European Lending Squeeze Risks Crimping Growth

Europe's corporate bond market is shrinking as redemptions outstrip issuance, banks borrow and lend less, and companies stockpile cash rather than invest in their businesses.

Banks have sold about 335 billion euros ($427 billion) of bonds in the common currency and pounds this year, down from 443 billion euros last year, 503 billion euros the year before and a record 671 billion euros in 2009. Banks cut their lending to euro-area companies by 45 billion euros in the third quarter from a year earlier, according to the European Central Bank.

“It's not clear whether the lack of bank lending is a reflection of broken banks or more a problem of dire economic outlooks for corporates,” said David Watts, a strategist at CreditSights Inc. in London. “Companies that are able to do so are tapping the bond markets. The rest either can't or don't want to borrow.”

ECB President Mario Draghi vowed in July to “do whatever it takes” to preserve the euro as the sovereign debt crisis crimps economies and undermines company and consumer confidence. Asked yesterday about the availability of credit for small- and medium-sized companies, Draghi said: “Are we satisfied with the financial conditions? No, we're not at all satisfied.”

Total bond issuance in euros and pounds has reached 633 billion euros this year, up from 583 billion euros at this point last year and compared with 652 billion euros for all of 2011, data compiled by Bloomberg show. The value of outstanding bonds is about $632 billion, down 8 percent from the end of last year and a slide of more than 12 percent from a record reached in July 2011, according to Bank of America Merrill Lynch's EUR Corporates, Banking index.

Treasurers of large companies, scarred by 2008's credit squeeze, are refinancing at yields driven down by central banks cutting interest rates close to zero. That cash isn't flowing into the economy. Non-financial members of the Stoxx Europe 600 Index hold 577 billion euros of cash, up from 570 billion euros in 2011 and the 345 billion-euro average of the three pre-crisis years ended in 2006, Bloomberg data show.

“Companies aren't pursuing new investments, they're not hiring, and they're letting plants deteriorate because they don't see opportunities,” said Derek Hynes, a London-based portfolio manager at ECM Asset Management Ltd., which runs about $9.5 billion in fixed income. “The implications for the macro economy aren't good. They have to get back to growth, to mergers and, most importantly, to hiring.”

Spread Compression

Yields on Spanish 10-year bonds, which peaked at 7.75 percent on July 25, have fallen to about 5.7 percent, about 432 basis points more than similar-maturity German debt. Italian 10-year bonds yield 4.9 percent, down from a peak of 6.71 percent, also on July 25, and now pay a 352 basis-point premium to bunds.

“Draghi has compressed spreads from astronomically high levels to just very high levels,” said Richard Barwell, European economist at Royal Bank of Scotland Group Plc in London. “The environment is very uncertain, so if you don't need to invest, you don't. You won't have stellar returns but at least you won't die.”

Among banks that have sold bonds are Intesa Sanpaolo SpA, Italy's second-largest bank, which raised 1.71 billion euros in senior unsecured 4 percent bonds due 2017 on Nov. 7. UniCredit SpA, the biggest Italian bank, was able to issue 1.25 billion euros of 10-year 6.95 percent subordinated bonds on Oct. 22.

That was a “big event” because it shows how the cost of doing those deals has fallen, according to Suki Mann, a credit strategist at Societe Generale SA in London.

“Banks being able to do their own issuance has helped,” said Andrew Lim, a banking analyst at Espirito Santo Investment Bank in London. “Even so, the transmission mechanism isn't working effectively for the real economy. Draghi has taken the tail risk of a euro break-up off the table, but not much else.”

The ECB held back from cutting rates from 0.75 percent at its November meeting yesterday. Draghi has acknowledged that rate moves are less effective than they should be because of distortions in the region's financial markets. The Bank of England left its rate at a record-low 0.5 percent.

European central banks, and the ECB in particular, have to focus on working through the banks because “it's a very heavily banked economy,” according to Barwell at RBS.

“Banks don't want to lend in part because companies don't want to borrow,” Barwell said. “Boards ask 'do we need to do this now? Are the chances of a nasty outcome higher than in, say, 2004?' Then they put off spending.”

GDF Suez SA, the Courbevoie, France-based natural gas distributor, leads Europe's cash hoarders, doubling its holdings to 18.3 billion euros from 9 billion euros in 2009, according to Bloomberg data. It's followed by Volkswagen AG, which has doubled cash to about 18.1 billion euros, and Fiat SpA, with 16.9 billion euros, up from 3.7 billion euros in 2009.

“It's a vicious circle,” said Watts at CreditSights. “Companies don't hire, so they don't create revenue for households, which then don't buy, and that doesn't create wealth for corporates, which don't hire, and so on.”

Bloomberg News

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