* Firms at low end of investment grade seek to avoid junk
* Could issue new shares, bonds which convert to equity
* Companies in utilities, telecoms sectors in focus
LONDON, Jan 17 (Reuters) - European companies with big debts could take advantage of a surge in equities to two-year highs to raise money by selling shares or bonds that convert to shares to protect them from costly credit rating downgrades.
The buoyant equity market, which started its climb in the second half of 2012, gives companies under pressure from the weak economic climate an opportunity to bolster their balance sheets.
Telecoms firms, utility companies and builders in southern Europe are the most likely candidates, bankers say. They would follow steelmaker ArcelorMittal, which raised $4 billion selling shares and convertible bonds this month to help avoid slipping further into junk territory.
Analysts have said Telecom Italia and Telefonica , which have so far been selling off assets with mixed success, could or should look to raise money from new shares.
"You could see rights issues (share issues) from those non-financial companies which are at risk of a ratings downgrade or are under some sort of balance sheet pressure and need to have more equity for strategic flexibility," said Craig Coben, head of equity capital markets for Europe, Middle East and Africa (EMEA) at Bank of America Merrill Lynch.
As well as issuing shares, bankers said mandatory convertible bonds, like those sold by Arcelor, could be more in vogue. These bonds, where bondholders are repaid in shares rather than cash at maturity, tend to be treated as equity by ratings agencies, so can help protect credit ratings.
"The rating agency outlook continues to be quite negative and you have a number of names that have been downgraded, or are about to be, simply for performance reasons," said a senior debt capital markets banker.
"They would love to defend their rating and that is where you could see some additional equity issuance, such as mandatory convertibles."
Companies don't like credit rating downgrades because they increase borrowing costs. Corporates that have crossed over into a junk or non-investment grade rating pay around 2.3 percent more than companies on the bottom rung of investment grade, according to Bank of America Merrill Lynch data.
Some corporates have previously favoured hybrid bonds, a blend of debt and equity, as a cheaper way of raising money to protect their credit rating without diluting shareholders. But some have found they were not enough. Arcelor last year issued a hybrid, only to be subsequently downgraded anyway.
Bankers and advisors said companies in countries such as the UK and Germany were less likely to come to market for credit rating reasons, having spent the last few years shoring up their balance sheets.
But in Spain and Italy, where corporate ratings have been under pressure due to downgrades to the countries' credit ratings, there could be more activity.
There are 40 listed companies in EMEA which are rated as being on the bottom two rungs of investment grade by at least one of the three main credit ratings agencies, Moody's, Standard & Poor's (S&P) and Fitch. They are also labelled as "negative outlook" or "negative credit watch," a signal they could be considered for a downgrade.
Italy and Spain are the countries which feature most frequently, with seven and six companies respectively, while utilities and telecoms are the most represented sectors.
S&P has the utilities and steel sectors as a whole on a negative outlook. Moody's, in November, warned the outlook for telecoms service provides in Europe remained negative, with revenues under threat due to economic weakness, aggressive price cuts and tough regulation.
Companies do not tend to flag publicly any equity raising plans ahead of launching a deal because it risks putting downward pressure on their share price.
But advisors and analysts expect new shares could ultimately be needed by some companies to avoid their access to debt financing becoming more difficult and costly.
Many of the companies on the list told Reuters they had no need to refinance this year, or were focusing on repairing their balance sheet through other methods such as asset sales.
"Potentially where there have been declines in consumer spending, or aggressive acquisitions in the past which led to a high leverage. These guys might need to do something," said one equity capital markets banker.
"Also those impacted by global declines in economic activity," he added, highlighting construction firms. Industrials companies could also be in need of balance sheet repair, other bankers said. (Additional reporting by Clare Kane, Tracy Rucinski and Andres Gonzalez Estebaran in Madrid, Danio Masoni, Stephen Jewkes and Lisa Jucca in Milan and Natalie Harrison at IFR. Editing by Carmel Crimmins and Jane Merriman)