Junk Bonds Stay Out of ECB QE Scope After Collateral Rule Change


(Bloomberg) -- Junk bonds will remain outside the European Central Bank’s quantitative easing universe for now, even after changes to rating criteria that make recently downgraded bonds eligible as collateral for liquidity operations.

Wednesday’s decision applies only to lending operations, an ECB spokesman said. “We do not exclude that we make further changes in the future but for now, BBB- remains one of the criteria for the CSPP,” he added.

The central bank said Wednesday it would accept debt ranked as low as BB, two steps below the investment-grade threshold, as collateral for its loans to banks, as long as they held an investment-grade rating on April 7. But for the time being at least, the ECB’s support for junk bonds remains implicit, rather than direct.

A Bloomberg News report that the ECB would discuss accepting junk bonds as collateral sparked speculation that it would automatically make them eligible for QE. This was based on the wording of the decision to implement the corporate sector purchase program back in 2016, when ratings criteria were included as part of the so-called marketable assets requirement rather than a standalone clause.

Analysts have repeatedly flagged the risk of “fallen angels” -- investment-grade firms that fall to junk -- triggering forced sales by investors focused on higher quality debt. As much as $145 billion of debt from Europe, the Middle East and Africa could be cut to junk as the coronavirus pandemic takes its toll on businesses and economies, according to S&P Ratings Global Ratings.

The ECB said on Wednesday that it “may decide further measures” to continue the smooth transition of monetary policy. In the U.S., the Federal Reserve has said it’ll buy high-yield debt and exchange-traded funds as part of a program to support small and mid-sized businesses during the crisis.

The move provides “no direct support as it were, but it does remove the significant technical risk of indigestion in the high yield market from fallen angels,” said Tom Ross, a portfolio manager at Janus Henderson, which oversees $375 billion. “We believe the implicit support is there, as they stated they are willing to change the criteria further in the future.”

The ECB decided last month to allow Greek government bonds, which are rated well below investment grade, as part of its emergency bond-buying program in an acknowledgment of the broad scope of the coronavirus shock.

©2020 Bloomberg L.P.

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