MS Morgan Stanley

As central banks run out of bonds to buy, they flood corporations with cheap money

By Christopher Whittall 

The European Central Bank's corporate-bond-buying program has stirred so much action in credit markets that some investment banks and companies are creating new debt especially for the central bank to buy.

In two instances, the ECB has bought bonds directly from European companies through so-called private placements, in which debt is sold to a tight circle of buyers without the formality of a wider auction.

It is a startling example of how banks and companies are quickly adapting to the extremes of monetary policy in what is an already unconventional age. In the past decade, wide-scale purchases of government bonds -- a bid to lower the cost of borrowing in the economy and persuade investors to take more risk -- have become commonplace. Central banks more recently have moved to negative interest rates, flipping on their head the ancient customs of money lending. Now, they are all but inviting private actors to concoct specific things for them to buy so they can continue pumping money into the financial system.

The ECB doesn't directly instruct companies to create specific bonds. But it makes plain that it is an eager purchaser, and it lays out the specifics of its wish list. And the ECB isn't alone: The Bank of Japan said late last year it would buy exchange-traded funds comprising shares of companies that spend a growing amount on "physical and human capital, " essentially steering fund managers to make such ETFs available to buy.

The furious central-bank buying has been a relief to companies and governments that can now borrow at rock-bottom interest rates. But it has also spurred criticism that the extreme policies are killing the returns available to other investors, such as pension funds, and loading up the economy and financial system with potentially overpriced debt.

The ECB was late to the central-bank party -- it began quantitative easing only in 2015, years after the U.S., the U.K. and Japan -- but it has embraced bond-buying with fervor. In March, it boosted its purchases to EUR80 billion ($90.6 billion) a month from EUR60 billion and surprised investors by saying it would soon add corporate bonds to its shopping list.

It had already bought so many government bonds that it was running out of things to purchase.

The ECB had bought more than EUR16 billion of corporate bonds as of Aug. 12, according to the latest available data from the central bank, after starting purchases in early June. The lion's share has been already-issued bonds trading in secondary markets, but some has come in new debt sales, according to the ECB.

And Morgan Stanley has arranged two private placements that have been bought by the ECB, according to a Wall Street Journal analysis of data from Dealogic and national central banks.

The ECB cited its website when asked to comment on the corporate-bond-buying program. On Thursday, it updated information on the site to clarify that the bank can participate in private placements. The ECB isn't involved in defining the characteristics of the bonds in these sales, a spokeswoman for the central bank said.

Private placements are private debt sales not open to the broader market, typically relying on a handful of investors that want to buy a company's bonds.

For the company, such a sale allows it to raise cash quickly without having to draft a bond prospectus. Investors, for their part, are guaranteed to get a sizable chunk of the bonds they want to buy without having to compete with the wider investment community.

"Typically there won't be a prospectus, there won't be any transparency, there won't be a press release. It's all done discreetly," said Apostolos Gkoutzinis, head of European capital markets at law firm Shearman & Sterling LLP.

The ECB executes bond purchases through the eurozone's national central banks, which function like branches.

The Bank of Spain holds some of a EUR500 million private placement issued by Spanish oil company Repsol SA on July 1, and some of a EUR200 million deal from Spanish power utility Iberdrola SA sold on June 10, two days after the ECB program got under way.

Both deals were solely arranged by Morgan Stanley and are the only private placements issued since the start of the ECB's corporate buying program to have been bought by national central banks, according to the Journal analysis. Morgan Stanley declined to comment.

Iberdrola didn't respond to requests for comment. A spokesman for Repsol said it makes sense for the company to lock in low borrowing costs in bond markets. "It's all about bringing your global interest payments as low as possible," the spokesman said.

It is impossible to say exactly how much the ECB holds, because the national central banks that make the purchases disclose only which bonds they have bought, not the amounts. For almost the first six weeks of the program they didn't give any details about which bonds they had bought.

Still, the scant data are enough to make traders and strategists scramble to divine what the big fish is buying. Guessing right can pay off. Yields on corporate bonds have plunged in Europe. (Yields fall when prices rise.) The average yield on euro investment-grade corporate bonds is 0.65%, according to Barclays, compared with 0.99% before the program started and 1.28% before the bank said in March that it would buy corporate bonds.

"We're all looking at the data," said the head of credit trading at a major European bank. "They're only one new customer -- but it's a big one."

And banks are rushing to serve it. Credit Suisse Group AG reshuffled its sales coverage of national central banks in recent weeks when the trading desk realized it wasn't doing enough business with the new largest buyer in town, according to a person familiar with the matter.

The ECB's corporate-bond program may well grow further. The bank is widely expected to extend quantitative easing beyond March, when it is planned to end. Government bonds are growing increasingly scarce. The ECB can buy only bonds that yield more than its deposit rate, currently minus-0.4%. That rules out vast amounts of German government debt, and much else too.

More corporate bonds are one option, and the central bank could buy a greater proportion directly from companies. The program has only been operating in the summer, typically a slow season for bond sales.

That means more opportunities for investors.

Credit strategists at Citigroup Inc. calculate that bonds eligible for ECB purchases have outperformed ineligible bonds by roughly 30% since the program was announced in March.

Tom Ross, a portfolio manager at Henderson Global Investors, said he spends a good deal of time perusing a spreadsheet created by his team to track and analyze ECB purchases.

"It has a number of implications," he said. The ECB owning a bond "is almost like a backstop bid. It provides liquidity in a time of stress."

--Tom Fairless contributed to this article.

Write to Christopher Whittall at christopher.whittall@wsj.com

(END) Dow Jones Newswires

August 22, 2016 02:47 ET (06:47 GMT)

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