Failed ECB asset purchases plan has wrought 'malign impacts' for the market

David Wigan
Published on:

The corporate bond market fears crowding out as quantitative easing looms.

As the European Central Bank (ECB) moves toward fully fledged quantitative easing, the recent performance of its existing programme to buy covered bonds and asset-backed securities (ABS) might give it pause for thought, market participants say.

Having launched its bond-buying strategy in October, the central bank would have hoped to have substantially expanded its balance sheet and injected confidence into markets that have struggled since the financial crisis. On both counts it has failed.

Peter Mason-large
  The actions of the ECB in buying covered bonds and tucking them away in its balance sheet is a potentially distorting factor in the secondary markets

Peter Mason

In its most recent report, the bank’s assets totalled €2.16 trillion, compared with €2.05 billion when the asset purchase programme was announced. Some progress, seemingly, but the asset purchase programme’s contribution has been negligible, amounting to just €33.1 billion in covered bonds and ABS over the past few months. The bank aims to expand its balance sheet to €3 trillion.

"From the perspective of trying to fill in that trillion euro hole, the purchase of asset-backed securities and covered bonds has been a drop in the ocean," says Gareth Davies, head of European ABS and covered bond research at JPMorgan. "There have also been some malign impacts which could do longer-term damage to liquidity and pricing, and may be a sign of how things could go for corporate bonds."

From the moment the ECB announced plans to  buy ABS and covered bonds in early September, price action in the securities reflected the presence of a new and powerful buyer in the market, with spreads moving sharply tighter. 

In September, average covered bond spreads narrowed around 5 basis points, and the trend was reinforced in October when the central bank published details of its plan, specifying that the purchases would continue for at least two years and in unlimited amounts. 

In addition, the bank said it would buy a broader range of covered bonds than in its previous two programmes – launched in 2009 and 2011 – bringing the total amount eligible to around €545 billion, or nearly half the publicly placed market.

By late October, as the ECB made its first secondary-market purchases, the spread of European covered bonds to their non-European counterparts had tightened by 10bp, a sizeable chunk for securities that seldom trade wider than 30bp over mid-swaps.

From an issuer point of view, tighter spreads represented excellent news, and banks across Europe wasted no time in printing deals.

"From mid-October to mid-November, we saw a decent flurry of euro-denominated bonds," says a London-based banker involved in some of the transactions.  "The first one was from Nordea Bank Finland and the central bank put in a decent order and got around 10%."

In the Nordea deal, the central bank in the event asked for a bigger slice of the €1 billion 10-year note, the banker says, but told the issuer it wanted to be treated like any normal real-money account. The Nordea team had subsequently telephoned the bank to say it had long-term investors it did not want to let down, an explanation accepted by the central bank, which settled for its 10% share.

New dynamic

Unfortunately the moderation was short-lived, and over subsequent weeks a new dynamic emerged that saw long-term investors receiving lower and lower proportions of the distribution.

"Once we saw the peripheral Italian and Spanish banks coming in, secondary levels were moving tighter and the ECB allocation got bigger and bigger," says Peter Mason, London-based head of FIG DCM, EMEA at Barclays. "The driver was that we effectively had the investor community saying spread levels were too tight".

As investors sat out, coverage levels fell, and in late 2014 they ranged from 1.36 times for German mortgage bank Heslan to as low as 1.1 times for France’s BPCE. 

Just a few weeks after Nordea, Germany’s Helaba printed a €1 billion transaction in which the central-bank allocation rose to 63%, with the deal pricing at 15bp through mid-swaps. Seven-year deals from Sweden’s Stadshypotek and Norway’s DNB Boligkreditt priced at swaps minus-2bp and minus-3bp respectively.

When Finnish specialist credit provider OP Mortgage Bank came in late November with a €1 billion 10-year deal, investor appetite had all but evaporated. Syndicate bankers struggled to fill the order book, and the issuer paid a relatively generous swaps plus-4bp.

A few days later, Ireland’s AIB pulled a proposed 10-year deal and effectively shut the market.

"The ECB programme drove prices to a level where many investors were not interested," says Tim Michael, London-based head of financial bond syndicate at Citi. "The spate of underwhelming deals in November last year was the culmination of a period in which the ECB became an increasingly important player in both the primary and the secondary market, and crowded out much of the traditional investor base."