Specifically, the article looks at how the credit crunch is increasing Europe's default rate.
In particular, the default rate will increase for firms that have little or no equity value but have enough value so that senior lenders like the banks can be repaid.
At the same time, banks have an incentive to continue using extend and pretend on the loans to zombie companies where they would have to recognize a loss on the loan and the resulting reduction to Tier I capital.
Corporate defaults may almost double in Europe as companies struggle to refinance debt and banks hoard cash borrowed from the European Central Bank or use it to buy government bonds.
Europe’s default rate may soar to 8.4 percent or more, from 4.8 percent at the end of 2011 as the recession bites and company financing dries up, according to Standard & Poor’s. ...
“It’s very challenging for anyone to raise money from lenders right now,” said Andrew Cleland-Bogle, a Frankfurt- based director at corporate finance specialist DC Advisory Partners. “Combine that with increased bank capital requirements and you can see that although banks are getting money they’re very selective when it comes to lending it. 2012 is going to be a very, very tough year.”
Speculative-grade companies have to refinance about 230 billion euros ($300 billion) through 2015, according to S&P. At the same time, banks and loan funds that provided the initial funding are scrambling for capital or reaching the end of their reinvestment periods and may be unwilling to extend loans....Note the use of the word 'may' in the highlighted sentence.
“There are a lot of zombie companies that are trapped by their debts and have no way out,” Bryan said. “The recovery isn’t really happening and there’s a high probability we’re going into a double-dip recession. For all that the banks kicked the can down the road once, the realization is dawning that they can’t just do that again.”A very big assumption that banks cannot kick the can down the road again particularly now that they have guaranteed access to funding through the ECB.
Companies bought by leveraged buyout firms during the boom years in the middle of the last decade are particularly vulnerable to the dearth of funding because their debt levels are higher than investors are willing to accept, said Edward Eyerman, head of leveraged finance atFitch Ratings in London. And because banks and collateralized debt obligations are also leveraged, the problem is amplified, he said.
“For companies that have five times leverage, are in cyclical industries, exposed to anemic economies and have near- term maturities, it’s questionable how much equity value is underneath the debt,” Eyerman said. “When these highly leveraged borrowers get into trouble, the focus on what’s the right capital structure for a company within its industry to perform effectively competes with the demands of banks and CLOs to preserve the senior debt.”...
Lower-rated borrowers that have a large part of their business in the nations hardest hit by the sovereign debt crisis, and which haven’t refinanced loans coming due this year and next, will “face particular difficulties,” he said.
The European Banking Authority, which found a 115 billion- euro capital shortfall in its most recent stress tests on lenders, has given banks until June to find the cash or face nationalization.
Struggling to raise the money, lenders are choosing to reduce risk-weighted assets instead. European banks, which currently have total assets of about 26.5 trillion euros, will probably reduce their balance sheets by 5.1 trillion euros in the next three to five years, according to Alberto Gallo, a strategist at Royal Bank of Scotland Group Plc (RBS) in London.
“Given the large shortfall in equity capital and persistent sovereign risk, we think it will be difficult for European banks to start transferring their liquidity to the broader economy,” Gallo said.
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