Animal Spirits Chase BlackRock Into European Bond Refuge
The world’s biggest money managers are seeking refuge in European bond markets as dealmaking by American companies and the prospect of higher borrowing costs spur U.S. borrowers to load up on debt.
Pacific Investment Management Co., which runs the world’s biggest bond fund, and BlackRock Inc., the largest asset manager, say Europe offers safer opportunities as U.S. companies from Booz Allen Hamilton Holding Corp. to Verizon Communications Inc. raise debt to finance shareholder payouts and takeovers. Europe is 12 months to 18 months behind the U.S. in ratcheting up credit risk because it’s still emerging from the sovereign debt crisis, according to Pimco.
“Animal spirits are higher and recovery is further along in the U.S,” said Eve Tournier, London-based head of European credit at Pimco, which manages $1.94 trillion of assets. “The European environment is a not-too-hot, not-too-cold sweet spot to hide out in until the storm of higher interest rates passes.”
Borrowing for mergers, acquisitions, dividends and share buybacks are helping to keep sales of investment-grade bonds in the U.S. at close to a record pace, contributing to $495 billion of issuance this year, according to data compiled by Bloomberg. Last quarter, credit-ratings downgrades for U.S. borrowers involved in the deals exceeded increases by the most since 2009, data compiled by Moody’s Analytics show.
With yields on investment-grade corporate bonds in euros falling to a record 1.58 percent, the extra compensation investors now demand to hold U.S. company debt has risen to a five-year high of 1.44 percentage points, index data compiled by Bank of America Merrill Lynch show.
The European Central Bank is considering cutting interest rates next month and using asset purchases to spur economic growth as President Mario Draghi tries to prevent a prolonged period of subdued price gains from derailing the recovery in the 18-nation euro area.
At the same time, the Federal Reserve is scaling back its bond buying, even as Chair Janet Yellen makes clear that she believes the U.S. economy still requires a strong dose of stimulus five years after the recession.
“Europe offers more protection for credit investors relative to the re-leveraging in corporate America,” said Owen Murfin, a London-based money manager at BlackRock, which oversees $4.32 trillion. “The pendulum has swung from building balance sheet strength and preserving cash flow to shareholder returns and using the strength of balance sheets to be a consolidator within a sector.”
While acquisitions in Europe have also rebounded as their economies heal, dealmaking by companies in the region still lags behind in the U.S.
Pending and completed transactions by North American acquirers have jumped 49 percent this year to $529 billion. That compares with 36 percent growth in Europe to $298 billion.
The number of leveraged deals will climb in the coming year as takeovers increase and companies return more cash to shareholders, according to a JPMorgan Chase & Co. report dated May 8. The gap between the two regions is already widening, with the dollar amount of U.S. acquisitions more than doubling in April, versus a 25 percent increase in Europe.
“Event risk in the U.S. is far higher than in Europe,” BlackRock’s Murfin said. “The potential to fund very large transactions fuels the imagination of ambitious CEOs. You don’t want to be holding expensive corporate bonds in a name that’s about to re-leverage its balance sheet.”
New York-based Verizon extended debt maturities this year after its record $49 billion bond sale in September to help fund the purchase of Vodafone’s 45 percent stake in Verizon Wireless.
Issuance of U.S. junk-rated loans to finance acquisitions surged to more than $85 billion last month, topping 2007’s record pace, as demand for high-yielding debt allows borrowers to strip away protective covenants.
U.S. banks are relaxing their standards on commercial loans, a Fed survey last week showed. Regulators pushed lenders to maintain prudent standards, while warning that excesses in parts of the debt markets may already be emerging.
Booz Allen, the McLean, Virginia-based provider of cybersecurity services to U.S. defense agencies, risks falling deeper into junk by borrowing more money for dividends and loosening covenants to pursue acquisitions, Moody’s Investors Service said last month.
Pimco recommends buying “select” European bank capital securities, corporate hybrids and “rising stars,” or companies whose ratings may be raised to investment grade from junk. BlackRock also favors financial debt in the region.
Europe’s riskiest financial debt securities have returned 7.32 percent this year as banks improved their finances, data compiled by Bank of America show. Bonds of UniCredit SpA, Italy’s biggest bank, led with a 11.16 percent gain.
“As a credit investor, you want to be invested in deleveraging sectors, and I can’t think of a better sector than European banks,” BlackRock’s Murfin said.
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