Borrowing costs

Analysis: After ECB shock, European companies face higher borrowing costs

An illustration of euro banknotes, April 25, 2014. REUTERS/Dado Ruvic

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Feb 18 (Reuters) – European companies hoping to fund mergers and acquisitions and capital spending in bond markets this year are facing a sudden rise in borrowing costs and wary buyers after the ECB shock in favor of a tighter monetary policy.

Bond issues are a key source of corporate finance and have grown in importance relative to bank borrowing in the euro area, especially since the financial crisis.

Caught off guard by the hawkish tone of European Central Bank President Christine Lagarde after the bank’s February meeting – which opened the door to rate hikes this year – European investment-grade corporate bonds ( IG) saw their yields jump 60 basis points.

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Euro credit had been less affected by January’s volatility stoked by the US Federal Reserve’s hawkishness, with IG bonds generating less than half of the losses in the US. ,

But those falls accelerated after the ECB and yields have more than doubled this year to 1.18%, the highest since May 2020, according to BofA.

This is still extremely low, but a sudden increase in borrowing costs is significant. If it continues, it may impact businesses’ ability to invest, possibly slowing economic growth, so central banks are watching credit spreads carefully.

Nearly half of investors in BofA’s February Investors in Credit Survey said IG spreads of up to 150-175 basis points, from around 110 basis points currently, would lead to a dovish shift from the ECB .

A boom in mergers and acquisitions and the need for capital investment have been seen by many as driving a surge in European corporate bond sales this year – JPMorgan, for example, expects a record 645 billion euros of IG issues.

While the steps taken so far are not enough to derail those expectations, Helene Jolly, head of EMEA IG corporate syndicate at Deutsche Bank, said borrowers and investors are adjusting to “the new normal”. .

“Companies have had to look at the new levels of coupons required because of the rates being paid…and investors have had to think about what this means to me, what is my current view of rates and where do I want to play,” Jolly said.

Sentiment has changed rapidly – just 16% of European credit investors are net positioned in IG debt, the lowest since 2019 and down from 27% in December, while corporate debt funds hold more cash than they’ve had in years, according to the BofA survey.

One consequence was lower bond sales – in the two weeks after the ECB meeting, companies raised around €9 billion, a volume similar to volumes in the week before the meeting, according to Refinitiv IFR data. Several sessions resulted in no shows.

Euro IG yield and spread


Given that many companies have borrowed heavily and cheaply during the pandemic, there is no panic about their ability to refinance debt, even for lower-quality “junk” issuers.

Only two junk issuers have sold bonds from the ECB, according to the IFR. The vast majority of issuance came from Italian credit and data management group Cerved, which raised most of its funding from a floating rate bond. These compensate investors as interest rates rise. Read more

“People are suspicious of new issues, not because they think they are bad credits, but they are afraid that if you buy a credit with a yield of 3.5% today and in a week, the same credit returns 3.75%, your bond goes down a few points,” said Ben Thompson, co-head of leveraged financial capital markets at JPMorgan for EMEA.


Issuers may have to start hitting the markets soon, with the ECB expected to suspend bond purchases by September. Read more

Last year, the ECB bought more than 70 billion euros in corporate debt, around 6% of its total purchases during this period. Read more

IG spreads have widened by more than 25 basis points this year and the extra premiums companies pay for new bond sales have already been above average since 2015, according to BNP Paribas.

Viktor Hjort, global head of credit strategy at BNP, believes a rush in M&A and investment-related borrowing could widen spreads by another 15 basis points.

“Businesses have a big need for spending, especially investment, which is unsustainably low… so the credit market is going to have to fund a round of investment, and it’s also facing a demand shock,” Hjort said. .

In the junk market, critical for funding leveraged buyouts, the average coupon on the BofA index exceeds its yield, according to Refinitiv Datastream, so on average new issues will cost companies more than the interest on their current debt.

Still, higher yields should not derail borrowing.

Shanawaz Bhimji, strategist at ABN AMRO, believes that companies’ total equity returns this year will exceed the current cost of equity, even assuming a cost of net debt much higher than current rates, so they should continue to rise. investing in mergers and acquisitions and investments.

To lower the cost of funding, borrowers can opt for shorter-term funding or issue floating-rate notes, patterns that are already emerging on some transactions, bankers said.

“Issuers are going to have to be realistic about the cost of debt,” said JPMorgan’s Thompson.

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Reporting by Yoruk Bahceli; edited by Sujata Rao and Toby Chopra

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