Corporate bonds prepare for a world without CSPP
Europe’s corporate bond market has been shaped in the past year, for better or worse, by the European Central Bank’s unprecedented corporate bond buying programme. But as Michael Turner reports, market participants are deeply divided about what may lie ahead as the end of central bank largesse draws near.
The European Central Bank has bought around €80bn of bonds since it launched its Corporate Sector Purchase Programme in June last year, to heckles from bankers, who claimed the market did not need intervention as it was already working perfectly well.
The programme has not got any less divisive in the 11 months it has been running. Investors, bankers and issuers disagree over the impact it has had on the market.
“CSPP has had a pronounced effect,” says Suzanne Keane, co-head of credit research at Pioneer Investments in London. “It has suppressed market volatility and has increased the difficulty to source bonds in the secondary market.”
Although the ECB has bought about 85% of its bonds in the secondary market, the primary market has still been profoundly affected. This was most noticeable when new issue premiums plunged to zero as some investors scrambled to pick up new debt.
“Asset managers who are measured against a benchmark have been forced into buying in primary markets at overly tight spreads,” says Keane. For this reason, Pioneer has been underweight CSPP-eligible assets since last summer.
Borrowers leap in
Issuers have taken advantage of this historically cheap debt, piling into the market at record rates. Euro bond issuance by European investment grade companies hit €218bn in 2016, according to Dealogic, up from the €185bn printed in 2015 and a little under double the size of the market in 2010. Already this year, €81bn of investment grade corporate debt has been priced.
“The programme provided impetus for a growth in primary investment grade volumes, without a doubt,” says Marco Baldini, head of European bond syndicate at Barclays in London.
A large part of the growth is attributable to investors looking to non-CSPP-eligible parts of the high grade market to try to capture yield, sending spreads down there as well.
“We have not really noticed a difference between our bonds and those who are eligible,” says Gary Admans, head of capital markets at BP, a UK company and hence outside the scope of the CSPP. “It doesn’t seem to have made a difference.”
The CSPP led to “indiscriminate tightening” across the corporate investment grade market, says Baldini at Barclays.
“Even for those not eligible for the programme, spreads moved to such a degree that more and more issuers were encouraged to come to market,” he adds.
Some bankers working on the primary side of the bond market see things differently, particularly as, by all accounts, they treated the ECB as just another real money investor when it began buying in primary, rather than as a special case deserving higher allocations.
“When CSPP was announced,” says Rupert Lewis, head of European syndicate at BNP Paribas, “the expectation was that it was going to become like the covered bond market, with real money investors squeezed out of primary, but that has not happened.”
Meanwhile, the CSPP’s effect on spreads has become less clear since the initial sharp tightening.
“In the wider market, if you are trading at 300bp over and someone else [comparable] is at 250bp, it’s pretty obvious that the ECB is causing that,” he said. “But when spread differences are a few basis points, it’s harder to say that it’s because of the ECB.”
One thing bankers and investors agree on is that it is difficult to work out exactly what prompted the ECB to begin its CSPP in the first place.
“The assessment at the time was that CSPP wasn’t needed in the corporate IG market,” says Baldini. “It was a highly efficient market that saw oversubscriptions regularly and in size. You could not dispute that it was already a fully functioning market.”
The end is nigh
The case of how much ECB buying has shaped the corporate market may be solved at the end of this year, as it only plans to keep the programme going until December.
“What CSPP has done is put a sense of wellbeing and general underlying support into the market,” says Lewis. “When they begin to taper more aggressively towards the back end of the year, there’s going to be some downside.”
Admans broadly agrees with this sentiment, but highlights the political risk in Europe, particularly the German federal election on September 24 and the still unclear plans of US president Donald Trump, as bigger risks to bond markets than the end of quantitative easing.
For BP, the oil price is also more of a factor for its credit spreads than the CSPP, says Admans.
Looking at what CSPP has done to yields, few investors will agree. On March 10, 2016, before the CSPP was announced, almost no euro investment grade corporate debt traded at a negative yield. By July, that had risen to 18% of the market — €250bn of debt — according to Amundi.
This yield drought has put pressure on investors to go further out along the maturity curve, even though futures markets are now pricing in a more than 50% chance of the ECB raising rates — for the first time since 2011 — in December this year.
On the defensive
Already the corporate bond primary market has shifted to a more defensive tone. Maturities longer than 10 years are a tougher sell, while short dated floating rate notes fly off the shelves. Those who bought long dated debt in recent months are likely to suffer on a mark to market basis.
“The CSPP universe is vulnerable as we move towards the end of the CSPP programme, and the return to more normal pricing in investment grade credit may be painful for bondholders,” says Keane.
“At the same time, while economic growth is picking up in Europe, idiosyncratic risk is also rising, with M&A a growing theme, which may pressure credit profiles.”
Utilities have been a particular beneficiary of ECB buying, according to Keane, meaning they could underperform as the programme starts to wrap up.
The ECB has maintained that it will hold the bonds it has bought until maturity once the programme finishes. Many market participants agree that if the central bank tried to trim its portfolio by selling debt back into the market, it would lead to deeply negative sentiment and a sharp widening of spreads.
Regardless of what the ECB does in December, spreads have already tightened so much that, while there is still some room for them to tighten a little further, there is plenty of room for them to widen significantly.
“There’s an asymmetric risk,” says Baldini. “We have low spreads and yields and if the ECB is taking its foot off its programmes then the propensity is for spreads to widen. Where they are now, they could go a little bit tighter but they could also go a lot wider.”
The likely degree of widening is hard to predict. Many believe spreads will go back to being much wider than where they are today. But not all.
“I’m not convinced that if we didn’t have CSPP, spreads would be 75bp wider,” says Lewis. “We’ve had deals where we’ve asked investors if they would prefer the issuer got rid of the step-up coupon to make it ECB-eligible, or keep the 125bp step-up for protection, and investors have repeatedly told us they want the step-up because fundamentals are still important.”
Central bank action may muffle the sounds of real life, but it can’t shut them out forever.