© . FILE PHOTO: An image of euro banknotes, April 25, 2014. REUTERS/Dado Ruvic By Yoruk Bahceli () – European firms looking to fund M&A and capital spending in bond markets this year face a sudden rise in borrowing costs and are wary buyers following the ECB shock are turning to tighter monetary policy. Bond issuance is an important source of financing for companies and has become more important relative to bank lending in the eurozone, especially since the financial crisis. Captivated by the aggressive tone of European Central Bank President Christine Lagarde after the bank’s February meeting – which opened the door to rate hikes this year – bonds issued by European investment-grade (IG) companies have lowered interest rates by 60 basis points rise. Euro credit was less affected by January’s volatility, fueled by the aggressive stance of the US Federal Reserve, with IG bonds accounting for less than half of the US losses. But those declines accelerated after the ECB and yields have more than doubled this year to 1.18%, the highest since May 2020, BofA said. That’s still extremely low, but a sudden jump in borrowing costs is significant. If it continues, it could affect companies’ ability to invest and ultimately slow economic growth, so central banks are keeping a close eye on credit spreads. Nearly half of investors in BofA’s February survey of credit investors said IG spreads rising to 150-175 bps, from around 110 bps at the moment, would trigger a mild turn for the ECB. A boom in mergers and acquisitions and the need for capital investment is seen by many as driving European corporate bond sales up this year — JPMorgan (NYSE:) for example, expects a record $645 billion in IG investment. issue. While the measures so far aren’t enough to derail those expectations, Helene Jolly, head of the EMEA IG business syndicate at Deutsche Bank (DE:), said borrowers and investors were adjusting to “the new normal”. “Companies have had to look at the new levels of coupons that are required because of the fees being paid…to play,” Jolly said. Sentiment has turned quickly – only 16% of European credit investors are net long on IG debt, its lowest since 2019 and down from 27% in December, while corporate debt funds hold more cash than in years, the survey finds. research by BofA. † One consequence has been declining bond sales — in the two weeks since the ECB meeting, companies have raised about €9 billion, according to Refinitiv IFR data, comparable to volumes in the week before the meeting. Several sessions yielded zero issuance. (Image: https://fingfx.thomsonreuters.com/gfx/mkt/mopanyenqva/euro%20IG%20chart.png) BEWARE Because many companies borrowed cheaply and abundantly during the pandemic, there is no need to panic about their ability to refinance debt , even for sub-investment grade, “junk” issuers. According to IFR, only two junk issuers have sold bonds since the ECB. The vast majority of issuances came from Italian credit management and data group Cerved, which raised most of its funding from a floating rate bond. They compensate investors if interest rates rise. “People are wary of new issuance not because they think it’s bad credit, but they’re concerned that if you buy a credit today with a yield of 3.5% and in a week the same credit will yield 3.75% , your bond a few points,” said Ben Thompson, co-head of EMEA leveraged finance capital markets at JPMorgan. ISSUE BOOM? Issuers may need to enter the markets soon and the ECB is expected to end bond buying by September. Last year, the ECB bought more than 70 billion euros in corporate debt, about 6% of total purchases in that period. IG spreads have widened by more than 25 basis points this year and the additional premium companies pay for new bond sales is already higher than the average since 2015, according to BNP Paribas (OTC:). Viktor Hjort, Global Head of Credit Strategy at BNP, estimates that an imminent rush on M&A and capex-linked loans could widen spreads by an additional 15 bps. “Businesses have a great need for spending, especially capex, which is unsustainably low…so the credit market will have to fund a capex cycle and also face a demand shock,” Hjort said. In the flea market, which is critical to financing leveraged buyouts, the average coupon on the BofA index is higher than the yield, according to Refinitiv Datastream, so new issuances will cost companies more on average than the interest on their current debt. However, higher interest rates are not expected to derail lending. Shanawaz Bhimji, strategist at ABN AMRO (AS:), estimates that total return on equity this year will exceed the current cost of equity, even if the net cost of debt is much higher than current interest rates, so they should continue to invest in mergers and acquisitions and capex. To make financing cheaper, borrowers can opt for shorter-term financing or issue floating-rate bonds, patterns that already show up with some deals, the bankers said. “Issuers will have to be realistic about the cost of debt,” said Thompson of JPMorgan.
