There are several potential risks for the fragile equilibrium that currently exists in the European corporate credit landscape. While sufficient capacity may currently exist for corporate refinancing over the next four years, funding for growth is likely to be quite limited.

According to our estimates, European corporate issuers must refinance about $8.6 trillion of maturing debt by 2016 and an additional $1.9 to $2.3 trillion of incremental commercial debt financing that companies will need for growth. This demand for funding may compound the negative effects of credit rationing that could occur as banks seek to restructure their balance sheets and as bond and equity investors reassess their risk-return thresholds. In our view, these factors — the current euro zone crisis, a soft U.S. economic recovery and the prospect of slowing Chinese growth — raise the prospect of a “perfect storm” for credit markets. In such a scenario, a wider pool of borrowers than just the highly leveraged ones could find their future funding in jeopardy. (Larger corporate issuers are having an easier time finding debt capital.)

We assume, based on various factors, that global banks and debt capital markets should be able to continue to provide most of the liquidity that corporate issuers need to manage their forthcoming refinancing. We also believe, however, that these factors could be negatively affected by changing or newly emerging sensitivities. For example, governments and banking regulators may not be well-placed to counter another credit squeeze as they have already exhausted much of their fiscal and monetary arsenal in dealing with the economic problems of the past few years. Furthermore, many countries are implementing austerity measures to deal with their own sovereign debt and budget deficit issues, which are likely to hamper their capacity to respond to new macroeconomic problems.

Europe’s particular vulnerability

In Europe we consider that continued reliance on bank funding may pose a problem for corporations’ future funding needs, as European banks weigh up their own strategies to contend with the ongoing economic difficulties in the region, and stricter regulatory capital and liquidity requirements.

We believe the credit quality of nonbank corporate issuers has improved in recent years, partly because of the economic rebound, but also because of their higher cash balances resulting from higher discretionary cash flow and retention of earnings. This latter condition has also undoubtedly helped banks to rollover existing term loans to these issuers, particularly where the bond market could refinance a part of the lending banks’ exposure. There is little evidence to suggest that the banks would change their policy of tactical deleveraging while continuing to lend to their corporate clients in the near term, although we have observed something of a flight to quality in bank lending; the middle-market and small-business segments face greater funding challenges.