Corporate purchases ECB Bond Program Hammers Yields

The European Central Bank's corporate bond-purchasing program is now in full swing, with the companies involved revealed for the first time. But it's causing yields to decline significantly, hitting investors.
The ECB's corporate bond-buying program has now gone into overdrive.

Question: What do German companies Robert Bosch, RWE, Metro and Siemens; French companies Air Liquide and Danone; Belgian beverage maker Anheuser Busch Inbev; Spanish telecommunications company Telefónica; Italian and oil producer Eni; and Dutch insurer Aegeon have in common?

Answer: They are among the 150 companies whose bonds the European Central Bank has been buying since June 8 as part of a massive stimulus program to revive economic growth in Europe.

On Monday, the bank, headed by Mario Draghi, revealed the names of the companies from which it has acquired a total of 450 bonds for a total investment of €10.54 billion ($11.55 billion). "The ECB is setting the pace and has purchased significantly more bonds than many investors had initially expected," said Garland Hansmann, a fund manager with Investec Asset Management.

Suki Mann, who runs Credit Market Daily, a credit strategy comment site, likened the central bank's action to that of a "vacuum cleaner."

The ECB's move has serious consequences for the market. The substantial demand from the bank has contributed to yields on corporate bonds denominated in euros declining to less than 0.6 percent on average. Yield is a combination of interest coupons and price gains. In other words, investors who want the buy the securities now will no longer be getting much for their money. "It won't be long before the first corporate bonds with negative yields are placed," Ms. Mann said.

With their purchases, the central bankers aim to stimulate lending and, consequently, growth and inflation in the euro area.

Thanks to the flood of ECB money, the absurd world of negative interest rates is now reaching corporate bonds. Deutsche Bahn, Germany's rail operator, already created a precedent when it placed a bond with a negative 0.006 percent yield about a week ago. The ECB chose not to buy those bonds, but rather old bonds from the state-owned company.

Five-year bonds from Deutsche Telekom and utility RWE are already trading at slightly negative yields, and both the ECB and the German central bank, the Bundesbank, have acquired some of those bonds.

Government bonds have been caught in the maelstrom of negative interest rates for some time, and are deeper in it now that the ECB has been buying those bonds since March 2015. As a result, the supply of purchasable bonds available to the central bank is beginning to dwindle. Negative yields mean that investors who buy the securities now and keep them until maturity will incur a loss, because they receive less money back than they invested in the first place.

With their purchases, the central bankers aim to stimulate lending and, consequently, growth and inflation in the euro area. The ECB is now buying €80 billion in bonds each month, primarily government bonds. By expanding the program to include corporate bonds, it intends to push yields down even further.

Its goal is to encourage investors to invest in higher-yield investments, and to incentivize banks seeking higher returns to lend more to small and medium-sized companies that are not refinancing through bonds. Lending in the euro area in May, the most recent month for which data are available, declined by 1.4 percent over May 2015.

But this doesn't appease critics of the ECB bond-buying program. The central bank favors large companies with direct access to capital markets, which are already able to refinance at favorable rates, said Michael Kemmer, general manager of the German Association of Banks in Berlin. He fears that the ECB's policy "will lead directly to new excesses in the financial markets, such as when the extremely low cost of credit results in inflated prices in corporate acquisitions."

In the short term, at least, prices of corporate bonds could continue to rise while, conversely, yields will decline. "In light of the negative yields on many government bonds, investors are being driven further in corporate bonds," said Marco Stöckle, head of corporate bond research at Commerzbank. He doesn't think it's healthy. "The economic picture has hardly improved. Economic growth in the euro zone is anemic, and company financial figures are slowly getting weaker."

But this isn't stopping the ECB from buying up corporate bonds. Many fall within its predator-prey rules. To qualify for the ECB program, interest-bearing securities must be denominated in euros and issued by companies rated investment grade by at least one of the major rating agencies, Standard & Poor's, Moody's, Fitch or the Canadian agency DBRS.

The ECB can purchase all bonds issued by companies with at least a subsidiary in the euro zone. This enabled the Belgian central bank, acting on behalf of the ECB, to buy the bonds of companies such as Coca-Cola, Shell and Unilever. Bank bonds, however, are excluded from the program.

For Mr. Hansmann of Investec Asset Management, it is worth nothing that the ECB immediately went all out with its purchases. "It quickly pounced, even on the long-term bonds of companies with poor credit ratings, and as a result of this aggressive action, it caused yields in the broad market to drop considerably."

Ten-year bonds issued by Telecom Italia are on the purchase list. Fitch Ratings barely rates the telecommunications company as investment grade, while other rating agencies relegate the bonds to junk status for weaker borrowers.

The central banks in Germany, France, Belgium, Finland, Italy and Spain are buying the corporate bonds. Until now, the ECB had muzzled the participants, and only isolated pieces of information were leaked here and there. The national central banks have now released the lists, which usually consist only of untraceable identification numbers.

The reason is that the respective central banks are immediately forking over the bonds for so-called securities lending. This means that "if investors want to buy a specific corporate bond from a bank dealer, but the bank doesn’t have security in stock, the dealer can borrow the bond from the ECB in return for collateral," explained analyst Mr. Stöckle. In doing so, the dealer has bought time so that he can later buy the bond from another band or an investor.

With these lending transactions, the ECB wants to prevent the market from drying up. Dealers can also borrow the bonds of governments and government-affiliated institutions, as well as mortgage bonds. "The market has become even more illiquid, especially with corporate bonds. This means that bonds with a volume of less than half a billion euros, in particular, are difficult to trade," said Mr. Hansmann.

The reason, he added, is that "most investors only want to buy, so that it’s difficult to find a seller." He does not believe that the lending transactions will be very effective, and expects that dealers will also hold back in the future.

The national central banks will now publish their shopping lists every week, but without any information about volume.

"Nevertheless, it should be possible to draw certain conclusions, such as whether the ECB is broadly reproducing the market with its purchases or is giving preference to certain segments, names and countries – and whether there are differences among the six leading national central banks," Mr. Stöckle said.

Effectively immediately, Monday afternoons will now be a fixture in every investor's calendar.

 

Andrea Cünnen works at Handelsblatt's finance desk in Frankfurt, reporting on the bond markets. To contact the author: [email protected]