Cheap credit and feeble growth opportunity have created an atmosphere of cautious corporates
Source: The Wall Street Journal
The European Central Bank began buying billions of euros worth of corporate bonds earlier this year in a high-profile experiment aimed at spurring private investment. So far, the spending hasn’t materialized.
Since June, the ECB has bought €44.3 billion (around $46.9 billion) in corporate debt. Borrowing costs have tumbled, and debt issuance is up.
But the very reason the ECB started buying the bonds—a weak economy—is crimping the program’s success. The ECB buys bonds to stimulate tame growth with corporate spending. However, companies aren’t spending, executives say and data suggest, because they see few opportunities amid feeble growth and because credit was already cheap.
“We just don’t see much evidence that the behavior of corporates has changed as a result of the” corporate bond-buying program, said Hans Lorenzen, head of European credit strategy at Citigroup Inc. “On the whole, corporates in Europe remain very cautious.”
Corporate savings in the eurozone hit their highest level in at least 22 years in the year to June 2016, according to J.P. Morgan Chase. Corporate savings reflect the difference between cash flows and spending.
Nonfinancial companies in the eurozone held on to $315 billion more than they spent over that 12-month period. U.S. nonfinancial firms, by comparison, had a financing deficit of $43 billion.
Unlike in the U.S., European companies have barely taken advantage of cheap debt to buy back stock and boost their share price. According to Goldman Sachs, a quarter of cash held by S&P 500 companies is spent on buybacks, compared with 5% for Stoxx Europe 600 companies.
Instead, that money is going into the bank, despite the ultralow interest rates that mean it isn’t earning hardly anything as it sits there.
There are few expectations of a boom in capital spending. Analysts project a 3.37% drop in capital expenditure for companies on the blue-chip Euro Stoxx index for 2016, followed by a shallow decline in 2017.
Mergers and acquisitions volumes for European companies are down 28% so far this year compared with the same period in 2015, according to Dealogic, amid a global slowdown in such activity.
The ECB says its actions have brought down credit costs, including in markets where it has not bought bonds, and spurred debt issuance.
That is true. Investment-grade companies have sold €116.2 billion of euro-denominated debt since June 8, when the ECB started buying. That is more than in the same period during any year since the euro was created in 1999, according to Dealogic.
In September, German consumer-products company Henkel AG and French drugmaker Sanofi SA each sold bonds at negative yields, meaning investors were essentially paying for the privilege of lending to the companies.
Still, corporate borrowing costs were already very low before the ECB entered the market. It is doubtful that pushing down debt costs by fractions of a percentage point more will boost investment, analysts argue.
The average yield on eurozone senior debt of nonfinancial companies is 1.1%, down from around 1.4% before the ECB announced its buying plans in March, according to IHS Markit’s iBoxx index. Yields fall as prices rise.
That move is small compared with the decline in funding costs over the past several years. The yield was 7.1% in late 2008 at the height of the global financial crisis.
Juha Kervinen, group treasurer at Finnish telecom company Elisa, said the company hadn’t had any difficulty raising funds, so the ECB buying two of its bonds “really hasn’t changed our thinking.”
“For us to increase [investment] we’d need to see an improved return, not just building networks without any reason,” he added.
Rather than spend, many companies are instead locking in cheaper funding in longer-dated bonds. Others are simply getting cheaper debt to fund what they had already planned to do, such as acquisitions.
The ECB was among the buyers when Spanish company Cellnex Telecom SA raised €750 million this August to finance a series of acquisitions it had announced earlier this year. Central-bank buying helped push down Cellnex’s financing costs, which the company welcomed. But lower borrowing costs aren’t about to make Cellnex invest more money.
“It has not driven us to do more M&A,” said Isard Serra, head of corporate finance at Cellnex. “If there is an opportunity we will look at it, whether the ECB is helping or not.”
In minutes from its most recent policy meeting, the ECB said uncertainty was holding back investment, including the potential for greater protectionism.
Some analysts say the program should be given time to work. Corporate finance departments can be slow to change investment plans. The ECB has also pointed to wider benefits such as lower interest bills across the region.
The ECB’s program was supposed to trickle beyond those companies whose debt is bought on public markets. If large corporations and banks find it easier to finance themselves, they may be willing to extend more credit to smaller businesses.
Bank credit to nonfinancial corporations increased from April to July, but it fell in August and was broadly flat in September, according to the ECB.
Some companies want to avoid loading up on debt to avoid problems down the road, when the debt may need refinancing.
“In 10 years or 15 years, the rates can be completely different,” said Juraj Bayer, finance director at ZSE Group, a Slovak power distribution and sales company. “Therefore we do not want to take on high indebtedness,” he said, adding that he is focused on keeping the company’s investment-grade rating.