22nd July 2016

Non-performing loans – the ECB cometh

FTSE 100
6,670, -29
10,156, +14
S&P 500
2,165, -8
iTraxx Main
67bp, -2.5bp
iTraxx X-Over Index
313bp, -8.5bp
10 Yr Bund
-0.02%, -1bp
iBoxx Corp IG
B+127bp, -1.5bp 
iBoxx Corp HY Index
B+461bp, -5bp
10 Yr US T-Bond
1.56%, -2bp

ECB day stymies activity…

As always, the ECB meeting brings the week to a premature end. It at least gave time for the markets to absorb the €4bn of Teva debt from Wednesday’s session and perhaps oversee a final portfolio consolidation before the holidays. Three weeks into a very quiet month has seen the Markit iBoxx IG corporate index tighten by 27bp to B+127bp YTD and the index yield fall by 22bp to a new record low of 0.94%. Everything has rallied, and even with “stuff” going in Italian banking the CoCo market has pushed on, with some 60bp of tightening in July so far. Yields have fallen here too of late, but the index at around 7.5% still has 200bp to go in order to achieve the lows of last year – although we are over 200bp lower than the wides seen this year. It’s going to be a tough ask for us to get anywhere near those previous lows given the uncertainty around a still difficult outlook for the banking sector (bail-ins and so on included). At 3.46% and B+383bp (index yield and spread, respectively), that other high beta sector – non-financial hybrids – is pretty much at the lows of the year so far, but approximately 100bp off the lows seen in Q1 2015. There is a “go long risk” trade in there, we believe, liquidity permitting.

So the ECB left it all unchanged, seemed comfortable with the markets overall reaction to the UK referendum result and even gave a high octane blast to bank stocks in beleaguered peripheral countries as Draghi suggested the need for public backstops for struggling banks. That’s all to be done within the existing rules obviously, but the ECB’s intentions are clear. He suggested the need for a fully functioning NPL market where debt could be traded easily. After all, what is the difference between a corporate bond and a corporate loan? Not a lot (usually the lack of a rating and some kind of security, perhaps liquidity). But are we seeing the early stages in next step of another market manipulation process? Those interested in NPLs are usually vulture funds, and there modus operandi of them is to buy loans at distressed prices in order to generate an acceptable rate of return over the remaining lifetime of the loan. The ECB, on the other hand, could easily stomach a much lower rate of return. So, if the ECB for example buys at a price which is perhaps slightly lower than what the banks have the loans marked at, then they take out the vulture funds and free up cash for the selling bank. But if they buy at an “elevated” price, they will be seen to be bailing out the banks. This reaction to it all is going to depend on where the banks have the loans marked, and what price the ECB might be looking to lift the NPLs at (if indeed this is their intention).

Interfering busy body

The point is, we believe the ECB is trying to fix a broken market – or in Draghi’s words – one which needs to be “fully functioning”. Several years ago, the covered bond market was broken and the ECB stepped-in to fix it and lended much authenticity to this  market. For the NPL market, some deals do get done, but the bid-offer is just too wide for efficient functionality. Therefore, loans are left on the banks’ books – and are just stuck there. Anyway, regardless of the mechanism adopted (say the ECB buys into an SPV and then securitises and sells on), the ECB’s involvement would be an attempt to fix a broken market by giving it some of the same authenticity it gave the covered bond market several years ago. Maybe, for once, there is some method in the ECB’s madness (that was/is sorely missing when they decided to tackle the corporate bond market)!

Otherwise, Draghi gave what can only be taken as a rather upbeat assessment (certainly the tone of his message was) as he brushed aside any fears of economic risk from Turkey, and decided not to move on rates. Nor did he hint at expanding the current QE programme. On we go to September. European stocks otherwise moved in tight ranges although bond yields were more choppy with Bund yields positive again – before turning negative into the close, and against some greater volatility in Italian yields as the 10-year BTP yield rose to 1.31% before settling at 1.24% (+1bp). The Bund closed to yield -0.02% (-1bp) as did the equivalent Gilt at 0.83% (having been up at 0.88% in the session). Lest we forget, Spain’s 3-year auction was executed with a negative yield and ended the session to yield -7bp.

All set for the weekend

In primary, Teva’s world tour continued and the pharmaceutical company was busy lifting CHF1bn in Switzerland, having previously lifted €4bn in Europe and $15bn in the US before that. The only other deal of some note was a €150m tap by Viesgo of the existing 26s. There was nothing else apart from some SSA issuance, and we will be surprised if anything pops up in today’s final session of the week. That’s €10.65bn in issuance with a week to go and we conclude thus far a very light and disappointing month on this front.

In secondary, spreads tightened some more and overall, the Markit iBoxx IG corporate bond index was down at B+127bp (another 1.5bp tighter), while the index yield was unchanged at its record low (see above). For once, the HY market was also joining in, and we did see it better bid. The index was lower at B+461bp (-5bp). Finally, credit protection costs continued to fall into the happy-go-lucky feeling that plays into the corporate bond market. Main closed at 67bp (-2.5bp) and X-Over at x313bp (-8.5bp).

Have a good weekend. More on Monday.

Suki Mann

A 30+ year veteran of the European corporate bond markets and in his role as Credit Strategist, Dr Mann has been ranked number one in the Euromoney Investor Survey eight times in ten years. Previously with Societe Generale and UBS, he now shares views of events in the corporate bond market exclusively here on CreditMarketDaily.com.