Takeways: Countdowns and markdowns. Less than a month before the crunch on Greece; 90 days until the UK General Election; who knows on the Fed – US data is still mixed. Meanwhile, Russian ratings drop again and the head spinning loosening of monetary policy continues. Cue more currency volatility, negative bond yields, higher pension deficits and accumulating risks. These are unpredictable times and it might seem odd for companies to be focusing on M&A. However, rising levels of currency, demand and price volatility are forcing companies to look across their portfolio and think about the ‘where’ as much as the ‘what’.
Brussels hold ‘em
The meeting between the Greek Finance Minister and the ECB’s President was billed as the master of game theory versus the poker-faced Euro-saviour. Neither side gave much away during the first hand, but this is a game of high stakes that could run until someone goes all in.
On Monday an FT interview with the chief Greek protagonists boosted market hopes of a swift resolution. The proposal of what is effectively a ‘debt for equity swap’ via new growth-linked bonds, with a (smaller) permanent budget surplus and a plan to target wealthy tax-evaders sounded…well….like a proposal from advisors to a distressed company. The government had engaged Lazards. They were planning a tour of creditors. Markets reacted with positive surprise. It was as if they’d expected members of the newly elected Greek government to turn up with placards or in a wooden horse. Even the Adam Smith Institute approved.
The situation is obviously extremely fluid – as they say in 24hr news circles – but as we post, positive expectations are dashed. In truth, it was never going to be that easy. For the Troika and Berlin, the terms of the bailout were set in stone –as their latest hardball statements and actions confirm. So, this is where we are:
- Greece’s bank life-line, support via the emergency liquidity assistance (ELA) mechanism, is in doubt beyond 1 March, when the bailout extension expires.
- Frankfurt and Berlin’s hard-line is exemplified by the decision by the ECB to remove a waiver allowing Greek sovereign debt to be used as collateral for cash. That’s a big pile of chips they’ve pushed in. Meanwhile, documents prepared for the Eurogroup meeting in Berlin confirm that the German government will not tolerate any ‘rolling back’ of the existing austerity measures:“The Eurogroup needs a clear and front-loaded commitment by Greece to ensure full implementation of key reform measures necessary to keep the programme on track”
- Removal of the ELA backstop leaves a big gap between 1 March and a new deal on debt – assuming this can even be achieved. This could trigger a Greek coalition breakup–to form group than can accept the ECB’s terms – or a force a new election.
There is a long road before any GREXIT, but there’s obvious potential here a rocky few weeks before a deal –if we get a deal.
Is there a way through this impasse? Lowering of the primary surplus requirement is probably the most crucial component for Greece. The real sticking point will be Syriza’s reigning back on previously agreed measures, like privatisation and raising the minimum wage. A deal is possible. The recent ‘Stability and Growth Pact’’ acknowledged the need for increased domestic demand to diminish debts. Syriza will probably have to accept primary budget surplus closer to the current 4.5% than the 1% it wants. It will need to offer up more reforms.
Interestingly, fellow bailout nations are taking some of the hardest lines, as they blanche at Greece apparently escaping their austere fate. However, it would be beneficial to all if Greece didn’t keep coming back like a bad cent and, crucially, show that compromise is possible, even between the most unlikely of bed-fellows. Given recent political developments – and rising levels of global debt – it’s not a bad example to set.
According to McKinsey & Co, global debt has increased by $57tn since 2007 to almost $200tn – up as a share of GDP from 270% to 286%. Ireland’s debt to GDP ratio – including household, non-financial corporate and government debt – is up by 172% since 2007. Greece is up 103%, Portugal 100% and Spain 72%. Mckinsey calls for “fresh approaches” to preventing future debt crises. Is it time for a broader debt debate?
The good, the bad and the ugly of (even easier) easy money
- Number of central banks who have eased so far in 2015: 16
- Amount of government bonds trading with negative yields: €2.5tn (RBS)
The currency surrender continues and yields continue to tumble. It is getting hard to remember what it was like before monetary policies became the chief defence against our economic ills; but even in the context of the last five years, the first few weeks of 2015 have been exceptional.
Those effectively being paid to borrow are enjoying the ‘good’. Borrowers like Germany Switzerland and Nestlé, whose 2016 Eurobond is the first corporate bond of a year or longer to have a negative yield. Europe’s relatively small financial, sovereign and investment grade market is squeezed when investors seek havens, even further when ECB promises €60bn a month of buying and even further when deflation hits. The ECB haven’t even buying started yet and they’re not buying corporate bonds, but high sovereign demand is pushing investors into other markets. After all, Nestlé has the same rating as France. It feels like a great time to refinance. This flow of cash seeking assets should also help banks clear some problem debts.
The bad news is that many of these companies will also be struggling with their pension deficits – at a record high in the FTSE 350, according to Mercer. As we discussed last week, currency fluctuations are also a constant worry. The ugly? The trip back up again to normality – whenever it comes. The potential consequences of investors chasing yield when exit options are limited. Yields for BB rated nonfinancial corporate bonds are down to 2.62%, according to Barclays. Although yields at ratings below BB haven’t felt so much of the QE effect – greater discretion is still a theme of 2015.
UK bank lending to rises despite uncertainty
All of this adds up to lower margins and a struggle for profitable growth for banks. However, economic growth should be enough to spur UK banks to resume lending growth in 2015, according to the EY ITEM Club. However, lending growth will be slow and alternative finance providers will retain – and expand – their foothold. Indeed, the trend across Europe is for bank disintermediation. According to S&P, the European direct lending market–where dedicated credit funds lend directly to predominantly sponsor-owned businesses—grew to more than €10bn across more than 200 deals in 2014, from about €5bn a few years ago. Companies in the mid-market now have a far wider range of borrowing options open to them.
Our figures show that global M&A began 2015 with a bang, recording the highest deal values in January since 2008. A few themes we’d pick out. Firstly, the continued focus on ‘big ticket deals’. Boardrooms are still interested in transformative M&A and still have the confidence to pursue substantial acquisitions. Secondly, the high number of deals focused on corporate restructuring and spin-offs. Portfolio management is high up the agenda in 2015. Thirdly, the rise in cross border deals – at their highest in January for nine years. There are obvious opportunities – and risks – in increasing monetary and economic divergence. It’s a good time for companies to think about how they can use M&A to build resilience, through geographical coverage as well as their product portfolio.