FRONT STORY EUROPEAN CORPORATES
Downgrade risk for Triple Bs
Eurozone recession could lead to billions of euros of downgrades
Hundreds of billions of Triple B rated
issuance could be at risk of downgrade if the
eurozone falls into recession, sparking fears
about the high-yield market’s capacity to
absorb such a deluge of paper.
Lower-rated investment-grade issuers have
taken advantage of attractive funding costs
thanks to the ECB’s Corporate Sector Purchase
Programme to go on a huge borrowing spree
over the past couple of years.
Of the €155bn-equivalent printed in the
European investment-grade market in the
lRSTûHALFûOFûTHISûYEAR ûFORûEXAMPLE ûALMOSTû
half came from Triple B rated issuers,
according to IFR data.
And with yields still low by historical
standards - despite the recent sell-off in
credit markets - investors have been falling
over themselves to get their hands on this
class of paper.
BAYER’s long-awaited €5bn four-trancher in
June saw over €21bn of orders despite the
company being downgraded two notches by
S&P to BBB and one notch by Moody’s to
Baa1 just weeks before the deal was priced.
4HEûDOWNGRADESûREmECTEDûEXPECTATIONSûOFû
rising leverage after the German chemicals
company buys US peer Monsanto.
But some analysts fear that any eurozone
downturn could cause turmoil in credit
markets, and especially the high-yield sector
- which has shrunk over the past three and a
half years - if investors have to sell newly-
downgraded bonds or when junked
COMPANIESûNEEDûTOûRElNANCEûMATURITIES
h4HEûIDEAûOFûTHEûNEXTûEUROZONEûRECESSIONû
lLLSûUSûWITHûAûLOTûOFûFEAR ûNOTûJUSTûBECAUSEûMANYû
central banks would be relatively constrained
in their ability to cut rates after the big post-
GLOBALûlNANCIALûCRISISûEASING ûBUTûMOREûBECAUSEû
of how disruptive it could possibly be to the
euro credit markets,” said credit strategists at
Bank of America Merrill Lynch in a recent
RESEARCHûNOTEûENTITLEDû@4HEûhNEXTvûRECESSION
While the note says a recession is not yet on
the cards, even a weakening in growth could
become a tipping point for many companies.
It points out that since the beginning of
2015, the size of the Triple B rated corporate
market has grown from €450bn to €755bn -
led by €200bn from debut issuers.
At the same time, the high-yield market
has shrunk from €310bn to €285bn as the
strict eligibility of the CSPP has pushed junk-
rated companies to delever in order to attain- or regain - investment-grade status.
,ASTûMONTH ûFORûEXAMPLE ûARCELORMITTAL
was upgraded by Moody’s to Baa3, following
a similar move by S&P earlier this year. The
upgrade, leaving the steel maker with one
junk rating, has pulled the issuer out of
"!-,SûWIDELYûTRACKEDû)#%ûHIGH
YIELDûINDEX
But if a downturn was to occur, a slew of
potential downgrades from companies that
have been on a borrowing binge “would
have overwhelming consequences for the
credit market in Europe. The potential for
such a vast amount of fallen angels at a time
when euro high-yield bonds are shrinking
would cause enormous ructions and
indigestion in the market,” said BAML.
The US bank is not alone in fearing a
pessimistic outcome. “On some measures,
leverage today is higher than during the depth
of the last couple of recessions,” said Puneet
Sharma, head of credit strategy, investment
management at Zurich Insurance Group.
“The minute you have a recession, it will
get out of control. It’s like a ticking time-
bomb in a way.”
Corporate leverage fell sharply in 2017,
according to Hans Lorenzen, credit strategist
at Citigroup, while interest coverage and
cash to short-term debt rose to record highs.
Yet with M&A now on the up again - in the
lRSTûlVEûMONTHSûOFûTHEûYEAR ûACQUISITIONSûBYû
European companies doubled year-on-year
to more than €200bn, according to Citigroup- the leverage trend appears to be changing.
And that could spell trouble even if there
aren’t any immediate concerns.
“Strong fundamentals at a mature point in
the cycle are not unusual. It was no different
BEFOREûTHEûGLOBALûlNANCIALûCRISISûANDûYETû
default rates subsequently spiked to more
than 10%. With moderate releveraging over
THEûNEXTûCOUPLEûOFûYEARS ûINûPARTICULAR ûWEûSEEû
FEWûREASONSûTOûEXPECTûAûBETTERûOUTCOMEûINûTHEû
future,” said Lorenzen, who thinks that about
€120bn of debt is at risk of being downgraded
to junk in the event of a downturn.
With funding conditions becoming
tighter, the hope is that companies will
FOLLOWûTHEûEXAMPLEûOFû!RCELOR-ITTALûANDû
embark on deleveraging before it’s too late.
“It’s true that with the CSPP, there hasn’t
been a huge incentive to maintain high
ratings. But moving to sub-investment is still
a very different proposition because the cost
of borrowing is much higher,” said one
portfolio manager.
h9OUûCANûDElNITELYûPAINTûAûPICTUREûABOUTû
how big the Triple B sector is, but the
intention is very much to delever.”
Danish telecoms operator TDC is the only
European fallen angel this year, following its
acquisition by a Macquarie-led consortium.
Rating agencies also junked Israel’s TEVA
PHARMACEUTICAL INDUSTRIES in late 2017/early
ûONûEXPECTATIONSûITûWOULDûSTRUGGLEûTOû
MANAGEûSIGNIlCANTûDEBTûBURDENSûWHILEûFACINGû
a prolonged period of earnings erosion.
Only a handful of European names were
on the Moody’s potential fallen angel list
earlier this year, such as Spain’s REDEXIS GAS
and Italian broadcaster RAI.
“There are indeed some concerns around
downgrades, in particular in the commodities
sector, but most companies will do their
utmost to keep their investment-grade
rating,” said one syndicate banker.
But Sharma warns that management’s
good intentions to reduce their debt burden
MIGHTûNOTûBEûSUFlCIENTûINûAûRECESSION
“The banking system and sovereign are
very much interlinked. If a country gets
downgraded, some companies might also get
downgraded,” he said.
Pauline Renaud, Yoruk Bahceli
BONDS
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