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FILE PHOTO: European Central Bank (ECB) headquarters building is seen in Frankfurt, Germany, March 7, 2018. REUTERS/Ralph Orlowski
October 11, 2018
By Dhara Ranasinghe and Virginia Furness
LONDON (Reuters) – Euro zone corporate debt will be hit harder and faster than government bonds by the withdrawal of massive European Central Bank support, which means companies will see funding costs rise and investors will need to scrutinize borrowers more carefully.
Confident that the economy is in decent shape and inflation is picking up, the ECB appears set to end its 2.6 trillion euros($3 trillion) asset purchase scheme in December.
The big unwind from an era of easy money is already under way – overall ECB monthly bond buying dropped by half in October. But the end of quantitative easing (QE) comes with a bigger bump for corporate bonds than for government debt, which will continue to see massive inflows for some time thanks to reinvestments from maturing debt already held by the ECB.
As a result, several European companies are already finding new debt and refinancing conditions tighter. Corporate borrowing costs relative to those of governments have risen by around 50 basis points this year, and the pool of negative-yielding corporate bonds is at its lowest since June 2016.
Last month, the ECB bought 30 billion euros of debt, which includes 4.5 billion of corporate bonds, according to analyst estimates. With monthly purchases cut in half this month, buying of corporate bonds is estimated at 2.5 billion euros.
But next year, when purchases are likely to be limited to reinvestment of maturing debt, corporate debt’s share will shrink faster than that of government debt.
ECB data shows a monthly average of just 470 million euros worth of corporate debt maturing over the next 12 months, compared to government debt maturing at a rate of almost 13 billion euros a month, almost as much as the ECB is buying now.
And there is still uncertainty over reinvestment policy, which the ECB has yet to spell out, including how it will deal with redemptions from asset-backed securities. Some policymakers have even advocated not rolling over corporate bonds and spending the proceeds elsewhere, Reuters reported.
“The concern within the market is that reinvestments (in corporate debt) in 2019 are rather limited,” said ING’s head of developed market strategy and research Jeroen van den Broek.
(Interactive chart https://tmsnrt.rs/2Nqxh3Z])
ECB’s QE redemption estimates – https://tmsnrt.rs/2NpEjpM
READY OR NOT
As the ECB’s sizeable presence unwinds, the corporate bond market is already starting to feel the effects. Higher funding costs could also reduce appetite for mergers and acquisitions, or push corporates back to the loan market for more concessional borrowing, bankers and investors said.
German media company Bertelsmann was unable to find enough demand to print a seven-year euro-denominated bond in May after offering a starting price of 45 basis points over mid-swaps, a risk-free benchmark.
Bertelsmann returned to the market last month with a slightly shorter tenor and a starting price of 85 basis points. The deal, which raised 750 million euros, was finally priced at 65 basis points over.
“Companies like Bertelsmann have seen their funding costs blow out,” said Marco Baldini, head of European bond syndicate at Barclays Bank.
“You can’t see any clearer indication as the end of the effect of CSPP on the corporate bond market,” he said, referring to the Corporate Sector Purchase Programme, the ECB’s name for its corporate bond buying scheme.
A Bertelsmann spokesperson declined to comment.
Bankers and dealers said this factor was only beginning to surface in the primary market.
“We’ve not had that much issuance since QE was tapered at the start of October, so I don’t think the impact has been felt yet,” said a debt syndicate banker in London.
The segment of the market most at risk is the 25 billion euros of high yield bonds which only just qualify for ECB purchases because they have an investment grade rating from one ratings agency, bankers said. Of this, 19 billion euros of bonds appear on the ECB’s purchase list.
Access to cheaper funding led to an “explosion” in the amount of single BBB-rated paper in Europe, which is now the “most mispriced” segment of the market, Baldini said.
ECB QE, launched in March 2015, first focused on the biggest and most liquid government bond markets but was extended to include corporate bonds in June 2016. Economists estimate the ECB now owns about a fifth of the stock of eligible corporate bonds, versus about a quarter of eligible government debt.
Without a boost from ECB buying, bond prices will increasingly reflect market factors, said Edward Farley, head of European corporate bonds at PGIM Fixed Income.
“Ultimately, this means there will be more focus on fundamentals and getting those right because you don’t have anybody propping up the market in an artificial way.”
As a result, the difference between corporate and government bond yields has widened and the pool of negative-yielding investment-grade corporate bonds is shrinking.
(For interactive chart: https://tmsnrt.rs/2OzhvIJ)
Pool of negative yielding corporate debt shrinks – https://reut.rs/2OMhFwx
“The whole corporate bond market has gone through a drastic repricing,” said Baldini at Barclays.
He said anticipation of the end of QE has helped push the euro-denominated European Aggregate Corporate BBB index 50 basis points wider from January to September, more than double the widening of the U.S. equivalent.
Investment grade corporate bonds still retain a QE premium, so further spread-widening is likely said Stephen Caprio, global credit strategist at UBS.
Corporate bonds and the QE effect png – https://tmsnrt.rs/2yq5j33
Farley said the end of QE marks an opportunity, because prices more accurately reflect risk. Previously, his firm had been “very underweight” ECB-eligible names, because bond spreads traded so tight.
“New issues are now coming at sensible levels rather than ECB compressed levels,” he said. “There are plenty of reasonably attractive opportunities that just simply weren’t there before.”
(This version of the story corrects currency to euros from dollars in paragraph two.)
(Reporting by Dhara Ranasinghe and Virginia Furness; Additional reporting by Balazs Koranyi in Frankfurt; Graphics by Ritvik Carvalho, Editing by Peter Graff)