ECB May Discuss Junk Debt Collateral in Call on Wednesday

(Bloomberg) -- European Central Bank policy makers will hold a call on Wednesday evening where they may discuss whether to accept junk-rated debt as collateral from lenders, according to officials familiar with the matter.

The video conference could be intended to head off concerns that some sovereign and corporate bonds will soon be downgraded to non-investment grade because of the cost of fighting the coronavirus pandemic.

S&P Global Ratings is set to review Italy’s credit rating on Friday, which it currently ranks two notches above investment grade with a negative outlook. A downgrade would be a step toward potentially excluding the euro zone’s third-largest economy from the ECB’s refinancing and asset-purchase programs, precipitating a crisis.

Governors expect collateral to be discussed on the call, the officials said, asking not to be identified as the meeting is confidential. An ECB spokesman declined to comment.

ECB May Discuss Junk Debt Collateral in Call on Wednesday

“It would be another game changer” if the ECB decides to accept junk bonds as collateral, said Piet Christiansen, chief strategist at Danske Bank in Copenhagen. “Going from even never wanting to touch them to now actually discussing it is another point which shows that ECB is really going the extra mile.”

Ratings are a pressing concern in markets as lockdowns spark the biggest recession in decades. Moody’s Investors Service, which will review Italy in May, rates the nation at its lowest investment grade.

While the ECB’s current rules mean Italy would have to be cut to junk by each of S&P, Moody’s Investors Service, Fitch Ratings and DBRS to be excluded from its operations, the prospect of downgrades is unnerving investors.

Italian bond yields have risen in recent days, and the premium investors demand to hold 10-year Italian debt over Germany’s soared 25 basis points on Tuesday, despite the country managing a successful sale. In raising more than 110 billion euros ($119 billion), it reminded investors just how much it needs the cash.

Barclays Plc sees outflows of as much as 200 billion euros if the nation’s rating is cut below investment grade. Moreover, a cut in the sovereign would flow through to the corporate bonds and commercial paper that the ECB also buys and takes as collateral.

iTraxx Crossover, the gauge for high-yield corporate debt risk in Europe, tightened 30 basis points on Wednesday morning. Government bond yields for Italy and Greece fell slightly.

What Bloomberg’s Economists Say...

“When push comes to shove, the European Central Bank has always done what’s needed to prevent the euro area from being torn apart -- at least eventually. Similarly, it’s unlikely to allow rising yields to tip Italy into a sovereign debt crisis.”

-David Powell. Read his ECB INSIGHT

The U.S. Federal Reserve said on April 9 it would move to buy high-yield debt and exchange-traded funds as part of a program to support small and mid-sized businesses during the coronavirus crisis.

The ECB set its own precedent for accepting junk debt last month by agreeing to allow Greek bonds as part of its emergency bond-buying program. That was an acknowledgment of the broad scope of the coronavirus shock.

This month it extended that concession to accepting Greek government debt as collateral, effectively allowing Greek lenders to borrow from the central bank. It eased other collateral rules at the same time.

The ECB video conference underscores that it is still on the frontline of fighting the economic fallout of the pandemic, ramping up liquidity measures and loosening self-imposed restrictions on what it can do.

While European Union governments have unleashed unprecedented stimulus at national level, they are at odds over how to fund a recovery in the bloc and are not expected to come to a detailed agreement when leaders speak in a video conference on Thursday.

©2020 Bloomberg L.P.

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