Blue-chip bond buys add liquidity fuel to companies already swimming in cash.
Whatever financial dangers stalk the world these days, it is a great time to borrow money—and the European Central Bank (ECB) is making it even greater, for some. After years of buying eurozone countries’ sovereign debt, the ECB announced in March that it would begin buying select corporate bonds as well. That policy, the Corporate Sector Purchase Program (CSPP), came into force in June.
“The crises of the last few years have pushed monetary policy into uncharted territory,” ECB executive board member Sabine Lautenschläger remarked at a meeting organized by the Commissariat of German Bishops. “This program is intended to support the other measures by additionally lowering long-term interest rates…and at the same time it gives a signal that monetary policy is committed to its goal of stable prices.”
ECB president Mario Draghi is not thinking small. Bond purchases topped €2 billion a week by July, and could reach four times that amount, predicts Fenton Burgin, head of UK debt advisory in the London offices of Deloitte. Although the largesse is restricted to blue-chip eurozone companies such as food producer Danone or telecoms giant Telefónica, ECB-injected liquidity has spilled into the rest of the market, paring average interest rates on investment-grade corporate debt by some 30 basis points to an even 1%, Deloitte estimates. That compares with more than 2% in the US, and the gap may widen if the Federal Reserve Bank moves into its endlessly anticipated tightening phase.
It’s no wonder a parade of non-European companies, especially US-based household names, are heading across the Atlantic to borrow. Coca-Cola placed an €8.5 billion ($9.5 billion) bond issue in February with an attractive coupon of 0.75%. General Motors, drugmaker Johnson & Johnson and convenience food empire Kraft Heinz, among others, have followed suit on a somewhat smaller scale. In all, so-called “reverse Yankee credits” account for more than 20% of European corporate debt issuance so far this year, feeding a patriotism of sorts in continental financial circles. “U.S. Companies Love the Euro,” German newspaper Handelsblatt crowed in a recent headline. “We are already seeing the bond purchases have helped to further improve borrowing conditions,” the ECB’s Lautenschläger said. “It is, however, too early to analyze statistically the unfolding effects on growth and inflation.”
Despite the enthusiasm, only a select few foreign corporates have what it takes to cash in on bargain-basement euro financing. The first requirement is operations within the eurozone to spend the borrowed cash on. Swap rates from euros to dollars have gone up as euro interest rates have gone down, and will likely nullify the advantage of cheaper funding, Burgin says. There’s little point to borrowing euros you are not planning to use in Europe.
The second hurdle is an investment-grade credit rating. European investors remain a conservative lot compared to Americans, despite the derisory yields available from safe-looking instruments. The continent has struggled to develop high-yield debt markets for growth companies below investment grade, and what it did achieve is collapsing in 2016. The volume of euro-denominated “junk” bonds fell by 50% in the year to August 1, to a scant €27.5 billion, according to highyieldbond.com. European banks are strapped for capital because of low returns and increased regulation, leaving the market more dominated than ever by ultracautious pension funds.
Emerging markets corporations are also suspect to the continent’s buyers, analysts say. The ECB is opening its wallet just as big issuers in the developing world face credit exhaustion. Emerging markets companies added an impressive $4 trillion or so in dollar-denominated debt from 2008 to 2015, according to the Bank for International Settlements, but up to 2014 many of the hungriest debtors were commodity exporters like Brazil’s Petrobras and Russia’s Gazprom, whose appetites have shriveled, owing to crashing prices for their products worldwide and political problems back home.
Chinese companies, the biggest national group among emerging markets borrowers, kept up the pace until recently. In 2015, government-owned stalwarts like China State Grid International Development Co. and China Construction Bank led a boomlet of diversification into European bond markets, raising $9 billion on the continent, compared with $80 billion in dollars. But Beijing, justifiably alarmed by mushrooming foreign indebtedness, seems to have started tightening the taps late last year. “The third quarter of 2015 may have marked an inflection point in the growth of mainland [China]-related dollar credit,” reports the Bank for International Settlements. Foreign currency lending within China actually contracted by $70 billion during those three months. European bond buyers, for their part, have gone “risk-off” on what they see as exotic credits, Burgin says.
The post-2008 dollar debt binge also taught emerging markets corporate finance managers a stern lesson in the risks of currency mismatches, especially when borrowing in a currency that seems weak. It is hard to remember now, but much of that $4 trillion in IOUs was racked up when developing markets finance ministers blasted Washington for driving the greenback down, and the Chinese yuan seemed poised to rise against the dollar indefinitely. Instead, the dollar has climbed 7% against the yuan since January 1, 2015, and more than 5% against a global currency basket, leaving nervous debtors around the world. The euro may be languishing now, but it could well rebound substantially over the course of a typical five- or seven-year corporate bond term, especially against emerging markets currencies that are on slippery footing themselves.
The biggest beneficiaries of the CSPP may be smaller European companies that have traditionally been excluded from bond markets and have seen bank credit grow scarcer, Deloitte’s Burgin says. Nonbank lenders are taking advantage of tiny interest rates to raise as much as €35 billion slated for the continent.
These so-called direct lenders account for 75% of corporate finance in the US, compared with just 20% in bank-focused Europe, according to New York investment bank Brown Brothers Harriman, leaving a huge gap to fill. “European markets are transitioning very quickly to the US model, and European mid-caps are benefiting,” Fenton concludes.
Whether that benefit will be enough to drive the ECB’s overarching goal of firming up the eurozone’s flaccid economy is another question. So far the outlook is uninspiring. In September the bank lowered its own 2017‒2018 growth forecast from 1.7% to 1.6%.
Draghi may have brought the continent back from the brink with unprecedented purchases of Greek, Italian and Spanish sovereign bonds starting in 2010. But Moody’s warns of unintended consequences. The obvious early effect of this year’s initiative is giving already cash-rich corporate giants slightly cheaper funding for acquisitions and share buybacks.
The biggest single euro-denominated bond issue of 2016 was the €13.25 billion raised by Belgium-based beer maker Anheuser-Busch InBev to help finance its megamerger with global rival SABMiller—not an obvious boon to anyone beyond the companies’ investment banks. Bank of America warns that the CSPP could “quickly become its own worst enemy,” fueling a rise in leveraged buyouts— because “cheap debt can suddenly make unviable candidates appear ‘viable’ for private equity”—and increasing volatility in credit spreads.
The continent’s pension funds, meanwhile, face a tougher challenge paying for their members’ retirement, as early September saw the world’s first negative-yielding corporate bonds, issued by French pharmaceutical firm Sanofi and German cement maker Henkel. Many funds have little choice but to accept lower returns as they are mandated to invest in Europe.
Draghi and the ECB are not alone in pumping more money for diminishing returns. Unconventional monetary policy seems to have run its course in the US and Japan as well. Alternative backstops for the fragile global economy are not in sight. Commerzbank analysts believe “yields will dive again later this year when it becomes clear the current ECB measures are not meeting expectations.” Moody’s suggests the central bank’s purchases should be enhanced by structural reforms in many countries—in line with the bank’s own position.
“Monetary policy alone cannot build factories or create jobs or balance national budgets,” Lautenschläger acknowledges. “It can only create the right conditions for these things.” Still, changing fiscal policy is easier said than done.
“Central bankers know that QE can’t go on forever and are talking more about handing the baton back to politicians,” says Graham McDonald, head of private equity at Aberdeen Investment Management in London. “But I don’t see it changing any time soon.”