As most market participants might be aware, one of the most prominent actions taken by the European Central Bank (ECB), which hit the headlines on the 10th of March was the ECB’s expansion in terms of quantitative easing (QE) in regard the purchasing of non-financial corporate bonds. Despite the fact that other easing actions also positively impacted the credit market, the latter’s announcement had triggered a spike, on the day, primarily within the investment grade arena.
As announced lately, the ECB will commence purchasing investment grade bonds in June, with the main aim being economic stimulus through further liquidity within the economy. The ECB intends to initially kick-off with a slow pace, in order to stimulate bond issuance and slowly increase its pace of purchases to 5-10 billion euros a month.
Interestingly enough, according to a latest report published by Fitch, France and the Netherlands, accounts for circa 57 per cent of the bonds that the ECB can buy. To the ECB’s dismay, both countries already enjoy easy access to credit, however the ECB is hoping that eventually restricted borrowers will have access to the required financing in order to finance their projects, which ultimately is the ECB’s main aim.
Undoubtedly, amongst the restricted borrowers are peripheral countries, such as Italy and Spain which had to take drastic measures over the past years to reform their fiscal imbalances.
Surely the announced easing measure also had effect from a supply side perspective, with the latest data released by Fitch showing that European issuers sold bonds with the lowest coupons on record in the first quarter of the year, with high-rated companies paying less than 2 percent on bonds with a maturity of 10 years or more.
Looking at the numbers, since the ECB’s announcement non-financial companies in Europe have issued around 61 billion euros worth of euro-denominated bonds, which is 50 per cent more when compared to the same comparable period last year. Indeed such data implies that the program did trigger some sort of comfort from borrowers, however figures showed that the issuance was primarily concentrated in better rated countries, with Germany, Britain and France accounting for 70 percent of new bonds sold this year.
The interesting path of the ECB’s corporate decision also shadowed the European High yield market despite the fact that such segment within the credit market is excluded from the ECB's program. In fact, over the past days, junk borrowers were tapping the bond markets as the fall in coupons paid by investment grade issuers pushed investors towards riskier investments which benefitted from the possibility of issuing debt at lower levels. Few examples of latest issuance in such mode, was Sappi, the South African pulp and paper producers, which called its 6.625 per cent dollar bond and managed to re-finance in Europe at a low yield of 4 per cent and Heidelberg Cement which issued at MS+205bps.
The examples mentioned are relatively solid credit names within the high yield space, but what about fragile names? My view is that for some other names, the recent credit rally which was backed by the stimulus imposed by the ECB solely prolonged their existence. As said the recent rally by such names was solely triggered by a positive market sentiment towards the credit market, and not by any improvement in credit metrics. My perception is that the ECB did account for such possible risk, but at this stage boosting the economy is given much more weight than other risks.
Investors should be very selective when purchasing high yield debt and consider the long term implications of being exposed to such risks. Investors might capture short term gains, but gather long term pains. To circumvent such risk, investors should consider diversifying their risk by investing into bond funds which still offer very attractive returns when considering today’s low yielding environment.
Disclaimer: This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.