It is obvious (but surprising, one might think at first) that the problems of corporate financing are only now coming to light. Indeed, after a covid and these interminable confinements, one would have expected problems earlier. No doubt they have been postponed by the massive subsidies of "whatever it takes" (E. Macron's version). One gets the impression that investors, even in private equity or for start-ups, are more vigilant and more reticent. In a context of rising interest rates, bankers are becoming (too) cautious. What can we hope or fear in such a delicate and uncertain climate are the questions we intend to answer.
The banker, this being who lends his umbrella but takes it back when it rains is the image that many have. Rightly or wrongly. Overall, for various reasons, one can easily admit that financing rates and spreads have increased, and bankers have become more cautious. As always, favor to the biggest and best rated (i.e., highest credit ratings). In addition to the health crisis, there is an energy crisis which has increased the cost of production considerably, to the point of closing factories. I read about a French company whose cost of financing went from 3 to 9%. Incredible, isn't it? We then enter a negative and destructive spiral. Banks have been wondering how much credit risk they are willing to take and keep, in the absence of visibility on the economy. As is often the case, SMEs will be the first to pay a heavy price for this multiple crisis. And when the situation is less favorable, results suffer and so does the credit rating. A downgrading means a higher margin to pay to the market. We can better understand the perspective of the Vander Leyen Commission, which aims to set up the Capital Market Union (the famous "CMU") and has also envisaged DEBRA. The idea is to diversify the sources of financing, an elementary principle that many CFOs had forgotten along the way. This is a guilty error that could be paid for in cash. But in a context, such as this one, one understands the craze for the European Investment Bank (i.e., EIB) credits. Its subsidized and inexpensive loans are attractive if you present innovation and a minimal amount. It is not dedicated to SME's. Finally, even getting on-boarded by a bank has become a pain. There are sectors in which it is better not to navigate at the risk of not being bankable.
One wonders if the PE (Private Equity funds) has not eaten its fill. Its golden age is perhaps over. Hedge funds have also seen their fundamentals turned upside down and their values destabilized. Their financial leverage has been reduced and therefore the operations less profitable. We have seen a good number of so-called continuation funds, or passing on assets from one to the other, through a cosmetic sleight of hand. The final returns will not be (or will no longer be) those hoped for. Patience is a virtue that PE's will have to learn. Isn't she the mother of all virtues? Many acquisitions could not be made due to a lack of bank financing. Club deals are being used more than syndicated loans. LBOs have fallen by the wayside. Large-scale operations have disappeared. Debt funds remain, but their costs have also been impacted. The logic is as follows: if costs increase and returns decrease, one must pay less for the assets acquired. The ROI is impacted and pushes prices down. Gone are the days when everything went at any price. Good news for companies who, because of exaggerated and crazy multiples, could no longer buy at the risk of paying afterwards in the form of the terrible "goodwill impairment". A Cornelian dilemma. In this context, funds are raising less money and finding fewer investors, with more reasonable (shall we say) returns. The cards are being reshuffled, benchmarks are being lowered and net returns are becoming more logical and acceptable. Because the madness experienced in recent years in the field of hedge funds has been unparalleled. It was time to return to a more sober and defensible basis. Overpaying always pays off at some point.... In the same vein, poor stock market performance and American fears of old Europe are not helping the situation. IPOs have not been legion in this "horribilis" year of 2022.
The start-ups in which we used to invest without counting the cost are suffering from a lack of appetite from investors in such a context. This Sioux-like caution is not surprising. One could almost speak of a "credit crunch". Access to bank capital is generally more complicated. VC's are having a hard time convincing investors, even though a few months ago, we were swimming in innocent and candid happiness. More than ever, you must show cash flow generation capacity and huge potential. Efforts are becoming "normal" again; unfortunately, we had forgotten this. Venture capital is no longer as sexy as it once was. Again, the market will have to consolidate, and time will have to do its work to allow decent exits. So we'll sit back and wait for better days.
We have seen the bond markets battered, ratings downgraded (thereby increasing the cost of credit) and the junk bond market implode. What the US experienced in 2022 could happen to us soon. The sudden and violent rise in interest rates has hit companies. There is talk of a doubling of defaults... The American market, being more "floating" by nature, is therefore more exposed. Some sectors re-leveraged heavily after COVID, e.g., travel, cruises, airlines, etc... and the bill will therefore be doubly heavy.
The leverage markets were highly sensitive to the Fed tightening, particularly the low-rated companies, because they don't fully hedge their interest rate exposures. CLO's made up most of the demand for leveraged loans and therefore are at risk (i.e. Collateralized loan obligations).
And as if that were not enough, financial regulations could also play a negative role. Some had not even seen it in the past, but the plans to integrate the Basel rules could, if they remain as they are, impact the cost of guarantees and financing of "high value objects" considerably. The amounts calculated by some multinationals are frightening because they will penalize European companies and increase costs. Fortunately, EACT is watching over the interests of treasurers.
The European Central Bank (ECB) warned the eurozone banks that they are at risk from mounting bad loans and funding squeeze due to rising interest rates, higher inflation and a likely recession coming. The paradox is that banks results have picked up given rising rates. But ECB announced that good times looked unlikely to last due to probable increase in bad debts and rising funding costs for banks. In any case, higher interest rates and sluggish or potentially recessionary growth outlook may challenge the debt servicing capacity of borrowers going forward. It is easy to see that conditions are complicated everywhere, and we must remember the recent "sub-primes", more than a decade ago. Sometimes one market can affect, infect, and contaminate all others. Caution is advised and 2023 will not be an easy year for all those who must refinance heavily. Caution is required at all levels of finance. I would bet that refinancing will be one of the major concerns that will come out of the treasurers' surveys (e.g., EACT annual survey or PwC global treasury survey). Stay tuned and you will see...
François Masquelier, CEO of Simply Treasury – Luxembourg
Disclaimer: This article was prepared by François Masquelier in his personal capacity. The opinion expressed in this article are the author’s own and do not necessarily reflect the view of the European Association of Corporate Treasurers (i.e., EACT).
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