Figuring Out the Bank of England's Corporate Bond-Buying Program Is Turning Into Big Business
Has the British bond market gotten ahead of itself?
Speculation that the Bank of England could announce a corporate bond-buying program to help cushion the impact of the Brexit decision has sparked a rally in the debt sold by British companies, with borrowing costs now hovering near a record low. Estimates for the size of the program — a potential successor to the corporate bond-buying endeavor launched by the BOE in the aftermath of the 2008 financial crisis — have ranged to well upwards of 100 billion pounds ($131 billion) in recent weeks.
Such a move would follow in the wake of the European Central Bank's own corporate bond-buying program — known as the Corporate Sector Purchase Program (CSPP) — announced earlier this year. That program has sent the prices of a vast swath of Europe's investment-grade corporate bond market surging, tightening the spreads investors demand to compensate them for the risk of buying such debt, and lowering borrowing costs for firms in the process. Bank of England officials are meeting this week to discuss forecasts that will underpin next week's decision.
A new note from Citigroup Inc. threatens to pour cold water on over-excited investors in sterling debt, however, arguing that the U.K. central bank may end up purchasing far fewer bonds than expected. At issue is the pervasive dwindling of the British bond market combined with the bank's eligibility requirements set out under its previous asset purchase facility (APF).
"We’ve seen estimates as large as 131 billion pounds, whereas we reckon the pool would likely be much smaller, at circa 55 billion pounds," write Citi's Joseph Faith and Hans Lorenzen, who maintain that the chances of the central bank launching the corporate bond-buying program remain "somewhat less than even."
Still, parsing the size of a potential BOE purchases "is far from being of only academic interest," the analysts add. "A smaller potential universe lessens the impact (and hence utility) of including corporate bonds in an expanded APF in the first place, and all leaves questions about the nature of the broad-based rally in [sterling-denominated investment grade] spreads in recent weeks."
A key lynchpin of the BOE's 2009 "corporate bond secondary market scheme" included a requirement that companies in the program "make a material contribution to economic activity" in the U.K. Based on the BOE's last eligibility list and published purchases of corporate bonds, this would leave some 52.4 billion pounds worth of debt that still meets the central banks' credit ratings and maturity requirements. Leaving aside the "material contribution" requirement yields only an extra 7.8 billion pounds worth of bonds that could be eligible.
"This relatively small number is not entirely surprising in light of the paucity of net issuance in the sterling market over the last couple of years," the analysts write. "It's certainly possible that the BOE tears up its existing corporate bond buying rule book and ends up with a 130 billion pounds-plus universe," they added. But assuming continuity with the previous program, these great expectations are, they say, "at the very least premature."
There's still a significant reason why investors are eager to gauge the size and scope of what could be the newest BOE asset-purchase program. Figuring out which bonds are eligible for central bank buying has proved lucrative in the past, with the CSPP being but the latest, and potentially starkest, example.
"In euro credit getting that call right has translated into no less than 35 percent of spread divergence since the CSPP was announced," conclude the Citi analysts. "We see very little evidence of discrimination between the two at the moment."
It's a point that's been echoed by othes, including analysts Lotfi Karoui and Spencer Rogers at Goldman Sachs Group Inc. "While the CSPP’s announcement did cause spreads to tighten all across the board, the flow of purchases since June 8 has created a clear bifurcation between eligible and ineligible bonds," they wrote earlier this week.