Europe’s corporate balance sheet is improving that’s according to analysts at BCA Research.
Unfortunately, this claim comes in the same week that Italian bank Monte dei Paschi di Siena has been named as one of the weakest banks in Europe, a development which may overshadow the improving health of other European corporates.
BCA’s claim is based on the results from the firm’s European Corporate Health Monitor, which uses a combination of six financial ratios that calculate the financial health of the non-financial corporate sector, using macro data from the European Central Bank. To dig below the surface BCA’s analysts also conducted a bottom-up analysis of the Eurozone corporate bond market.
After analysing the debt of 419 European non-financial companies, BCA concludes that domestic European firms are improving their balance sheets and income statements at a fast pace in absolute terms and relative to foreign firms. Further, investment-grade companies have been deleveraging, raising the return on capital and more recently boosting margins yet foreign issuers, which have issued debt into the Eurozone market, have been ramping up leveraged while suffering a squeeze on margins.
Rather surprisingly this trend also extends into the energy and material sectors. Investment-grade financial health is now recovering in these industries for both domestic and foreign issuers.
Europe’s corporate balance sheet is improving, but…..
BCA’s optimistic assessment of the European corporate debt landscape is, in many ways, difficult to take seriously.
In recent weeks the International Monetary Fund has warned on the state of Italian banks’ balance sheets, which are collectively weighed down with €360 billion of problematic loans, equivalent to a fifth of the country’s GDP. Italy is Europe’s fourth-biggest economy and one of its weakest. Public debt stands at 135% of GDP.
Italian banks aren’t the only European financial institutions teetering on the edge. On Wednesday, Moody’s called Portugal’s banks, which are faced with low profits and souring loans, “among the most weakly capitalized institutions in the euro area.” According to the International Monetary Fund, corporate debt amounted to 110% of gross domestic product last year, and the Portuguese central bank believes that 12.2% of the country’s corporate loans are at risk of default. Moody’s believes this figure is overly optimistic.
Investors don’t need to be reminded how quickly a banking crisis that originates in one country can spiral out of control. A banking crisis in either Italy or Portugal would send shockwaves around the European economy, threatening the continent’s already weak economic recovery. Credit growth would dry up and the ECB, which is already throwing everything it has at trying to reignite European economic growth, would be left struggling to control the situation.
BCA’s research shows that European corporate credit quality is improving, but as Italy and Portugal struggle to restrain a full-blown banking crisis, it is unclear how much longer this trend will continue.