ECB corporate purchases positive for credit
Greg Venizelos, strategist within the research & investment strategy team of AXA Investment Managers, gives his views on the ECB’s Corporate Securities Purchase Program.
On 10 March the ECB delivered a well-targeted stimulus package, addressing some of the key risks that have dogged global markets in the past twelve months: (i) excessive dollar strength, which undermines global risk appetite; (ii) deep negative rates, which undermine bank earnings; and (iii) inability of its ‘sovereign’ QE to support euro credit spreads during its first year of operation.
Through the Corporate Securities Purchase Program (CSPP), the ECB has given itself the option to address the potential scarcity of issues in the sovereign debt space given the higher monthly amount and the means to suppress risk premia if euro credit comes under pressure.
Overall, the measures announced by the ECB are very supportive for credit, both non-financials and financials, including banks.
Positive for euro non-financials.
The prospect of direct purchases of non-financial credit should cap euro IG spreads and spread volatility during market corrections.
Signalling is a key element of CSPP; the program may not even need to purchase that much credit to exert downward pressure on credit spreads.
The ECB as a ‘buyer of last resort’ should in effect become a market liquidity backstop, encouraging investors to participate and absorb euro IG supply (oversupply proved a bugbear for credit last spring).
Portfolio rebalancing effects should prove a strong driver for euro high yield (HY) credit spreads to tighten, as investors rotate into higher-yielding credits. In fact, if CSPP purchases include split-rated bonds, the benefit to BB spreads will be even more direct than just spillover effects.
The technical details of CSPP remain sketchy, but it is reasonable to assume that the program the bank will buy euro senior debt: of non-financial corporates and non-bank financials; by entities established in the euro zone; rated investment grade (IG); either fixed or floating-rate notes; in sizes proportional to the composition of euro credit benchmarks; perhaps without maturity restrictions, but above a minimum issue size.
If the entity is a subsidiary, it should carry a standalone IG rating exclusive of any guarantees from a non-euro zone parent.
Credit rating thresholds will be a key element. The eligible pool will be larger if the CSPP is allowed to purchase 5B, 7B or 8B credits (5B, for example, is a credit with one BBB and one BB rating) but will carry higher fallen-angel risk.
Lack of maturity restrictions (at the short end) also enlarges the eligible pool, but may elicit complications due to bond buy-back and bond calls.
Pool size/purchase rate.
The Bank of America Merrill Lynch (BAML) index for euro IG non financials has a face value of just under €1tn. Of that c.€600bn is issued by euro zone entities and ~€550bn comprises bonds above €500mn (benchmark size). Adding FRNs, removing maturity limits (ie incl paper <1y), and considering a more lenient rating threshold of ‘best’ rather than ‘average’ rating, could raise the pool to above €700bn.
On the assumption that CSPP buys up to 50% per issue (CBPP3 precedent) we get a size of €350bn, or c.three years’ worth of purchases at a rate of €120bn per annum (€10bn pcm).
That said, while €10bn pcm is comparable to the rate of purchases under CBPP3, we think that the purchase rate under CSPP could be lower, around the €5bn pcm mark, to avoid ‘crowding out’ investors.
In fact, one may envisage that the purchase rate varies between the €5bn mark (in good times, to prevent crowding out) and the €10bn+ mark (in bad times, to prevent excessive spread volatility). For context, annual euro IG non-financial gross issuance is typically €200-250bn; net issuance €80-120bn; monthly traded volume in euro IG non-financials €25-35bn and weekly euro IG retail fund flows €0.3-0.4bn.
Like CBPP, it is reasonable to assume that CSPP will be involved in both the secondary and primary markets. The latter could become a problem for investors, in as much CSPP suppresses new issue spread premia in CSPP-eligible credits.