European companies are finding themselves trapped in the fallout from recent downgrades of GM and Ford.
The benign issuance conditions of the past 18 months have had a unique set of drivers. Regulatory changes have resulted in a move by insurance and pension funds out of equities and into fixed income. Meanwhile, the low interest rate environment globally has created a hunger for yield, increasing demand for credit. With supply low and redemptions high, the market was well bid.
As Stuart Bell, head of European DCM at ABN AMRO in London, notes, most corporate treasurers had become apathetic about market conditions. “They had been constantly told that issuance conditions were at the peak, but the predictions hadn’t become true, and consequently there was less urgency to issue,” he says. But in early March the technical conditions that had created that situation ground to a halt. “Everyone was fairly fully invested,” he says.
When GM’s earnings warning—the precursor of its downgrade—came on March 16, it created a change in sentiment that was more severe than most anticipated. “It began a spiral for the debt markets which it took until the end of May to recover from,” says Jean-Francois Mazaud, head of corporate origination at SG CIB in Paris. “The negative sentiment was fed by bad news for almost two months—first from GM and Ford, then by the downgrades and their removal from investment-grade indexes.”
The second event to shock the market was a complete surprise: the €3.85 billion LBO of Danish company ISS by Goldman Sachs Capital Partners and EQT, the largest European bond issuer ever to be targeted, at the end of March. Spreads widened by as much as 400 basis points (4%) on the 2014 bond, recalls Mazaud. “There was an immediate reaction among investors to consider almost anything—even DaimlerChrysler—to be at risk of an LBO, and spreads widened accordingly.”
Around the same time, the market decided that US rates would likely have to rise more quickly than expected. “It had an effect on the carry trade,” explains Bell. In a tightening spread environment, against a backdrop of low interest rates, it makes financial sense to borrow money to fund bond purchases. The trade is widespread, but hedge funds tend to leverage their trades, making them more vulnerable to rate rises.