ECB Ends Corporate Bond Buying, and Look What Happens

Companies feel the pain as euro junk-bond yields more than doubled from a year ago.

By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.

To the white-knuckle end, 2018 has been a terrible roller coaster ride for Spanish supermarket chain Dia, once one of Europe’s biggest grocery chains. The firm’s shares, reduced to a penny stock — despite the 22% surge today to €0.44 — have plunged 90% since January. During the same period, the company has issued no fewer than three profit warnings. Its credit rating was slashed to junk in a matter of weeks. To top it all off, two weeks ago, Dia suffered the ultimate ignominy of being ejected from Spain’s benchmark index, the Ibex 35, for being worth too little, to be replaced by a pulp mill called Ence.

As the pressure rises, the company’s senior management, newly appointed earlier this month, has promised to offload the firm’s cash&carry division and fragrance brand. It also plans to close its biggest loss-making stores, all in the hope of securing a new €200 million credit line from its lenders, which it hopes will tide it (and its providers) over until Spring, when it hopes — that “h” word, again — to raise a fresh round of capital. It’s a big ask.

As for the company’s creditors, they are understandably concerned. They include four of Spain’s five biggest lenders, Santander, BBVA, CaixaBank and Banco Sabadell, as well as European heavyweights like Barclays, Société Générale, and Deutsche Bank. Also on the long list of creditors, albeit featured less prominently, is the ECB, which owns an unspecified amount of Dia’s outstanding debt.

During is corporate bond-buying days that were part of its QE, the ECB didn’t disclose by name what it was buying, or the amounts. But it does disclose a list of its current bond holdings (you can download the list here). And those holdings include three bonds issued by a certain Distribuidora Internacional de Alimentos — Aka Dia — that are scheduled to mature in 2019, 2021 and 2023. Their total face value is €905 million.

According to sources cited by El País, the ECB, through its corporate bond buying program, holds at least €200 million — just over a fifth — of that debt. In October, those bonds carried investment-grade status. Today they are ranked well into junk territory (Caa1 from Moody’s, CCC+ from S&P’s; see the WOLF STREET color-coded cheat sheet for the different rating scales). The main reason for the downgrades was the third and final profit warning, released in late November.

The fallout for bondholders has been brutal. Bonds that were trading at around 100 cents to the euro at the beginning of the year, in large part thanks to the ECB’s support, are now trading at 68 cents, 60 cents, and 57 cents on the euro, in order of maturing date (2019, 2021 and 2023). In other words, the ECB’s “investment” in Dia has lost over a third of its value.

The meltdown at Dia bears ominous echoes of the Steinhoff scandal of 2017, when the ECB ended up selling its position in the bonds of South African retailer Steinhoff at a multi-million euro loss after it was revealed that the company had engaged in highly dubious accounting practices. Many are now wondering whether it will do the same with Dia.

This is testament to the boggling extent to which corporations in Europe have come to depend on the ECB’s largesse, which is scheduled to end in the next few days. The ECB, under its corporate sector purchase program, or CSPP for short, has snapped up over €176 billion of European corporate debt. That’s the equivalent of roughly a fifth of all eligible euro corporate bonds issued since June 2016, when the program was first launched.

At the program’s peak, the central bank was gobbling up over €2 billion of corporate debt a week. Some of the biggest names, from BMW to Daimler in Germany, to Spain’s Telefonica and Gas Natural, to Italy’s Eni, and to France’s Engie and Sanofi, have had as many as 15 bond issues bought up by the ECB over the last two and a half years.

Even after tapering its purchases earlier this year, the ECB was still buying corporate bonds at a rate of over €1 billion a week. It’s only in the past five months that average weekly purchases slipped below that amount. According to the FT, the ECB’s corporate bond buying could shrink to as little as €400 million a month in 2019 as it would only replace maturing bonds to keep the balance level.

That has already had a big impact on the price of corporate debt — and yields have surged. The average yield of euro-denominated junk bonds, according to the ICE BofAML Euro High Yield Index (chart), has more than doubled over the past 12 months, from the low point in November 2017 of around 2.1% on average, to 4.7% currently, which is still historically low, but a lot higher than it had been.

Europe’s corporate bond market is already feeling the pressure from the absence of the ECB, which will continue to impact the price of debt for many of Europe’s largest companies.

Many investors are clinging to the hope that the worst of the coming pain is already priced in, but a lot of the companies that have benefited from the central bank’s largesse are already finding it more difficult and more expensive to borrow by issuing new debt. Even a colossus like Volkswagen has seen its spreads against German government debt widen by around 100 basis points since the start of 2018.

The quality of corporate debt as a whole continues to deteriorate, with bonds that are rated BBB- (the lowest investment-grade category) now accounting for half of all investment-grade debt in Europe, compared to just 19% a decade ago. This BBB- debt is just waiting for a downgrade to junk. And funding for companies that have been downgraded to junk and that need new funding to survive is becoming more difficult and more expensive and perhaps impossible to get as the ECB is stepping away as relentless buyer. By Don Quijones.

No one knows what’s going to happen, and uncertainty reigns. Read… Amid Brexit Mess, UK Car Production Reels from Worst November since Financial Crisis  
 

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  17 comments for “ECB Ends Corporate Bond Buying, and Look What Happens

  1. Javert Chip
    Dec 27, 2018 at 9:17 pm

    Until reading this, I didn’t understand the ECB was buying corporate debt.

    It was stunning to see the deterioration in Greece after it ran out of other people’s money. Without the ECB sucking up corporate debt, the entire continent seems just a couple steps away from the boneyard.

