In the years since the 2008 crisis, European companies have been moving away from the long-established culture of reliance on loans from the region’s many banks. As the banking sector de-levered, corporates turned to the debt markets to replace loans – thereby improving their diversification of funding sources. In 2014, new bond issuance accounted for 39% of new funding – a sharp rise on the 25% average over the period 1999 to 2007. However, the bond share is down for the second year running as banks have gradually become keener to lend, supported by the continued loose monetary policy.
Total new debt (bonds and syndicated loans) rose 3% to a post-crisis record of €1.075 trillion in 2014, according to Dealogic data. Whilst total bond issuance contracted by 6% to €419bn and loans expanded by 9% to €656bn, volumes in the final quarter of 2014 were unusually weak – especially for loans, which hit their lowest level in five years. This trend has continued into the first two months of 2015, with year-to-date bond and loan issuance at their lowest levels since 2010 and 2011 respectively.
On a regional basis, eurozone periphery corporate bond issuance contracted last year – by 21% for Spain and 10% for Italy – reversing the trend of bond investors stepping in to fill the gap from retreating lenders. Loans to companies in this region were up marginally on balance – rising strongly in Greece, Ireland and Portugal and by 5% in Spain; but down 17% in Italy. In Europe’s three largest economies – Germany, France and the UK – corporates boosted funds by 16% in aggregate, spread across bonds and loans in each country.
Although the banks sector has regained its appetite for lending, tighter regulatory requirements are making loan growth more difficult. Banks have to hold an increasing amount of regulatory capital against the loans they extend, as Basel III rules are phased in. The bar is also being raised by the European Central Bank (ECB) in its role as the new single supervisor – it recently communicated its initial Pillar 2 expectations for buffer capital for each of the banks. They will also have to build their debt and capital buffers to meet total loss absorbency capacity (TLAC) and minimum requirement for own funds and eligible liabilities (MREL) rules. Gearing up bank balance sheets through loan expansion runs contrary to these regulatory pressures.
Search for Yield Boosts High-Yield Issuance
The ever-looser monetary policy backdrop In Europe – boosted by the ECB’s €1 trillion quantitative easing (QE) programme that will commence this month – continues to push investors into higher-yielding sectors, compressing spreads further. There is strong investor appetite for blue-chip corporate credit, to shelter from negative yields on increasing amounts of eurozone sovereign debt. There is also a return to a measured “risk-on” sentiment for European high yield. Fund inflows have been healthy in both investment grade and high yield; January 2015 saw the highest high-yield inflows since last June.
Single-‘B’ issuance resurfaced in January this year as investors placed measured bets on lower-rated bonds from repeat issuers; preferring to take additional risk in the form of more aggressive structures from known credits, rather than debut issuers or those with weaker corporate credit profiles. B rated bonds accounted for over half of new issuance in January – the highest monthly share since October 2014 – as their spread to BB’s tightened by 35 basis points (bp), buoyed by pent-up investor demand and confirmation of the ECB’s bond-buying programme.
European high yield issuance set a fifth consecutive issuance record of €178bn in 2014 – growing 36% year-on-year (YoY). Despite the headline-grabbing default of British mobile phones retailer Phones4U, the trailing 12-month default rate declined to 0.18%, by volume, through a combination of fewer defaults and rapidly growing market volumes.
New issuance will be supported by rising merger and acquisition (M&A) activity and a growing refinancing pipeline, due to maturing and callable debt from an increasingly mature and diversified issuer base. The growing size and diversity of European high yield issuance, coupled with policy support from the ECB, increase its resilience to macro shocks. However, a number of risk factors could subdue issuance volumes in 2015, including escalation of the Greek debt situation, persistently low growth, geopolitical risk and increased competition from loan products – given a recovering banking sector and growing institutional loan investor base.
High yield is increasingly regarded as a global asset class. However, the stricken oil and gas sector accounts for a much smaller share of the European universe than the US one: just 2.4% compared to 16%. Hence, the lower oil price may have a net positive impact on the European market, as lower input costs translate into better profitability and consumer-related issuers benefit from improved incomes. Differences in monetary policy further support the divergence between the US and Europe.
Demand for Funding Limited
Weak economic prospects are an important limitation on corporate funding needs in 2015. Corporate bond volumes so far this year are either flat or down on 2014. Most of recent years’ issuance activity has been driven by pre-financing to capture lower funding costs and for 2015 Fitch believes that M&A will need to ramp up to keep bond issuance level with last year.
Total new debt raised in 2014 was less than three-quarters of the 2007 high of €1.5 trillion. This gap reflects the fragile nature of Europe’s economic recovery, with the corporate sector investing only cautiously in view of deflationary pressures. While companies are facing a funding landscape of ample and low-cost debt from bond investors and bankers alike, demand will mainly come from refinancing and M&A rather than from capex needs.
From a sector perspective, the main changes in 2014 bond issuance came from oil/gas, energy and utility companies. Bond issuance by corporates in these sectors reduced, reflecting lower expansionary capex in the wake of the sharp fall in oil prices. Oil and gas issuance was down by one third, and energy/utility volumes fell by one quarter. By contrast, telecom and healthcare issuance grew strongly amid ongoing in-market consolidation. Loan volume trends were in line with all these bond market sector trends.
The telecoms, pharmaceutical, building materials and utilities sectors will see continued structural rebalancing in 2015. Together with the drive to boost revenues in a slow growth environment, this will lead to an increase in the level of strategic M&A activity in the near-term – likely to be funded through a mix of new bond issuance, bridge financing and equity. M&A will have varying rating implications for different sectors. For pharmaceuticals, it is the main driver behind Fitch’s negative sector rating outlook. For telecoms, consolidation is the main driver behind the rating outlook moving to stable from negative.
Issuance by Central and Eastern European companies was down sharply in 2014, with Russia accounting for more than half of the reduction. Headwinds such as geopolitical risks, domestic currency devaluation and slower growth will affect emerging market issuers to varying degrees this year.
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