Belief in companies’ debt repayment ability plummeting

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The loan market’s belief in companies’ debt repayment ability has weakened significantly over the summer.
      The risk premiums, reflecting investors’ views on companies’ debt repayment ability, have increased and are now approaching the record figures of last March. In part, the premiums have already reached the level that prevailed at the beginning of the millennium.
     
The risk premiums of loans are a kind of economic thermometer.
      When the expected rate of return on financially sound companies’ bonds is considerably higher than the expected return on the risk-free government stock, it normally implies a presence of an economic crisis in the country.
      At the beginning of the millennium, difficulties arose when the technology bubble burst. Today’s economic turbulence has been caused by a financial crisis following the housing loans that have been granted too open-handedly in the United States.
     
Concerns about companies’ debt repayment ability have emerged as a result of weakened economic prospects, said analyst Robert Liljequist from Pohjola Bank.
      The corporate loan market is also still encumbered by the recent depression in the bank sector. The availability of funds is not sufficient, as banks are liquidating their balance-sheet assets and investors are extremely cautious.
     
The number of notices of default issued to corporations is still at a historical low, while it has somewhat increased mainly in the USA. However, the increase in the number of risk premiums nevertheless predicts that such notices of default are becoming more common.
      According to eQ portfolio manager Jani Kurppa, the current level of risk premiums is extremely alarming. He does not believe that the national economy is in such a bad shape as one could imagine on the basis of the risk premiums.
      ”In order to justify the current level of risk premiums, the all-time worst financial crisis should be expected”, says Kurppa.
      However, Liljequist reports that the risk premiums could still increase, if the high expectations for next year do not materialise.
     
In Finland, the risk premiums have grown particularly in the forest industry corporations.
      Based on the company’s risk premiums, the certificate of debt of the Finnish forest corporation M-Real, due for payment in 2013, is now giving an annual profit before tax of some 20 per cent, provided that the company will be able to carry off its commitments.
      ”It is a colossal yield. In the stock market, an average return on investment is some 6 to 8 per cent, but this is a corporate loan we are talking about”, notes Liljequist.
      According to calculations made by Pohjola Bank, the loan market anticipates that there is a probability as high as 73 % that M-Real is likely to have problems relating to debt servicing over the next five years.
     
Mikael Lundström, the Head of Fixed Income at Evli Bank, says that the risk premiums of the companies with good investment grades have grown relatively more than have the risk premiums of so-called junk bonds.
      However, the risk premiums of junk bonds have not reached the same level as those at the beginning of the millennium. Moreover, the balance sheets of corporations are clearly more solid on average than they were at that time.
      The cash flow of an average Europan industrial enterprise is still good, and it can be used to repay loans if necessary”, concluded Lundström.
     
In the USA, the nation’s two largest government-sponsored mortgage finance lenders Freddie Mac and Fannie Mae as well as the investment bank Lehman Brothers have come under increasing scrutiny in the corporate loan market.
      The financial situation of these giant banks will also affect the lending of European banks.


Links:
  Evli Bank
  eQ
  Pohjola Bank

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