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ECB’s Steinhoff sale is red flag for perfect credit market

Central bank sells retailer’s bonds after downgrade to junk.

As the European Central Bank starts the new year planning to slash its asset buying in half, it’s a bond sale, not a purchase, that has caught investor attention.

The central bank revealed this week it had disposed of securities of Steinhoff International Holdings NV after the company was downgraded to junk following accounting irregularities. While the ECB can only buy investment-grade bonds, it’s not obligated to sell after such a cut, and its decision to offload the security has drawn attention to the program that’s scooped up 132 billion euros ($157.6 billion) of corporate bonds in less than two years.

“We think it ought to make investors a little more cautious regarding cuspy eligible names,” Joseph Faith, a credit strategist at Citigroup Inc. in London, wrote in a Jan. 9 note. “In a world where almost all eligible bonds are priced to perfection, the Steinhoff sale has steepened the cliff between ‘in’ and ‘out’.”

ECB purchases have boosted corporate credit across all ratings, eligible or not, since they were announced in March 2016, helping fuel a record year in European junk bond sales in 2017. While some expect the program to swell to more than 200 billion euros by the summer, this year looks set to mark a turning point for markets as central bankers pull back more on quantitative easing.

“If we’d hoped that in 2018 we could return to analyzing credit rather than CSPP eligibility criteria, the attention generated by the ECB’s unloading of Steinhoff shows that that day is still some way off,” Citigroup’s Faith wrote.

“While the sale crystallizes losses for the ECB, it also removes a source of ongoing controversy,” CreditSights analysts Tomas Hirst and David Watts wrote in a Jan. 10 note. Total acquisitions under the ECB’s asset purchase programs will halve to 30 billion euros a month from the start of this year and CreditSights said it assumes that CSPP portfolio purchases will be reduced pro rata.

The Steinhoff notes were the eighth to exit the central bank’s CSPP holdings after becoming ineligible for the program, following Arkema SA, Proximus SADP and Glencore Plc, according to data compiled by CreditSights.

Strong inflows

Many remain sanguine about the central bank’s program and prospects for the credit market in 2018. If recent fund data showing inflows into credit continues, “then the high-grade market will simply not be able to create enough bonds to satiate the weight of demand and ECB buying,” analysts at Bank of America Merrill Lynch Global Research wrote in a Jan. 10 note.

Absent a recession, the end of “happy days in credit” would require “an outbreak of hawkish and much less predictable central banks to end the great reach for yield,” according to the Bank of America analysts.

Still, they do flag another risk, a repeat of November 2017’s sudden rout in high-yield bonds.

“In bubblish times, investor confidence can quickly evaporate as event risks spook the market. If the smaller, debut, issuers — where fundamentals are getting weaker — become less scrutinized by the market, then this could mean more event risk shocks.”

© 2018 Bloomberg L.P

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