This month the Bank of England launches the Corporate Bond Purchase Scheme as one tool in a set designed to mitigate economic pressure that could follow the curious decision of British voters to quit the EU.
Through the scheme, the BoE intends to purchase up to £10bn in non-financials corporate bonds with at least one investment grade rating over a period of 18 months.
In the BoE’s own words, the purpose of the CBPS is to “impart monetary stimulus by lowering the yields on corporate bonds, thereby reducing the cost of borrowing for companies”. This, in turn, should stimulate new issuance of corporate bonds.
While the announcement of the programme surprised many, the Europeans had blazed the trail for the Brits only a few months before; the swift move of tightening sterling credit spreads and flattening credit curves was like déjà-vu. Following this distortion in valuations that the BoE caused, as credit investors we must now decide whether or not we are being paid for fundamental, Brexit and ESG risks with yields now much tighter.
First, let’s take a look at the impact on credit markets. At £10bn in size, the scheme is approximately 8 per cent of the available credit pool. While this is smaller in scale than the Corporate Sector Purchase Programme, which represents approximately 11 per cent of the eligible Euro credit market, the impact of the CBPS could be greater because the sterling credit market is shallower and thus less liquid.
Meanwhile, with the front end of investment credit curves now in negative yield territory, pension schemes and insurance companies are required to move further down the credit curve to find yield that meets their needs. Indeed at the confluence of this hunt for yield and the ability for companies to lock in long-term debt financing at historic lows, we are seeing UK corporates issue long-term debt. Take Vodafone for example. Days before the CBPS announcement, Vodafone issued an £800m bond with a maturity of 2049 and a coupon of 3.375 per cent at a credit spread of 190 basis points to gilts. Less than a week later, after the CBPS announcement and having seen that bond surge eight points in price, it was able to issue a longer dated bond – to 2056 – with a lower coupon (3 per cent) and a much lower credit spread to gilts of 168 basis points.
Because nothing happens in a vacuum, the indirect impact of the scheme has been palpable across debt markets. For example, “out-of-scope” securities have benefited immensely (but not evenly). Whereas lower quality names such as Matalan are trading approximately where they were before the referendum results were made known, higher quality names like Virgin Media are trading at or above where they were before the Brexit result.
Additionally, Standard Chartered which, as a banking institution is “out of scope”,issued a dollar-denominated additional tier 1 bond that attracted large demand from investors and had the largest order book for such a transaction from a European lender so far this year.
The siren call for yield is now loud and clear. As a result, valuations in some areas have traded through what’s fair for fundamental, ESG and Brexit risks.
We are finding opportunities in the long end of credit curves; in other jurisdictions, such as hard currency emerging markets and the US and in the capital securities of higher quality companies. Additionally, in high yield we remain focused on quality and are avoiding stressed names that require more confident macro environments to grow into their capital structures and/or are illiquid.