Quantitative Easing

ECB's corporate bond buys threatened by Steinhoff accounting

Steinhoff International Holdings NV Stores As Retailer Sees Europe, Africa Growth
Those Steinhoff bonds were no bargain. Source: Bloomberg/Waldo Swiegers

Steinhoff’s investors need nerves of steel these days. Less than a week after an accounting scandal came to light, the world’s second-largest furniture group lost billions of euros in market value – as well as its CEO, Markus Jooste, who resigned Tuesday.

In a statement released last week, the company urged “shareholders and other investors … to exercise caution when dealing in the securities of the group.” The European Central Bank is among those “other investors” after it bought up corporate debt as part of its euro-zone stimulus program. It purchased the bonds in July from Steinhoff, which has European operations but is headquartered in South Africa.

Since then, the market worth of those bonds has withered, dropping to less than 50 percent of their redemption value, compared to 101 percent in August. The case is turning into a cautionary tale for Europe’s central bank, which will likely lose money, and is fueling debate over its corporate bond-buying habits.

Since embarking on its quantitative easing scheme in 2015, the bank bought up more than €2 trillion ($2.4 trillion) in bonds in order to fight deflation across the euro zone. While the majority is sovereign debt, corporate bonds account for €129 billion of the total. The program was controversial from the start. “In my view, the ECB did too much in terms of scope,” said Michael Schubert, an analyst with Commerzbank. “In general, it kept softening its criteria for buying securities.”

At this point, Steinhoff’s bonds no longer adhere to the ECB’s minimum standards, which require the corporate debt it buys to be stamped investment grade by at least one major ratings agency. On Thursday, Moody’s Investor Services downgraded Steinhoff’s credit ranking to junk status.

The European Central Bank acknowledged that the Steinhoff bonds no longer meet its criteria, but there are no rules for how the bank should proceed, as it is not technically required to sell. For example, the ECB held onto bonds from German fertilizer supplier K+S after the company’s credit was slashed to junk status in October.

The ECB faces the choice of selling its bond holdings now, and potentially crippling the already-struggling company, or keeping them, and risking even higher losses.

In other instances, the bank cut ties quickly. ECB rules state that the bank is only permitted to buy bonds from companies based in the euro zone. In November, after commodities trading company Glencore relocated its bond-issuing entity to Jersey from Luxembourg, the bank sold off its bond holdings.

Yet the situation involving Steinhoff is even less straightforward. Many investors have already ditched their bonds since the retailer acknowledged accounting irregularities, which has also decimated its share price. The ECB faces the choice of selling its bond holdings now, possibly pushing an already-struggling company closer to the brink, or keeping them, and risking even higher losses. Taxpayers would ultimately be the ones to shoulder that burden. Unlike with sovereign bonds, losses associated with corporate debt are shared by euro zone countries, based on the ECB’s capital key. It is just under 26 percent for Germany, the bank’s largest shareholder.

Just how much financial risk the ECB faces is unkown, since the bank has not stated how much it holds in Steinhoff debt. Finland’s central bank, on the ECB’s behalf, bought into a Steinhoff bond issue worth €800 million with a maturity date in 2025. The ECB’s own rules prevent it from buying more than 70 percent of corporate bonds issued, so in Steinhoff’s case, the bank could have spent as much as €560 million. However, it is considered unlikely that the ECB would have bought up to that limit.

11 p30 ECB’s Steinhoff bonds-01

The Steinhoff quandary is not an isolated case for Europe’s central bank. Half of its corporate bond holdings are marked BBB, the lowest the bank is allowed to purchase. Although a study by Swiss bank UBS found that the ECB actually holds 26 issues of junk bonds.

Though some have voiced concern about the ECB’s corporate sector purchase program, most experts believe the financial risks are manageable. “The economic environment is very favorable at the moment,” said Peter Droste, a DZ Bank corporate bond analyst. “Therefore we anticipate for the foreseeable future very low deficiency and loss rates for corporate bonds.”

Even so, Steinhoff’s troubles will focus attention on the scope of the ECB’s bond-buying. In late October, the ECB said it would cut back in 2018, halving its monthly purchases to €30 billion, though it is uncertain how much of that would be sovereign or corporate debt. While some members of the bank’s governing council support buying more company bonds, the Steinhoff situation provides more firepower for their opponents.

Jan Mallien is Handelsblatt’s monetary policy correspondent in Frankfurt. To contact the author: mallien@handelsblatt.com.

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