ECB Policy

Flush With Cash, Then Drowning in Debt

  • Why it matters

    Why it matters

    The ECB’s extended purchases of corporate bonds have left many companies, including half of those in the blue-chip DAX index, at risk of drowning in their own debt.

  • Facts

    Facts

    • The ECB owns over €100 billion in bonds issued by around 200 European companies under the central bank’s quantitative easing program.
    • Since 2010, the net debt of DAX companies has jumped from €411 billion to a record €611 billion.
    • Since the spring of 2015, the ECB has bought sovereign and corporate bonds worth €60 billion every month.
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    Audio

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Wave built of Euro banknotes
Some companies that rode the wave may now get pulled under. Source: Getty Images

When the European Central Bank’s executive council meets this Thursday, no one expects an end to the flood of cheap money from quantitative easing. Interest rates, analysts say, will remain at zero, and ECB boss Mario Draghi will most likely plump for an extension of its generous purchases of sovereign euro-zone debt.

But many people forget that the ECB also finances companies. The bonds of some 200 companies are on the central bank’s books, including oil companies Shell and Total, aircraft builder Airbus and more than half the members in the blue-chip DAX, from chemical giant Bayer to carmakers BMW, Daimler and VW, and software colossus SAP. The ECB invests approximately €2 billion in corporate bonds every week.

As a result, companies now pay almost no interest on new debt. Not surprisingly, the abundance of cheap money may have tempted companies to launch expensive and occasionally ill-advised takeovers.

Now, analysts at Bank of America are sounding the alarm. If interest rates rise, companies could collapse under their own borrowing. Particularly vulnerable are heavily-indebted firms in southern Europe. Crédit Agricole, a French bank, says “some firms could have difficulties staying solvent.”

04 p05 High Debt, Low Interest 2-01

Europe’s governments have grown accustomed to big cash injections. Since the spring of 2015, the ECB has bought sovereign and corporate bonds worth €60 billion every single month, thus financing a large portion of countries’ (and companies’) debt. Last month, the German constitutional court raised doubts whether the ECB’s bond-buying program is compatible with a ban on financing members’ national debts.

The ECB also finances companies by buying their debt – partly because of a lack of eligible government bonds on offer, and partly to encourage companies to spend money. As of July, the ECB owned more than €100 billion in bonds issued by European companies under the central bank’s quantitative easing program. Documents at national central banks reveal many such companies are outside of Germany, include utilities Enel (Italy), EDF and Engie (France); Swiss food giant Nestlé; and US corporations Coca-Cola and construction equipment maker Caterpillar. As long as their bonds are listed in euros and don’t fall below a certain rating, a company can qualify for selling bonds to the ECB.

For a while, these companies enjoyed the windfall. And as interest rates fell, their debts got even cheaper. Across Europe, companies were only spending an average 1.3 percent in interest to service their bonds (see chart above). For German household names such as BASF, Continental, Linde, SAP and Siemens, the yield, or annual return to investors, fell to less than 0.5 percent. France’s pharmaceutical company Sanofi and German consumer goods manufacturer Henkel, incredibly, even managed to issue bonds at slightly negative rates, helping to pay off their debts.

According to Bank of America, 50 of the euro zone’s 600 largest companies might have to be classified as debt "zombies."

Cheap money, moreover, can make even stunningly expensive takeovers look attractive. Belgian-American beer brewer Anheuser-Busch Inbev bought its competitor SAB Miller for a record €100 billion in 2016 and, in the process, became one of the world’s largest bond issuers. Who buys them? The ECB, for one. Headquartered in Brussels, New York and St. Louis, the behemoth brewer paid €3.7 billion in interest last year on total debt of €116 billion. With profits of €15.1 billion (Ebitda), this is financially doable, as long as interest rates remain low.

But there are wider implications. Bank of America’s strategists warn that the high number of companies supported by the ECB’s bond-buying limits scope to slow these purchases in future. More tellingly, according to the B of A, 50 of the euro zone’s 600 largest companies might have to be classified as “zombies” because they pay far too much interest in relation to their profits. This means that these companies, on paper, risk collapse when the ECB’s financial support dries up. Monetary support in Europe over the last five years has enabled companies with low profitability to continue refinancing their debts and avoid payment defaults, warned B of A analyst Barnaby Martin.

For example, the debt-to-profit ratio is way out of kilter at Finnish steelmaker Outokumpu, which five years ago took over the Inoxum stainless steel division from ThyssenKrupp. Since then, Thyssen-Krupp has held almost one-third Outokumpu’s shares. At €130 million in 2015, the interest owed by Outokumpu actually exceeded its profit (Ebitda) of €109 million. Things improved a little in 2016, but overcapacity and cheap imports from China are still crimping revenues. Their financial straits would have been even worse without the ECB.

Since 2010, the net debt of DAX companies has jumped from €411 billion to a record €611 billion.

Most German companies don’t have debt problems this serious. But here too, the consequences of cheap money are painfully apparent. The situation is particularly dire at Bilfinger, a German construction and engineering company, which has financial liabilities of €512 million. In 2016, Bilfinger paid €28.8 million in interest to its creditors. That amounted to more than half of its profit of €50.5 million.

Even big DAX companies have tumbled into this debt trap. Since 2010, their net borrowings have jumped from €411 billion to a record €611 billion. Among DAX members, healthcare specialist Fresenius has accumulated debt of €18.5 billion, up from €13 billion in 2016. This spending gap was financed partly by issues of its low-interest bonds, which happen to also be on the ECB’s books. In the past year, Fresenius’ corporate bonds managed to make interest-rate earnings of €5.5 billion before taxes, interest and depreciation. But it’s easy to see the balance will deteriorate, as rising interest rates swell this burden.

Among Germany’s neighbors, France has more than its fair share of debt woes. French trainmaker Alstom paid €225 million in interest last year – but earned only a modest €836 million before taxes, interest and depreciation. In terms of economic performance, French companies are twice as indebted as the Germans, and a large chunk of that debt comes from acquisitions. When Danone, the food company, took over US organic food producer WhiteWave for €10 billion, it completely financed the purchase with bond issues, catapulting its outstanding debt to €18 billion.

So far, the ECB has provided cash on favorable terms. But almost two-thirds of French corporate debt, for instance, is based on variable interest rates. This increases the risk that as soon as the ECB stops buying bonds, interest rates will ratchet higher. And sooner than later, that day will come.

 

Ulf Sommer covers financial markets and companies for Handelsblatt. Jeremy Gray adapted this story from the original for Handelsblatt Global. To contact the author: sommer@handelsblatt.com.

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