Not going to be easy, especially for “zombie” companies.
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
An unusually fierce spat broke out this week between two of Europe’s biggest utilities companies, Spain’s Iberdrola and Italy’s Enel, both of which are locked in a bidding war for the Brazilian electricity company Eletropaulo. The Spanish firm accused its Italian rival, almost a quarter of which is owned by the Italian State, of unfair competition due to its access to cheaper debt.
“With the obvious support of the State, Enel clearly benefits from a privileged regulatory situation in Italy, which makes access to the capital markets both cheaper and easier,” complained Iberdrola’s CEO Ignacio Sánchez Galán in a scathing letter to the European Commission. He called for a debate on the privileges certain state-owned companies continue to enjoy despite EU competition laws on illegal state aid.
Sánchez Galán raises an important point: in the EU, partly or majority state-owned companies like Enel and Électricité de France (EdF) clearly enjoy funding benefits over their rivals, especially with the Eurozone’s sovereign bond market still being propped up by the ECB.
But he also omits an inconvenient fact: his own company, Iberdrola, is one of the biggest beneficiaries of the ECB’s corporate bond buying program. As a result, it has been able to pay next to no interest on new debt for the last two years.
State-owned companies like Enel and EDF have benefited two-fold from the ECB’s largesse, first from its corporate bond buying, and secondly from its sovereign bond buying. At one point the central bank was buying €80 billion of sovereign and corporate debt per month, which helped push yields into the negative for many securities. This helped push down the funding costs of Member States’ national debts while giving a select group of European companies and subsidiaries a massive funding advantage over smaller rivals.
On a number of occasions, the corporate bonds were not even bought on the open market; instead, the ECB bought them directly from the companies through “private placements.” These arrangements enabled the companies involved, including Iberdrola, to raise cash more quickly without having to jump through the regulatory hoops.
In 2017, the German constitutional court raised doubts about the legality of the ECB’s bond-buying program. But instead of ruling on the matter, it passed the buck on to its European superiors, the European Court of Justice (ECJ). As the German judges well knew, the chances of the ECJ ruling against the ECB on such an important matter are tiny. And in the highly unlikely event that it did, the ECB’s QE party would have already probably ended.
Over the last 18 months the ECB has reduced its bond purchases from roughly €80 billion a month to around €30 billion in January. But nearly all of the reductions over the first three months this year came from government bonds, while it largely maintained its purchases of corporate bonds.
At last count the ECB had a total balance sheet of €4.54 trillion, more than any other central bank on Planet Earth, of which €149 billion are corporate bonds that it has acquired since June 2016.
But there are signs that the ECB has quietly begun to taper its corporate-bond buying program. The rate of purchases under the Corporate Sector Purchase Programme dropped 50% in April to about €700 million per week, down from €1.4 billion during the first quarter, analysts at Deutsche Bank pointed out. That could mean the ECB is starting a “stealth taper” in order to wean the European bond market off the corporate debt purchases it began in June 2016, Deutsche Bank said.
But are the companies that benefited from the ECB’s largesse ready for life without Draghi? There’s no doubting the ECB’s bond buying has exacerbated distortions in the corporate bond market — distortions that were first engendered by the central bank’s low interest rate policy. Yields came crashing down and spreads narrowed.
At the peak of ECB’s bond buying binge, the average yield of the Iboxx non-financials index fell as low as 0.69%. For German blue-chip companies such as BASF, Continental, Linde, SAP and Siemens, yields fell to less than 0.5%. France’s pharmaceutical company Sanofi and German consumer goods manufacturer Henkel even managed to issue bonds at slightly negative yields, effectively helping pay off their debts.
But that was then. Now, the average yield of the Iboxx non-financials index is back above 1.10%. As Reuters reports, some of Europe’s biggest money managers are reducing their exposure to corporate bonds. Some are even shorting them, betting that stress is building in a market that was buoyed by years of rock-bottom borrowing costs. Some new bond issues have even struggled to find buyers, when not so long ago they were flying off shelves.
Bank of America guesstimated last year that as many as 50 of the euro zone’s 600 biggest companies deserve to be classified as “zombies,” as they pay far too much interest in relation to their profits. For these companies the ECB’s bond-buying program was a godsend, allowing them to continue refinancing their debt and stave off default. But interest rates are beginning to rise again.
Whether or not the ECB has already begun to taper its corporate bond buying on the quiet, the program will likely be phased out later this year. And yields have already been rising ever so gradually in anticipation. That means that the companies that have benefited from the central bank’s monetary support are going to soon find themselves facing a whole new, more challenging reality. For some it’s unlikely to be a pleasant one. By Don Quijones.
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