US and European companies are poised for a borrowing spree in the coming months as they respond to calls from their shareholders for higher returns, said bankers at Citigroup Inc.
Pressure to boost equity value, either through stock buybacks, dividends or mergers, will prompt companies to sell more bonds, Citigroup said, pushing up borrowing costs and cutting the value of existing debt.
"As a corporate executive you need to be a slave to the equity market," said Matt King, head of quantative credit strategy at Citigroup in London. "And you will find it harder to hit your earnings per share targets if you don't boost your levels of debt."
Global merger and acquisition volume increased 35 per cent in the first half of 2005 to $1,299 billion, according to data provider Dealogic, while numerous companies, including Vodafone, Nokia, BMW and Nestle, announced share buybacks.
Despite higher outlays, however, corporate balance sheets remain healthy. UK corporate gearing stood at only 33 per cent at the end of 2004, according to Morgan Stanley, and interest cover was at an all-time high of 6.6 times.
Cash on balance sheets also remained comfortably above average levels at 6.7 per cent of total assets at the end of 2004, compared with a 20-year average of 5.9 per cent.
Still, some 45 per cent of shareholders believe companies should return cash to shareholders - and boards that ignore those demands are likely to see their share price underperform, said Citigroup's King.
"Managers face a choice: either they say to shareholders that their expectations are too high, or they hit those high expectations by sacrificing the balance sheet and levering up."
Still, while the so-called leverage cycle has now turned, Mr King said, it will be some time before the effect is felt on credit spreads.
"The process of relevering has already begun, though debt to earnings ratios have not deteriorated," he said.
"But we are quite bearish going forward. Management psychology for this has been around a while, and all the risks are that it will go faster."
After the scares caused by the downgrades of General Motors in May, European credit spreads have returned to the record tight levels seen at the beginning of the year.