Europe's corporate bond market is shrinking as redemptionsoutstrip issuance, banks borrow and lend less, and companiesstockpile cash rather than invest in their businesses.

Banks have sold about 335 billion euros ($427 billion) of bondsin the common currency and pounds this year, down from 443 billioneuros last year, 503 billion euros the year before and a record 671billion euros in 2009. Banks cut their lending to euro-areacompanies by 45 billion euros in the third quarter from a yearearlier, according to the European Central Bank.

“It's not clear whether the lack of bank lending is a reflectionof broken banks or more a problem of dire economic outlooks forcorporates,” said David Watts, a strategist at CreditSights Inc. inLondon. “Companies that are able to do so are tapping the bondmarkets. The rest either can't or don't want to borrow.”

ECB President Mario Draghi vowed in July to “do whatever ittakes” to preserve the euro as the sovereign debt crisis crimpseconomies and undermines company and consumer confidence. Askedyesterday about the availability of credit for small- andmedium-sized companies, Draghi said: “Are we satisfied with thefinancial conditions? No, we're not at all satisfied.”

Total bond issuance in euros and pounds has reached 633 billioneuros this year, up from 583 billion euros at this point last yearand compared with 652 billion euros for all of 2011, data compiledby Bloomberg show. The value of outstanding bonds is about $632billion, down 8 percent from the end of last year and a slide ofmore than 12 percent from a record reached in July 2011, accordingto Bank of America Merrill Lynch's EUR Corporates, Bankingindex.

Treasurers of large companies, scarred by 2008's credit squeeze,are refinancing at yields driven down by central banks cuttinginterest rates close to zero. That cash isn't flowing into theeconomy. Non-financial members of the Stoxx Europe 600 Index hold577 billion euros of cash, up from 570 billion euros in 2011 andthe 345 billion-euro average of the three pre-crisis years ended in2006, Bloomberg data show.

“Companies aren't pursuing new investments, they're not hiring,and they're letting plants deteriorate because they don't seeopportunities,” said Derek Hynes, a London-based portfolio managerat ECM Asset Management Ltd., which runs about $9.5 billion infixed income. “The implications for the macro economy aren't good.They have to get back to growth, to mergers and, most importantly,to hiring.”

Spread Compression

Yields on Spanish 10-year bonds, which peaked at 7.75 percent onJuly 25, have fallen to about 5.7 percent, about 432 basis pointsmore than similar-maturity German debt. Italian 10-year bonds yield4.9 percent, down from a peak of 6.71 percent, also on July 25, andnow pay a 352 basis-point premium to bunds.

“Draghi has compressed spreads from astronomically high levelsto just very high levels,” said Richard Barwell, European economistat Royal Bank of Scotland Group Plc in London. “The environment isvery uncertain, so if you don't need to invest, you don't. Youwon't have stellar returns but at least you won't die.”

Among banks that have sold bonds are Intesa Sanpaolo SpA,Italy's second-largest bank, which raised 1.71 billion euros insenior unsecured 4 percent bonds due 2017 on Nov. 7. UniCredit SpA,the biggest Italian bank, was able to issue 1.25 billion euros of10-year 6.95 percent subordinated bonds on Oct. 22.

That was a “big event” because it shows how the cost of doingthose deals has fallen, according to Suki Mann, a credit strategistat Societe Generale SA in London.

“Banks being able to do their own issuance has helped,” saidAndrew Lim, a banking analyst at Espirito Santo Investment Bank inLondon. “Even so, the transmission mechanism isn't workingeffectively for the real economy. Draghi has taken the tail risk ofa euro break-up off the table, but not much else.”

The ECB held back from cutting rates from 0.75 percent at itsNovember meeting yesterday. Draghi has acknowledged that rate movesare less effective than they should be because of distortions inthe region's financial markets. The Bank of England left its rateat a record-low 0.5 percent.

European central banks, and the ECB in particular, have to focuson working through the banks because “it's a very heavily bankedeconomy,” according to Barwell at RBS.

“Banks don't want to lend in part because companies don't wantto borrow,” Barwell said. “Boards ask 'do we need to do this now?Are the chances of a nasty outcome higher than in, say, 2004?' Thenthey put off spending.”

GDF Suez SA, the Courbevoie, France-based natural gasdistributor, leads Europe's cash hoarders, doubling its holdings to18.3 billion euros from 9 billion euros in 2009, according toBloomberg data. It's followed by Volkswagen AG, which has doubledcash to about 18.1 billion euros, and Fiat SpA, with 16.9 billioneuros, up from 3.7 billion euros in 2009.

“It's a vicious circle,” said Watts at CreditSights. “Companiesdon't hire, so they don't create revenue for households, which thendon't buy, and that doesn't create wealth for corporates, whichdon't hire, and so on.”

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