Scepticism over BoE debt move

By Paul J Davies Published: March 25 2009 20:22 Last updated: March 25 2009 20:22 The Bank of England kicked off the £50bn corporate bond side of its £175bn ($254bn) programme to inject freshly printed cash into the heart of the economy on Wednesday when it bought almost £87m worth of debt. Anglo-American, British Telecom, Cadbury Schweppes, France Telecom, General Electric Capital, United Utilities, Vodafone and WPP were among the 17 companies to see the Bank added to their creditor list as it bought small chunks of 21 different bond issues, mostly at a premium to market value. Analysts and investors said the move could only be positive, but have questioned whether a programme sized at £175bn in a market worth more than £1,000bn would be too small to make any real difference to the economy. The initial auction alone was not expected to give any indications of whether Mervyn King, the Bank governor, would succeed in slashing borrowing rates for companies broadly, but it is a strategy some feel sits awkwardly between different stools. The market for buying and selling corporate bonds between investors – known as the secondary market as opposed to the primary market where companies themselves first sell bonds – has been just as much a victim of bank troubles as the business of making new loans. This is because banks historically have played a very important role in facilitating activity in all markets where trading is not based on exchanges, but over the counter – and, to some degree, in exchange-based markets as well. But the forced shrinking of bank balance sheets in the wake of the credit crisis, which has led to the drought in new lending activity to consumers and companies directly, has also stopped banks from trading in bonds and other securities quite so freely as before. Many have retrenched to a pure broker-style trading model, whereby they will only stand between buyers and sellers when they can match both sides exactly. This is because they no longer want to hold bonds, or much else on their trading books for any period, be it days or weeks. “Banks are very constrained. They are no longer dealing in the market because they cannot afford to take even temporary positions,” says one senior manager at a large institutional investor. “In the secondary market there is still no liquidity. You cannot sell a bond without a significant markdown.” The Bank of England and other central banks have focused their activities mostly on efforts to provide liquidity to the financial system in the form of extra cash. But Wednesday’s purchase of corporate bonds, while still pumping new cash into the system, is also aimed at supporting liquidity in the sense of how easy it is to buy or sell a bond. One of the measures of its success – separate from the absolute cost of borrowing for companies versus government bonds – will be the differences in the market between bid prices and offer prices. This bid-offer spread is an indicator of how liquid, or how readily tradeable, is any instrument. A wider spread indicates a bigger profit margin for those prepared to “make markets” in a security, but this profit is built in because there is a greater risk that the market maker will not be able to cover their positions by buying or selling the same asset later on. “The Bank wants to create more liquidity in a market that is suffering from the low risk appetite of market makers,” says Willem Sels at Dresdner Bank. “But, by buying corporate bonds, the Bank seems to be attempting to treat the symptoms rather than the causes.” Mr Sels and others believe that the solid investment-grade bond market, where the Bank is focusing its operations, is not the area most restricting bank risk appetite. Rather it is the triple B rated area, on the border between investment grade and junk, that most needs support. Mr Sels also thinks for the move to truly be effective in cutting the “liquidity premium” built into many corporate bond spreads, other central banks will have to embark on a similar path. “We think that market makers’ credit trading risk limits are likely mostly global as well, and reducing the overhang on the sterling book may do little to improve their overall risk appetite,” he says. Another concern is that the Bank’s actions will split the market, aiding liquidity and cutting both borrowing costs and bid-offer spreads for those groups whose bonds are involved, but doing nothing for those outside the scheme even if they are highly rated investment grade issuers. “As a smaller brother to quantitative easing [the printing of money to buy government bonds], it might help,” says Gary Jenkins head of credit strategy at Evolution Securities. “But the kind of companies that are benefiting from this process are all more than capable of raising finance in the markets.” Moreover, given the deteriorating economic outlook, some worry that, while it could help some companies raise extra cash, they are only hoarding it anyway. “Anything that helps to lower the overall cost of funding for corporates is a positive,” says Suki Mann at SG CIB. “This move in itself will not help the corporate investment side of the equation because any advantage garnered by corporates in terms of lowering their funding costs will be used to hoard liquidity.” Adekunle Ademakinwa, strategist at Deutsche Bank, said: “The scheme will undoubtedly be a short-term positive stimulus for sterling credit markets, if only because at the margin there is an additional buyer of corporate bonds.”