ECB shopping for solutions

Shortly after the unconventional easing programme was first announced by Draghi at the monthly ECB press conference, PDI argued that like other central bank initiatives before it, the programme was too limited in scope and unlikely to address the issues that continue to dog the eurozone as well as doing nothing to help the small- and medium-sized enterprises struggling to find financing.

Then, in late October, the outlook shifted again as the market absorbed the news that the ECB may also purchase corporate bonds. Though this may offer a boost to struggling eurozone borrowers, it has its risks too.

DOOMED TO FAIL

In the US, the Federal Reserve’s toxic asset programme hoovered up bad assets from US bank balance sheets and the credit markets duly rebounded. But the ECB’s programme is much more limited in scope. Saul Greenberg, chief risk officer for SCIO Capital agrees.

“Draghi has not gone the length and breadth that [the Fed’s] TALF and TARP went, they were mechanisms to act in the most all-encompassing way possible,” says Greenberg. “This is not. This is trying to strike a balance between the hawks and the doves.”

The ECB is trying to do more with less – with a plan to kick-start the ABS and covered bond markets, and so prompt more credit to recycle back into the system. But the programme, as officially announced, is indirect, and many question its ability to make a meaningful difference.

A better way to address the financing shortfall would be for the ECB to open up its cheap funding to non-bank lenders actively supporting the neglected European SME sector, suggests Floris Hovingh, a director in Deloitte’s Debt Advisory Practice.

Neither Hovingh or Greenberg are convinced that there will be a strong uptake of ABSPP and CBPP3 (the acronyms for asset-backed securities purchase programme and covered bond purchase programme, respectively).

The take-up of targeted long-term refinancing operations, the central bank’s last attempt to encourage the bloc’s banks to lend,, reached just €82 billion of the €400 billion available.

FINANCING THE FINANCED

The complexion of the programme took on a different hue later in the month when Reuters reported that the ECB is considering adding corporate bonds to the paper it will buy.

On the face of it, buying bonds of large corporates would have no more impact on financing for smaller companies than the purchase of ABS or covered bonds. Some observers suggested that it was simply to expand the pool of assets available for purchase, as the ABS and covered bond markets are not large enough to expand the ECB’s balance sheet by €1 trillion.

The Reuters report did not include details on the criteria for which corporate bonds would qualify under the potential expansion. However, it’s fair to assume that the ECB would apply similar criteria to those announced for ABS and covered bond purchases, i.e. euro-denominated, investment grade and meeting ECB criteria for collateral.

Analysts at Barclays made that assumption and estimated that up to €560 billion of non-financial and €320 billion of financial bonds could potentially qualify. A huge volume of debt, all belonging to entities that have no problem financing themselves in the bank or bond markets.

The significance of the plan is buried in a 46-page report published in April 2013. PDI’s attention was drawn to the dense central bank working paper – entitled ‘The ECB’s non-standard monetary policy measures: The role of institutional factors and financial structure’ – by Aurelija Augulyte, senior analyst and macro strategist at Nordea.

It discusses how easier credit for large businesses can translate into financing for smaller ventures. “Improved funding conditions for large corporations can also benefit small and medium-sized enterprises indirectly, in particular through two forms of financing within the corporate sector itself: intra-sector loans and trade credits. These represented 40 percent of the unconsolidated debt of non-financial corporations in the euro area (which itself amounted to €13 trillion in 2011), a share similar to that of bank lending,” reads the report.

Draghi has complained repeatedly of the ‘broken transmission mechanism’ between ECB monetary easing and real economy financing conditions in the European periphery. Is the ECB looking for a back-door fix to turn policy into practice?
Augulyte says that the move is not great news for the alternative lenders trying to boost their market share in Europe, but pointed out that the momentum is with non-bank forms of credit.

“Of course, the ECB measures favour banks. That being said, the Europe-wide regulations will still remain key headwind for bank lending versus markets-based lending for the coming years, and ECB help for banks won’t change this trend. US corporates are more than 70 percent market-financed, while it’s just around 30 percent in EMU, but I expect the EMU will follow the US in this respect in years to come,” says Augulyte.

NON-BANK BLOW

From a credit investor point of view, Greenberg says that the corporate bond buying, if it is aimed or even just results in company-to-company lending, is potentially dangerous. “What Draghi is doing again is reminiscent of the toothless dog type of approach [he’s] used before. He said in 2012 that he would do ‘whatever it takes to preserve the euro’. Whatever it takes – he isn’t doing it. He could take direct action with money for non-bank lenders instead of hoping that there will be some factoring or unsecured trade transactions between creditors and debtors in the market,” says Greenberg.

The ECB has the best of intentions – it is taking extraordinary measures to revive moribund eurozone growth rates and alarmingly low inflation levels. But the internal balancing act that restricts Draghi’s scope for action is badly damaging the bloc, Greenberg insists. “Small manufacturers in Germany are already showing signs of stress. Now that we’ve seen widening of spreads on the European sub-investment grade high yield bond and leverage loan side driven partly by anaemic growth expectations, it may not be too far off that we could go through another 2007/2008 – not of the same magnitude – but there will be stress and some defaults.”

And from a financing point of view, SME borrowers would be much better off with a standardised and competitive non-bank lending landscape, than having to rely on suppliers for finance.

“From a finance point of view, consider how important it is that there isn’t a friction cost. This not a conduit that ensures cash gets to the final beneficiary,” says Greenberg. “I’ve seen in trade financing transactions with corporates, rates and terms vary greatly from one to the next. And the rates vary so much, some are entirely punishing.”

With European lenders still in defensive mode to the extent that they are not using the ‘free money’ offered, it’s not surprising that the central bank is seeking an alternative. It’s just a pity that they continue to ignore the US example of a thriving non-bank lending market and instead appear to be looking to the failed Japanese zaibatsu model.