European companies take on pre-crisis levels of debt

June 22, 2014 5:48 pm

European companies take on pre-crisis levels of debt

By Andrew Bolger

European companies that raise finance are taking on levels of debt not seen since the financial crisis as they adjust to the prospect of low interest rates for the foreseeable future.

The ratio of debt to company earnings, or “leverage multiples”, for all European transactions were 5.1 times earnings in the first quarter of 2014, above the 10-year average (4.8 times) for the first time since 2008.

The European Central Bank’s decision to cut a key interest rate this month has exacerbated a mismatch in supply and demand for yield from investors. It had resulted in ever-tighter pricing for new issuance of loans and bonds, said Standard & Poor’s, the credit rating agency.

“Supply-demand imbalance could continue to lead to excessively borrower-friendly lending standards and more highly leveraged transactions, something we are already starting to observe,” said Taron Wade, an S&P analyst.

“Indeed, leverage multiples on transactions in Europe have been steadily increasing since 2009.”

The iTraxx Crossover index, a proxy for speculative-grade credit risk, tightened to its lowest level since the global financial crisis of 2007-09 after the ECB signalled it was willing to adopt unconventional measures to combat deflationary pressures and boost bank lending.

S&P said appetite for speculative-grade credit had been so strong that supply had not kept up with demand. But supply might be returning, it added, as M&A activity in 2014 had almost caught up with that for the whole of 2013.

Nevertheless, the general lack of debt supply had resulted in ever-tighter pricing for new issuance of both loans and bonds. In May, Schaeffler, a German ballbearing manufacturer rated a speculative BB minus, was able to reduce its average cost of funding to about 3.5 per cent, from 8 per cent previously.

Borrowing costs for companies with a higher rating of B and BB have also fallen, to 5.3 per cent and 3.2 per cent, respectively, as of June 17, well below their pre-crisis low of 6.9 per cent and 5.3 per cent at the end of 2006, according to the Bank of America Merrill Lynch Bond Index.

S&P said spreads on leveraged loans had not yet hit pre-crisis levels. However, the cost to borrowers when taking into account Euribor had declined from 4.3 per cent in mid-2007 to 0.7 per cent at the end of the first quarter.

Ms Wade said she expected companies to continue to take advantage of the demand and supply imbalance to seek advantageous pricing and liquidity from both European and US investors.

“The degree of this imbalance will influence the structure of transactions in terms of recovery prospects, leverage and the lack of covenants,” she said. “However, in the low interest rate environment, and with current market conditions, all signs point one way – toward more aggressive capital structures.”