By Yoruk Bahceli
LONDON (Reuters) – Coronavirus lockdowns have put corporate bonds totalling around 30 billion euros ($32.6 billion) at immediate risk of dropping into junk debt ratings and losing ECB support, calculations by Reuters show, raising expectations of policy support for them.
Strict social distancing measures implemented to curb the spread of the coronavirus pandemic has put many euro zone companies at risk of defaulting and becoming “fallen angels”, when their credit ratings fall into the sub-investment category.
Already this year four euro zone firms, with outstanding debt of about 16 billion euros, have become fallen angels whose bonds no longer qualify for ECB purchases.
And another 16, including the world’s biggest steel producer ArcelorMittal and airline Lufthansa that are on “negative watch” lists from all three major ratings agencies, Moody’s, S&P and Fitch, could follow as they are at risk of losing all of their investment-grade ratings.
Companies need to retain an investment-grade rating from at least one of the main agencies to remain eligible for the ECB’s current bond buying programmes.
But an ECB move last week allowing some newly junked debt to be used as collateral against borrowing has raised hopes it will eventually start directly buying such bonds. That would make it easier for them to tap funding markets, as the ECB would continue to buy their new debt.
“Adding fallen angels is of paramount importance, as the financing conundrum for investment-grade corporates offers far more opportunities compared to high yield,” ING analysts said.
BofA, BNP Paribas are also expecting such a move.
Relief in the junk bond market after the ECB decision shows in the iTraxx Europe crossover index, which measures the cost of insuring against defaults from junk-rated companies.
The gauge has fallen steeply, after earlier hitting highest levels since the euro-zone debt crisis in 2012
The volume of fallen angel debt could reach 110 billion euros of downgrades in the worst-case scenario, UBS estimates, while in a more positive scenario, it predicts 38 billion euros being cut to junk. In any case, this would also significantly swell Europe’s 350 billion-euro junk debt market.
But with banks posting a relatively small amount of corporate debt as collateral with the ECB, the focus is more on collateral eligibility as a first step towards outright purchases.
BNP Paribas sees a two-thirds probability the ECB will include fallen angel debt in both its emergency purchases as well as its conventional bond-buying programme at its Thursday meeting.
“Especially the weaker-end of Triple Bs, which have imminent fallen angel risk, would be the main gainer from such moves,” Cem Keltek, credit strategist at Commerzbank in Frankfurt, said although he does not expect such an announcement on Thursday.
If the ECB does add fallen angels to its purchases, it would extend an approach it already takes on companies it already holds in its portfolio when they are demoted to junk status.
While qualifying for the ECB’s corporate sector purchases (CSPP) requires at least one investment-grade rating from leading rating agencies, the central bank does not have to sell bonds it already holds that have been rated junk.
It still holds bonds from several of the recently-junked issuers, including French automaker Renault, and has even held bonds during a restructuring in the past, such as in the case of Spanish retailer DIA last year.
(Reporting by Yoruk Bahceli; Editing by Alexander Smith)
