Mario Draghi, the Pied Piper of Frankfurt, is playing a new tune – and some of Ireland's best-known companies are skipping behind him.
The European Central Bank’s latest push, part of a €1.7 trillion quantitative easing programme to reignite euro zone inflation and growth, will see Draghi begin hoovering up corporate bonds this month for the first time.
The ECB has been buying sovereign debt (government bonds) for more than a year, and in March cut its main interest rate to zero. Now, with its corporate bond-buying plan set to start next week, it’s about to embark on what has been dubbed its “kitchen sink moment”: to kick- start a euro zone recovery and prevent the 19-member currency sinking into a deflationary spiral.
Last month this prompted companies across Europe to sell about €50 billion worth of bonds, one of the busiest months on record. In Ireland this week, State- owned companies ESB and DAA, as well as Glanbia's largest shareholder, Glanbia Co-operative Society, joined in the bond bonanza.
If the ECB is coming into the market, they reckon, then the cost of raising corporate debt should be low, with big buyers lurking in the market all the time.
“It appears the ECB’s biggest concern was that [funds injected into the market from] its bond buying up until now weren’t making their way into the public domain and just getting stuck in the banks,” said Ryan McGrath, head of fixed income strategy with Cantor Fitzgerald in Dublin.
“The logic behind the new move is that it will encourage companies to take on more debt or refinance existing borrowings – and use the additional money or savings to expand, create jobs and have a real impact on the economy.”
The ESB is set to save millions of euro in interest payments after selling a 15-year bond last Tuesday with a coupon, or interest rate, of 1.875 per cent.
Strong demand
Indeed, demand was so strong for the ESB bond that the energy group upped the amount on sale by €100 million, to €600 million. Most of the proceeds will be used to refinance short-term bonds, such as debt maturing in 2019 that has a 4.375 per cent coupon.
A day later, airport operator DAA dipped its toe in the bond market for the first time in eight years, selling €400 million of debt, priced to yield 1.554 per cent. Much of the proceeds will be used to buy back €260 million of the DAA’s 2018 bonds, which carry a 6.59 per cent coupon, and prepare for investment in a new runway, which is due to be completed in 2020.
On Thursday, Glanbia Co-op sold €100 million in five-year bonds, which are exchangeable into its Glanbia shares.
The ECB can only buy bonds that are deemed investment grade by the ratings agencies. However, a slump in borrowing costs (bond yields) for these companies since the programme was announced may prompt bond fund managers to invest in even riskier debt. This could create problems for the future, according to analysts.
"There's good reason for investors to buy into the debt that the ESB and DAA issued this week, as both companies benefit from being in the euro zone's fastest economy," said Alan McQuaid, an economist with Merrion Capital in Dublin.
“But while the ECB is seeking to push down yields for corporate debt to make it easier for companies to borrow and invest and grow,” he said, “one of the big problems is that it creates a market where bond prices don’t reflect the risks attached to specific companies.”
This could store up problems for bond investors and the ECB itself, as it will be left holding billions of euro of potentially risky corporate debt on its balance sheet.
Detailed analysis
McGrath said investors piling into bonds are looking at the broader macro-economic impact on the debt market and economy from Draghi’s quantitative easing plan, rather than doing detailed analysis on the credit worthiness of individual euro zone countries or companies.
“When QE ends, we run the risk that investors will be holding lesser-rated corporate and sovereign debt than they’d like, without having the ECB out here as a back-up buyer of these,” said McGrath. “It’s then that there’s a real risk of a sharp reversal of [of the recent downward trend] on yields.”
There is also a challenge for companies that use cheap debt to invest in facilities or other assets, according to Davy analyst Joseph McGinley. If interest rates rise considerably by the time the borrowings are due to be refinanced, companies might be forced asset sales at potentially knock- down prices.
Still, most economists expect interest rates to remain low over the medium term because the ECB is seen extending QE beyond its current lifespan, which is to the end of next March.
In the meantime, Goldman Sachs analyst Francesco Garzarelli said in a note this week that the real winners from Draghi's plan will be companies whose bonds are rated junk or sub-investment grade – which the ECB can't buy.
This type of debt will look increasingly attractive for investors on the hunt for yield – or a return in terms of some kind of high interest rate.
Eir, which credit ratings firm Moody’s views to be five levels below what is considered investment grade, is poised to benefit from this. It is poised to enter the market next week to sell bonds to help refinance €350 million of high-cost debt, which carries a 9.5 per cent interest rate.
The average yield that investors demand to hold eurobonds sold by investment-grade companies now hovers near all-time lows at 1.04 per cent, according to Bank of America Merrill Lynch data. In contrast, analysts say a new medium- to long-term Eir bond could yield 5 per cent.
"Companies further down the credit curve in sub-investment grade tend to be either rising stars or fallen angels," said Colm Ryan, a bond analyst with Goodbody Stockbrokers. "The rising stars benefit from competitive funding levels as institutions compete for investment opportunities, while the falling angels are supported as their business wanes."
Eir, which delivered a fourth consecutive quarter of sales growth in the three months through March following years of decline, will be hoping that debt investors will see it as more of a rebounding star.
