While funding costs for many of the largest European corporates are at historic lows, few are likely to take advantage of cheap money for acquisitions or other uses until there is more evidence of stronger growth and a rebalancing of the European and global economy, according to Fitch Ratings.
Large, highly-rated companies are able to borrow cheaply from banks in the current environment as capital rules incentivise lending to the highest quality corporates and because banks can earn ancillary fee income to offset low-margin lending. Bond markets are also offering cheap money as investors worried by the eurozone crisis look for the safest and most liquid markets outside sovereign debt.
Fitch data indicate that Europe, Middle East and Africa (EMEA) non-financial corporate bond issuance was around €102bn in Q112, well ahead of the run rate in 2011, when total issuance for the year was €193bn. Fitch believes, however, that this is a sign that companies have made use of an open window in the market, rather than an indication that they plan to significantly step up borrowing.
While highly-rated corporates have access to plenty of funding, some of the main options for using it are likely to look unappealing. For example, companies are likely to respond to investor pressure for share buybacks and higher dividends, however Fitch believes this will more likely be funded by cash flows, rather than borrowing. This is because corporates will generally not want to increase leverage while they remain concerned about the recovery of the European economy.
Buying smaller, speculative-grade companies in Europe – with a few exceptions – is also likely to be seen as unattractive. Many of these businesses are over-leveraged, have received too little investment and are focused purely on European markets, so they have limited growth potential. Often they are units that the larger corporates sold off in the private-equity boom of 2004-2006, indicating that they were non-core, while the high prices paid by private-equity sponsors at the time means the prices they’re now willing to sell at aren’t compelling enough. The recent collapse of G4S’s attempted takeover of leveraged buyout ISS also highlights the execution risk large corporates assume when attempting these deals.
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