Friday letter: Should European lenders retrench ahead of a downturn?

Debt managers busy trying to carve out a bigger share of Europe’s mid-market have not timed it well, argue some cautious voices. But with central bank stimulus propping things up how much wariness is warranted?

“Now is not the time to be making money.” That was one debt manager’s disapproving take on a bank said to be aggressively trying to win a bigger share of European mid-market leveraged lending.

Her rationale – like many other European corporate debt experts we’ve spoken to – was that it was risky behaviour in the face of a potential downturn. 

The problem with that view, though, is that the continent’s monetary policy is profoundly geared towards supporting liquidity in financial markets and pushing corporates towards investment. 

Observers say the European Central Bank is poised to unleash even more stimulus measures to support the euro-zone following mediocre GDP growth of just 0.3 percent in the third quarter. 

ECB president Mario Draghi’s €1 trillion quantitative easing programme has already driven down investment grade credit spreads. And just the suggestion of more easing saw the German government sell two-year debt at record low levels of minus 0.38 percent this week. 

Some analysts expect the central bank to further cut its overnight deposit rate which, at minus 0.2 percent, is already in negative territory. 

With more easing to come it’s difficult to imagine that leveraged lending markets could suddenly be left high and dry, because the stimulus does the opposite, pushing yield-hungry capital into more illiquid markets. 

And even one of the more wary managers acknowledges that the European mid-market doesn’t seem to have turned too frothy thus far. “To have the hangover you need the party first,” he quipped.

His parting warning, though, was that the party doesn’t need to last long for you to regret it the morning after. In a borrowers’ market, everyone refinances at the same low rates and loose terms, creating years of potential workouts in just a few months. 

Which brings us back to the initial point. The European mid-market may not look like party central for the moment, but the most risk averse managers are already preparing for a quiet night in. 

And the smartest ones are making other plans.