Central-Bank Forked-Tongue Syndrome.
All over the world, corporations have taken on huge piles of fresh debt to try to weather the crisis. Many of those companies — after years of interest rate repression that encouraged them to borrow — were already heavily indebted before the crisis began. This is particularly true of France, where corporate debt was growing at an annualized rate of 5.8% in February, before the virus crisis began, according to the Bank of France. In March, the rate of growth jumped to 7.1%. It then surged to 9.9 % in April.
Much of this new debt issued during the pandemic is guaranteed by the French state — to the tune of 70-80% in the case of large companies. Thanks to this support, as well as the ECB’s negative interest rate policy, corporate bond buying programs, and countless other interventions, that debt comes at minimal cost for most corporations.
The interest rates on French banks’ corporate loans averaged just 1% in April — the lowest level since 2003, according to French financial daily Les Echos. The yields on the bonds issued by French firms in April averaged 1.58%, significantly higher than the record low of 0.48% registered in August 2019 but a marked improvement on the 1.99% registered in March, when bond yields were soaring.
While debt is still relatively cheap for large French firms, despite the bleak economic panorama, the risks facing excessively leveraged companies are mounting, Bank of France (BdF) warned in its biannual financial risk report.
“The increase in corporate debt could hurt many (firms’) solvency and this risk could be made worse if the recovery is weak and their ratings deteriorate,” the central bank said. “A sharp increase in corporate bankruptcies could in turn increase banks’ non-performing loans, slowing the flow of credit necessary for the economic recovery.”
Unlike many of their European peers, which have deleveraged somewhat since the 2008 financial crisis, French firms’ debt obligations have kept growing, reaching €1.8 trillion in April, according to BdF. That’s the equivalent of around 70% of France’s 2019 GDP — almost 10 percentage points above the EU average and significantly higher than the corresponding debt piles of non-financial corporations from Germany (41% of GDP), Italy (63%) and Spain (61%).
This debt measure is narrowly defined: commercial paper (short-term bonds), regular bonds, and loans from banks. These banks are “resident credit institutions,” meaning they are entities based in France, including the French subsidiaries of foreign banks. It does not include many other types of business debts, including debts by smaller businesses and loans issued by non-bank lenders such as PE firms and insurance companies.
By a different and much broader measure, the BIS ranks France sixth globally for the size of its corporate debt pile, which was equivalent to 154% of GDP at the end of 2019. The only countries with more corporate debt than France are the Netherlands (158% of GDP), Sweden (166%), Ireland (189%), Hong Kong SAR (225%), and Luxembourg (326%). All of these countries, with the exception of Sweden, are either global financial centers (Hong Kong) or corporate tax avoidance havens (Ireland, the Netherlands and Luxembourg).
Like many central banks in Europe, BdF has made a habit of periodically warning about the risks it itself has helped to create through its support of the ECB’s QE programs and interest rate repression, while simultaneously arguing for the expansion of said QE programs and interest rate repression. In a report published last November, it warned that French firms, many of them part-owned by the state, have been taking advantage of years of low or negative interest rates to take on dangerous levels of debt, much of which has been used to buy up overseas companies and assets.
Some French companies have held on to the extra funds as “dry powder” to fund capital expenditure (capex) needs, or as liquidity reserves to fend off takeover attempts. But many of them have used it to buy back their own shares or go on M&A sprees, often oversees. According to S&P, some companies did this to reduce exposure to French corporate tax, which is one of the highest in Europe. The companies essentially take on debt in France while generating the profits abroad where taxes are lower.
But French firms have also taken advantage of the euro’s reserve currency status “to engage in more risky but higher-yielding investment,” S&P said.
Many of the overseas acquisitions have taken place since 2016, when the ECB embarked on its corporate debt purchase program, which made it much cheaper for corporations to issue fresh debt. Indeed, the biggest beneficiaries of the ECB’s corporate bond buying program are French corporations, accounting for a 31% of the central bank’s purchases — compared to 24% for German firms, 11% for Italian firms and 10% for Spanish firms.
Yet many of the companies’ operating profitability has been falling for years. In a core sample of 177 large corporations, average operating profitability decreased from 11.1% to 9.8% between 2016 and 2018. And now these companies have to deal with the pandemic and its devastating impact on corporate profits. So the BdF is concerned about this excess leverage, while helping strenuously to drive it ever higher. By Nick Corbishley, for WOLF STREET.