issue cheap debt, with $1.2 billion hitting the European market in 2021, according to Refinitiv data.

But now the ECB is pulling out, reinvesting maturing assets but not buying new debt. If enough private sector investors step up to buy a bond anyway, lured by hefty interest payments or the reliability of the issuer, the lack of ECB support doesn’t matter. But in difficult market conditions, or for more fragile borrowers, the ECB provided essential support.

“[The ECB] is the difference between success and failure” when an issue garners just enough investor support, said Will Weaver, head of debt capital markets for Europe at Citi. “In an amazing market,” the ECB’s withdrawal might add only a tiny bit to the company’s cost of borrowing. But “in a market like this, it’s [half a percentage point] or maybe the deal is not done”.

Companies in Europe have a history of exploiting low costs to borrow opportunistically, to raise funds for general purposes or to accelerate the purchase of new equipment. In favorable market conditions, banks are often able to reduce borrowing costs through the one to three day process of collecting orders from investors.

No longer. Johannes Laumann, chief investment officer of German holding company Mutares, backed out of issuing a 175 million euro bond in June after failing to attract investors with promises of regular interest payments of 7.5%.

“It was honestly one of the hardest raises I’ve ever done,” he said. “You face investors who actually buy your story. . . but they say they won’t invest at all yet or there are better opportunities [elsewhere].”

French car rental company Europcar also reached a bond deal on May 9, canceling plans to raise debt to bolster its vehicle fleet.

Company executives held twice-daily talks with bankers over the 150 million euro deal, but as investors demanded ever-higher interest payments, company directors called a halt to the deal. the take, according to a person familiar with the deal. Investor demands were simply beyond Europcar’s limits, according to this person, especially since the company “didn’t really need” access to the market.

The value of new corporate bonds coming to the global market fell 17% in the first half compared to 2021, according to data from Refinitiv. Riskier so-called high-yield issues fell 78% to their lowest level in the first half since 2009.

This slowdown is bad news for banks involved in fundraising. In high-yield transactions, banks guarantee corporate debt and then resell it to specialist investors. But banks can incur losses on these transactions if investors demand higher borrowing costs than expected.

A banker said conditions were “awful” for speculative debt. “Most bankers lose money in high yield issues. There is no cash,” he added. Several bankers said it had become a “buyers’ market”, allowing investors to be more selective and making life difficult for less traditional borrowers.

JPMorgan and Morgan Stanley recently acted as bookmakers on £1bn of debt issued to fund gaming company 888’s takeover of William Hill’s European operations. They offered the debt at a deep discount to investors and with a yield of 11.5% – well above the euro high yield benchmark of around 7% – and are still struggling to entice investors. buyers.

Even much higher yields than previous years may not be enough. “Not all double-digit returns are sustainable here,” said Alberto Gallo, chief investment officer at Andromeda Capital Management, which he co-founded this year in anticipation of stress in credit markets. “As investors, we need to understand which companies can live with higher interest rates.”

Line chart of Euro Corporate Index (total returns) showing European debt has come under intense pressure this year

The stress is also clear in the secondary market, after debt issuance. The amount of European debt traded at distressed levels – with prices so low that yields are more than 10 percentage points above their benchmark – more than doubled from late May to late June.

Some investors fear a wave of defaults is looming, but most analysts are more optimistic, pointing out that the rush to issues in recent years should swell corporate balance sheets for now. According to data from Fitch Ratings, only one of the debt securities trading at distressed levels in Europe is expected to mature in the next 12 months.

Yet many new debt issues will cost companies more than they are used to. “Higher prices reflect more normal conditions,” said Ed Eyerman, head of European leveraged finance at Fitch. “What was abnormal was the period from 2017 to 2021.” Rising benchmark interest rates and slowing earnings mean a resumption of ratings downgrades is likely, Fitch suggested.

Analysts at Moody’s, another ratings agency, warn that companies with low cash flow and high amounts of floating-rate debt, where interest payments rise in line with benchmark rates, may lack sufficient cash to repay or refinance their debt. Floating rate debt represents 18% of high yield bonds in Europe.

Column chart of European high yield debt maturity dates (in billions of euros) showing that the 2021 borrowing glut pushes back maturities

Some of the pain is concentrated on particular borrowers and sectors. Three of the seven European bonds classified as distressed by Fitch and due to mature before the end of 2024 come from the troubled German real estate company Adler or its subsidiaries, for example.

S&P Global has also identified sectors that have yet to recover from the pandemic – including real estate, consumer discretionary companies and industrials – as the areas most vulnerable to a period of stagflation.

But as consumer confidence hits historic lows in the UK and hits new highs in the euro zone and the US, the outlook for credit markets is weakening. “There is very little that is protected against widespread consumer weakness,” said Sunita Kara, global co-head of high yield at Aviva Investors.

Several bankers said some companies were looking for new solutions – such as bank loans – rather than bonds, to take on debt. Companies would still need to borrow to invest, with the green transition requiring medium to long-term spending, said Guy Stear, head of fixed-income research at Societe Generale.

For issuers, the end of cheap money means that fear of missing out on good financial conditions in 2021 has given way to fear of making mistakes in a volatile market.

“Companies don’t want to take risks,” said one of the bankers. “If you’re a CFO or treasurer and you get board approval but then pull the bond, that doesn’t sound good for you or for the company.”

Comments are closed.