European corporate debt markets have become "intoxicated" by monetary stimulus from central banks and "aggressive" transactions are in danger of reaching the excesses seen before the global financial crisis, ratings agency Standard & Poor's has warned.
"Artificially low interest rates not only encourage an inefficient allocation of capital but create the incentive for excessive speculation in financial markets that ultimately risk doing more harm than good when boom turns to bust," Credit Analyst Paul Watters warned in S&P's quarterly European corporate credit outlook on Monday afternoon.
"The greater use of leverage and a growing number of aggressively structured transactions in the European leveraged finance market is reminiscent of some of the excesses of the 2006-2007 boom period."
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Concerns are centered on whether the right companies are benefiting from cheaply generating debt and whether they are using it in the most productive way. S&P believes that business confidence in Europe remains low, which is pushing companies to issue more debt at record-low rates than spending money on capital investment.
Because companies are opting to borrow rather than invest, central bank policy is helpless in triggering a self-sustaining recovery in the region, the ratings agency added. Instead, S&P says that both the U.S. and Europe are showing trends of surging merger and acquisition volumes, high debt issuance and more leveraged buyouts. This points to an erosion of market discipline and a greater reliance on financial engineering to generate returns rather than fundamental growth. S&P adds that this to magnifies the risks in the financial world and says that the problems are even more pronounced in the U.S.
While analysts and economists continue to debate over the exact reasons behind the 2008 financial crash, many accept that financial institutions became highly leveraged in the run-up, and had become overloaded with risky investments which accentuated the fall after years of rising markets. Interest rates in the euro zone have been at record lows since the crash, along with other developed nations, in the hope of stimulating lending and kickstarting an economic recovery after prolonged periods of recession.
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Bill Blain, a senior fixed income broker at Mint Partners, said that the outlook for the European credit markets is still looking "very glum" and much worse compared to those in the U.S. Business confidence is still low due to tough austerity regimes in the bloc and an overpriced currency, he said, adding that both of these mean that consumer spending is yet to truly recover.
"I agree that the skills to understand risk have been utterly eroded," he told CNBC via email. "That's why there are no seasoned bond or equity salesmen at banks any more, they all got binned to make way for compliant script reading graduates."
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Corporate credit ratings upgrades issued by S&P continue to outnumber the downgrades but this hasn't stopped the agency ringing the alarm bells. Monday's quarterly report was even entitled "trouble down the track" and builds upon a similar tone last year with a report that it headlined "proceed with caution." Back in June, S&P said that corporate debt in the Asia-Pacific region was set to exceed that of North America and Europe combined by 2016.