    Doesn’t anybody in Europe do anything of value (other than cook, wait on tables or tour guide)?

    • nearlynapping
      Dec 27, 2018 at 9:29 pm

      The ECB owning 20% of DIA is almost beyond comprehension. But it shows what Central banks will do to prop up the system. In a credit based fiat system, the credit must grow or you get a deflationary collapse which can only be delayed with more debt … and then monetization.

      I don’t know much about the other Spanish banks, but Santander equity will go to zero soon enough.

      • Kasadour
        Dec 30, 2018 at 6:45 am

        The central bank IS the system. Who will bail IT>/i> out?

        Santander equity is already at zero, as is Deutsche Bank, et al.

    • MCH
      Dec 29, 2018 at 4:32 pm

      This was a bit of a surprise. Reading through this, I am left to wonder how the EU is much different from China from an economic perspective. Let me be more blunt, I can see how the EU is a significantly more poorly executed version of China’s state run and directed economy.

  2. Sporkfed
    Dec 27, 2018 at 9:21 pm

    I wonder what the corporate bankruptcy laws in Europe look like .

  3. Atu
    Dec 27, 2018 at 11:03 pm

    A lot more should be made of this corporate funding by the ECB, and I am surprised it hasn’t encountered protest in terms of unfair competition. Ordinary banks are still bound by certain regulation, as well as to exposure to market conditions, no matter that they will have the central bank to lean on, but the ECB directly funding the carmakers, Airbus, Autoroutes du Sud de la France (Vinci), AEROPORTS DE PARIS ( part Vinci, which is taking a controlling stake in Gatwick) moves the whole equation to a new level.

    It isn’t just that various countries have their discreet means of subsidising particular enterprise but the ECB being blatant, it is also that the ECB is crossing the national boundaries of NCB activity and acting as if EU were totally its own jurisdiction. A board member from each country involved does not cut it in terms of sanctioning that kind of direct activity in the private sector .

    More to the point it highlights the existence of a trans-national corporate political framework that is tied via the ECB using the resources of all Euro members. Unlike sovereign debt QE, itself a travesty of the rules of the Euro ( a bailout is a bailout, even if snuck through the secondary market) and political leverage, with corporate debt the ECB cannot demand those private companies abide by certain parameters in return.

    • WT Frogg
      Dec 28, 2018 at 11:26 am

      @ Atu

      Bailout is the name of the game:

      https://archive.org/details/pdfy–Pori1NL6fKm2SnY

      The Creature from Jekyll Island……..well worth the read. Puts much of the “insanity” of the past 50+ years in perspective.
      Enjoy

      • Bill
        Dec 28, 2018 at 10:22 pm

        Martin Armstrong has penned some excellent criticisms of “The Creature From Jekyll Island.” Mr. Armstrong’s series on the topic begins with “The Federal Reserve: Part I ‘The Creature from Jekyll Island'” dated April 16, 2015. Very worth reading, as is Edward Griffin’s text.

  4. Rowen
    Dec 27, 2018 at 11:05 pm

    Europe’s got a population problem. In the sense that how are countries that are continually decreasing in population supposed to pay for debt that’s always compounding?

  5. MD
    Dec 28, 2018 at 4:28 am

    Who would have thought that a ridiculous system that demands constant growth but at the same time looks to pay people less and less, load them up with debt whilst still teenagers and foist more overheads onto a shrinking, underfunded state would have systemic problems down the line..?

    What a shocker.

    Apparently though this is the best system we can come up with as a human race – and there’s clearly massive social capital available to bail out these ‘free markets’ – so that’s the stockholders looked after. So that’s OK.

  6. MC01
    Dec 28, 2018 at 6:34 am

    While the costs of servicing their debt tick higher and higher and the European grocery market becomes more and more saturated, what is DIA doing to overhaul their business model? Start sponsoring the Spanish female basketball association of course. Straight from their corporate website: https://www.diacorporate.com/es/

    I don’t know how that will help them out, but I am sure there’s some ingenious corporate spin to it.

    • John Henderson
      Dec 28, 2018 at 7:51 am

      Thank you for the link.
      It’s instead of shouting…..look there’s a squirrel!

  7. joe
    Dec 28, 2018 at 8:42 am

    Hilarious. I just read an article debunking the Drake equation – my take is that what people call “intelligence” is just a more effective method of self destruction. The sum of the parts is stupider than the part.
    More on point. This article never mentions the word “profit”. A casual reader would assume the purpose of a corporation is to talk other people into loaning them ever increasing amounts of money.

  8. Steve clayton
    Dec 28, 2018 at 12:07 pm

    Hi Don, great article and really interesting ref Dia massively in debt. Which country by value has the most debt purchased by the ECB?

  9. Iamafan
    Dec 28, 2018 at 6:50 pm

    Looking at the list provided, it looks like a list of private companies in socialism. This is quite disgusting and pretty hopeless. Central banking gone wild.

  10. R Davis
    Dec 28, 2018 at 7:19 pm

    Great article.

  11. Paul morphy
    Dec 29, 2018 at 6:58 pm

    Great article Don..

    ECB activity in the corporate/sovereign bond market has been widely publicised because without central bank purchases demand for bonds would die, yields would surge.

    A huge amount of zombified corporations and zombified banks have been deliberately kept alive by central banks, to maintain a pretence of solvency.

    We live in a time of completely artificial markets across every instrument of exchange : cash, shares, bonds, commodities property.

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