French corporate debt has ballooned to record levels as other euro zone countries have seen their firms cut debt, unsettling the central bank and prompting a cap on bank lending to the most indebted corporate borrowers.
Yet, while the surging debt is stressing regulators, senior bankers, ratings agencies and some economists say it is not so much a case of reckless borrowing as of clever financial engineering in which companies by take advantage of low interest rates to cope with high taxes.
France’s financial stability council, which includes the finance minister and central bank governor, has taken the unprecedented step of limiting a bank’s exposure to highly indebted firms to five percent of its capital.
It was essentially a shot across the lenders’ bows about over-exposure.
French corporate borrowing has grown at more than six percent this year, and closer to eight percent for big companies with easy access to the bond market, Bank of France data shows. That compares with forecasted economic growth of 1.8 percent.
In fact, 60 percent of the recent increases in euro zone corporate borrowing came from French firms even though France represents only 20 percent of the bloc’s gross domestic product, also according to the French central bank.
That has left French corporate debt at a record 134 percent of GDP, data from the Bank for International Settlements show. Stripping out intra-group loans, the Bank of France pegs the figure at a more manageable but still record 72 percent.
“We consider that there is a risk that big companies in particular are going too far,” Bank of France Governor Francois Villeroy de Galhau said.
The central bank is particularly worried that, thanks to cheap credit, some firms are overpaying for acquisitions and could find themselves nursing painful losses should they have to book big writedowns on takeover values in the future.
The council says the lending cap, which will take effect in mid-2018, applies to about 10 firms which it is has not identified.
Villeroy said it concerned firms with net debt over 100 percent of equity, which could cover companies like Air France KLM (>> Air France-KLM), Suez (>> Suez Environnement), Airbus (>> Airbus SE), EDF (>> Electricité de France) and Casino (>> Casino Guichard-Perrachon), according to Thomson Reuters data.
Companies not based in France but with big operations there could also be affected, which could include highly indebted Dutch-registered telecoms group Altice (>> Altice).
The companies either declined to comment or were not immediately in a position do so when contacted by Reuters.
While debt levels are manageable now, a return to historic norms for interest rates could cut profits by more than 20 percent, Natixis chief economist Patrick Artus calculates.
“The corporate credit situation in France is very highly dependent on what happens to interest rates,” Artus told Reuters. “There’s a real problem with corporate debt in France.”
Villeroy acknowledges there is no imminent danger and the lending cap is for now more bark than bite.
“It gives an extremely strong signal that we don’t want certain exposures to be increased,” Villeroy said, adding that it could be tightened if necessary.
Economist Marion Amiot of Oxford Economics, meanwhile, says that high levels of debt are not a major cause for concern as the borrowing was put to good use.
“Companies have used the money to invest and improve their profitability, even in the face of a high tax burden and rigid labour laws,” she wrote in a research note.
Even though French firms’ profit margins are among the weakest in the euro zone, they have maintained above-average investment rates, according to national accounts data.
Also, rather than returning cash to shareholders or buy back shares, French firms have retained earnings, keeping balance sheets relatively healthy despite the additional debt.
While regulators are uneasy over record debt, investors so far seem content to oblige borrowers.
When utility Veolia (>> Veolia Environnement) tapped the market for a three-year bond last month, not only did it secure a negative interest rate, but investor bids reached four times the amount offered.
Moody’s analyst Guillaume Leglise said that credit quality and companies’ ratings were on average stable, even though some firms had leveraged up.
“Everything is on track, there isn’t a short-term liquidity risk, most companies are taking advantage of exceptional market conditions to refinance or to finance acquisitions with debt,” Leglise said.
Indeed, Moody’s forecasts French corporate bond issuance to rise next year as the economy picks up.
Societe Generale co-head of corporate debt origination Felix Orsini said issuers were being cautious, even if the temptation to take on debt was rising after years of low interest rates.
“It’s true that after a while management asks, can we take advantage of these financing conditions to make acquisitions or investments, hence the upturn in M&A,” he said.
But he added: “corporate finance directors, and especially those in France, are among the most cautious people I know.”
Source: Reuters (Reporting and Graphics by Leigh Thomas; editing by Richard Lough/Jeremy Gaunt)