Corporates look like the last safe haven in the bond markets, thanks to international investors abandoning the peripheral European government bond markets and issuance of senior unsecured bank bonds grinding to a halt again last month. Bonds of national champion companies in peripheral countries, think Enel in Italy and Iberdrola in Spain, now often trade at levels below the sovereign. Investors take comfort from many investment-grade corporates strong balance sheets and margins, and cash surpluses. They make a sharp distinction from banks whose accounts investors no longer trust. Corporates used to be at the risky end of the cretdit spectrum, with governments supposedly risk-free and banks benefiting from implicit sovereign support. That order is now inverted. However, when you talk to corporate treasurers, they are hardly revelling in this. While a shrinking banking system has less capacity to fund corporates, European companies are also making contingency plans for renewed disruption in the debt capital markets. Thats why many rushed to the bond markets in the first quarter of the year when investors risk appetite was buoyed by the European Central Banks (ECB) long-term refinancing operation (LTRO). One large multinational company tells Euromoney that its contingency plans now include preserving the ability to carry on functioning if the term debt capital markets close for an entire year. And this is not just issuer paranoia. Investors share the concern. Ineos hit the headlines recently for a large refinancing of bank debt through US dollar and euro covenant-lite loans that suggested strong risk appetite. Lost in that tale is, perhaps, its more telling experience in the US high-yield bond market in February. When the company touted for orders for an $850 million bond, key US investors said they would demand an 8.75% coupon, but if the company raised twice as much they would buy bonds at 8.375%. This was not a case of offering a premium for liquidity. When pressed, dealers will admit that secondary liquidity is awful across the bond markets. Investors wanted the company to retire more of its debt maturities coming due in 2013 and 2014, a process the company had completed by the start of May. Investors themselves are nervous about refinancing risk.
This state of anxiety is likely to increase this month in the run up to the Greek election amid fears over possible widespread bank runs and break-up of the euro. There were tremors over the possibility of depositors withdrawing funds from Bankia last month, even after the troubled bank had effectively been nationalized, relating to fears that the Spanish government itself beset by higher borrowing costs might lack the financial capacity to restore the countrys banking system.
Bankias official statement that evolution of deposits in the first half of May had a markedly seasonal nature wasnt re-assuring.
Now, as the game of chicken unfolds between Greece and core Europe over the possibility of a Greek exit, Hans Lorenzen, credit strategist at Citi, has been pondering the possible impact of capital controls across Europe, starting from the obvious point that the imposition of capital controls in Greece might lead to deposit flight in other countries and the possibility of capital controls elsewhere.
These could be potentially highly disruptive for corporates, if cash becomes trapped inside companies, and present difficulties for debt service. Lorenzen points to a Moodys study in 2009 of emerging markets crises that shows capital controls as a key contributor to 30% of corporate defaults in Argentina in 2001-02 when default rates soared.
It seems almost surreal to be talking about capital controls in western Europe; the treaty behind the single market act enshrines free movement of capital as a core pillar. But in extremis, governments will do what they have to, and the treaty that prohibits restrictions on movements of capital also allows exemptions in exceptional circumstances where such free movement infringes prudential supervision of financial institutions and restriction is justified on the grounds of public policy or public security.
A widespread withdrawal of deposits from a national banking system turning into an outright run could quickly become an issue of public security. The obvious way to prevent such runs would be a joint and severally underwritten eurozone-wide deposit guarantee scheme, backed by the ECB. Thats a federal Europe guaranteed by Germany under another name.
Could capital controls be introduced in ways to halt deposit outflows without also inhibiting companies ability to service debt payments due in one country with earnings derived from another? Possibly, but that would require carefully considered legislation to be drafted and enacted at a time of panic.
Even if existing debts could be serviced, Citi suggests that supply of new international funding would be cut off to any but the strongest and most internationally diverse companies. And even companies with strong liquidity would suffer if suppliers or customers had funding cut off.
The imposition of capital controls in Europe might sound far-fetched even now, but it is another form of jump-to-default risk that investors might have to start quantifying the likelihood of and pricing into provision of funding.
|Bankia chairman José Ignacio Goirigolzarri|