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Thursday, September 28, 2006

Corporate Borrowing in the Eurozone

This is going to be an additional headache for the ECB:

Eurozone corporate borrowing grew last month at its fastest rate since the euro’s launch in 1999, and money supply figures watched closely by the European Central Bank also accelerated, strengthening the case for another interest rate increase next week.

The unexpectedly buoyant money supply and lending data released by the ECB on Wednesday highlighted the strength of economic activity in the 12-country eurozone, especially in the corporate sector, which is undergoing a wave of merger and acquisition activity. “They’re consistent with a positive frame of mind – by consumers and corporates. People are happy to take on debt,” said Michael Dicks, economist at Lehman Brothers.

This is because, as the FT suggest, it puts them under pressure to continue raising interest rates since:

the data will add to fears that still-low interest rates are encouraging excessive borrowing and creating longer-term inflation risks. The dangers of rapid credit expansion are likely to be cited by Jean-Claude Trichet, ECB president, after the central bank’s meeting in Paris next Thursday, when it is expected to raise interest rates by another quarter percentage point to 3.25 per cent.

Now this might all be fine and well were the borrowing to finance a new round of productive investment, but this may not be what is happening, what we seem to have is some kind of mergers and acquisition frenzy (especially in the energy sector) and this, in fact, is making the rating agencies nervous:

The huge increase in Eon's offer raised questions about the German group's financial discipline. German utilities gained a reputation in the previous round of consolidation for overpaying but Eon changed investors' opinions when it walked away from a bid for the UK's Scottish Power last year.

Standard & Poor's, the rating agency, said Eon's AA ratings remained on watch negative. A rights issue of up to 10 per cent could be possible depending on how much over the 50 per cent acceptance level a bid reached.

And please don't miss this one:

European investors who lend in leveraged buyouts face greater risks as borrowers chip away at creditor rights, Standard & Poor's said in a report.

Buyout firms who borrow to fund acquisitions are offering investors less protection against default as they rewrite loan documents in their favor, S&P said in the report entitled ``Ratcheting Up The Risk.''

Weaker loan contracts let companies cut their debt at a slower pace and give lenders fewer voting rights in the event of a bankruptcy, S&P said. Borrowers also have to set aside less cash to prepay their loans. At the same time, interest margins to compensate investors for taking greater risk have declined, S&P said.

``Financial sponsors are now able to borrow more and repay less, with fewer restrictions and for lower cost,'' S&P's report said. With demand for loans rising, companies will be tempted to weaken contracts even more and ``further erode lenders' rights.''

The survey covers 12 financing agreements for five borrowers including German chemicals distributor Brenntag Holding GmbH, British petrochemicals company Ineos Group Holding Plc, and Cablecom Holdings AG, the Swiss cable-television provider owned by Liberty Global Inc.

S&P cut its debt ratings by an average of one step on companies in the survey that amended their financing agreements following a refinancing.

Rising demand from investors has prompted buyout firms and borrowers to ``push the boundaries of transaction size and financial leverage,'' S&P said.

So what we may face moving forward is a eurozone which is slowing and a central bank which keeps raising rates to stop excess corporate spending and increasing credit default risk. Not an easy picture, and certainly a connundrum.

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