ECB relaxes collateral rules to accept ‘fallen angel’ obligations

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The European Central Bank has changed its rules to accept “fallen angel” bonds that lose their prime credit ratings to maintain banks’ access to ultra-cheap liquidity during the coronavirus crisis.

The move, which was approved by an unexpected appeal by the ECB’s governing council on Wednesday, aims to limit financial turmoil that could otherwise be caused by an expected wave of credit downgrades in response to the pandemic.

About $ 275 billion in non-financial corporate bonds could become fallen angels by downgrading below the triple B minimum required for investment grade status over the next year, according to OECD estimates in February.

The ECB has already granted a waiver for Greek sovereign bonds from its ban on collateral assets that have a credit rating below investment quality as part of a general relaxation of its collateral rules that she announced two weeks ago.

The ECB said on Wednesday that it had also decided to temporarily exempt bonds that are downgraded to junk status from its requirement that any collateral it accepts should have an investment grade rating. Its relaxed warranty rules will remain until September 2021.

He said he was ready to go further if necessary to avoid a eurozone debt crisis. “The ECB may decide, if and when necessary, to take additional measures to further mitigate the impact of downgrades, in particular with a view to ensuring the smooth transmission of its monetary policy in all jurisdictions in the euro area “, He specified.

Alberto Gallo, portfolio manager of the hedge fund Algebris Investments, said: “The ECB acts to limit the pro-cyclical action of rating agencies and to protect sovereigns like Italy from deterioration. High-yield firms and SMEs account for a large part of the real economy. It is important that the aid is not only for large companies. “

Investors are particularly concerned about a possible downgrade in Italian sovereign debt ratings, with Standard & Poor’s expected to announce a decision on Friday. Italy’s already weak economy was one of the hardest hit by the coronavirus crisis, raising fears that its high debt could become unsustainable.

Italian 10-year sovereign debt yields were sketched out on Wednesday before the ECB’s unannounced announcement, reaching 2.27% before falling to 2.08%.

However, ECB officials said that its decision to accept fallen angel bonds as collateral was more aimed at corporate bonds. Any downgrade of Italian sovereign debt to trash could be treated using a waiver similar to that granted to Greek bonds, they said.

UBS underscored the magnitude of the potential fallen angel problem, noting recently that since 2011, European bonds rated triple B minus, a notch above junk status, had “swelled” from € 330 billion to 1, 14 billion euros. However, the issuance of junk bonds rated double B on the high-yield market increased from 74 to 185 billion euros.

The US Federal Reserve has gone a step further by including junk bonds in its asset purchase program and Wednesday’s ECB decision prompted speculation that it could follow suit as early as next week when its board will meet to discuss monetary policy.

“Right now, companies in the high-yield space are borrowing at high levels,” said Mona Mahajan, investment strategist at Allianz Global Investors. “Both the ECB and the Fed are working to ensure that the high-yield and credit markets remain generally liquid and functioning.”

Bob Michele, chief investment officer and global fixed income manager at JPMorgan Asset Management, said: “The ECB pretty much telegraphs to the EU if you increase the spending packages, we are able to increase our purchases to help control funding. of this package. “

The ECB said it had “decided to extend the eligibility of marketable assets and the issuers of those assets that met the minimum credit quality requirements on April 7, 2020 in the event of a deterioration in credit ratings decided by credit reporting agencies.” ratings accepted in the Eurosystem. as long as the ratings remain above a certain level of credit quality ”.

This means that all investment grade bonds as of April 7 will continue to be eligible even if they are downgraded below the triple B level by the major credit rating agencies as long as their rating remains no more than two notches below. investment grade.

Securities backed by assets with a rating of at least A-minus will benefit from rights acquired under the ECB’s guarantee scheme as long as their rating remains equal to or greater than double B plus. Fallen angel assets will be subject to “haircuts” to reduce their collateral value based on their last credit rating.

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