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14-03-2023 12:53

Nordea On Your Mind: The financial flak vest

Is there a leverage problem in the Nordic region? Will higher interest rates be a source of pain for corporates going forward? Our Nordea On Your Mind team returns to the theme of corporate funding in their latest report, “The financial flak vest.”
The financial flak vest

Back in 2019, the Nordea On Your Mind team released a report called “The financial life jacket,” exploring the state of corporate funding at the time. Now, the team revisits the theme in their latest report. Only this time, they’ve replaced the life jacket metaphor with a flak vest, referring to the heavy, reinforced jacket often used for protection in war zones. The title reflects the heightened need for protection from a corporate funding perspective, given today’s turbulent market environment.

Leverage is a greater challenge for households

By international comparison, Nordic public finances are very strong, both state budget balances and debt. The potential leverage challenge lies with Nordic households, whose debt to disposable income levels are very high. Nordic large corporates have lower leverage than in Asia, North America or Europe, and actually even lower recent net debt to EBITDA (1.05x) than the 2006-19 historical average (1.28x). Nordic corporate leverage is unlikely to become a general problem, but may need some attention in segments such as real estate and private equity. As an illustration, roughly 20% of total Nordic large corporate loan volumes in the past five years have been represented by financial sponsors, which had an average senior debt to EBITDA ratio of 4.2x – far above that of general corporates.

Interest rates have not been a major issue, but... 

Over the past year, corporate funding costs have risen to 2009-11 levels, owing to both rising policy interest rates and widening credit spreads. From lows in late 2021 of around 0% for investment grade, and ~2% for high-yield, funding costs have climbed to 3.1% and 6.4%, respectively. Our analysis shows that debt service costs for large corporates were roughly 200 bp lower in 2020-22 than 2007-19. Should these higher funding costs persist, they would reduce global EBITDA by ~4%, but only ~1% in the Nordic region, which has lower leverage. Looking at global sectors, we find that real estate and utilities would be the worst hit, with 14% and 8% lower EBITDA, respectively, all else being equal.

A rude awakening

A buoyant market environment and some powerful structural drivers made Nordic corporate bond issuance grow to an average of EUR 45bn per year in 2012-22, almost triple the level of the prior decade. Soaring inflation and interest rates, paired with risk aversion, reduced issuance by roughly EUR 10bn in 2022, reminding borrowers that bond demand can vary significantly. For example, there was virtually zero issuance of rated Nordic local currency high-yield bonds in 2021-22. There will be bond maturities of EUR 40-45bn per year in 2023-26E; if all of those were to be refinanced in the bond market, it would require annual new issuance more or less on a par with the strong average of the past decade. This could be particularly challenging, since more than half of all bond maturities during the period are unrated or high-yield.

We offer borrowers similar advice as in 2019

In our 2019 report, The financial life jacket, we encouraged corporate borrowers to not assume that the buoyant debt capital market was a 'new normal', which has proven to be true. We again emphasise the importance of diversifying potential funding sources and managing maturity profiles and interest rate risks, which have become meaningful again for many companies. With Basel IV bank regulations to be implemented from 2025, credit profiles and credit ratings will for large corporates create even more of a watershed for availability and cost of funding than in the past.

Corporate and Nordea expert views

We interview Outokumpu CFO Pia Aaltonen-Forsell and Stena AB Finance Director Peter Claesson about their respective funding and leverage views and journeys in recent years. We also turn to Nordea's Head of Large Corporates & Institutions Norway Morten Ristvedt, and Head of Debt Solutions & Structuring Lars Fischer, for high-level perspectives on the evolution of the Nordic funding market environment and corporate options.

Nordea On Your Mind is the flagship publication of Nordea Investment Banking’s Thematics team, which produces research for large corporate and institutional clients. The research does not contain investment advice and typically covers topics of a strategic and long-term nature, which can affect corporate financial performance.

Top decision makers at Nordea’s large clients across the Nordic region receive Nordea On Your Mind around eight times per year. The publication’s themes vary widely, and many are selected from suggestions by clients. Examples of covered topics include artificial intelligence, wage inflation, M&A, e-commerce, income inequality, ESG, cybersecurity and corporate leverage.

Nordea On Your Mind