By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
To the white-knuckle end, 2018 has been a terrible roller coaster ride for Spanish supermarket chain Dia, once one of Europe’s biggest grocery chains. The firm’s shares, reduced to a penny stock — despite the 22% surge today to €0.44 — have plunged 90% since January. During the same period, the company has issued no fewer than three profit warnings. Its credit rating was slashed to junk in a matter of weeks. To top it all off, two weeks ago, Dia suffered the ultimate ignominy of being ejected from Spain’s benchmark index, the Ibex 35, for being worth too little, to be replaced by a pulp mill called Ence.
As the pressure rises, the company’s senior management, newly appointed earlier this month, has promised to offload the firm’s cash&carry division and fragrance brand. It also plans to close its biggest loss-making stores, all in the hope of securing a new €200 million credit line from its lenders, which it hopes will tide it (and its providers) over until Spring, when it hopes — that “h” word, again — to raise a fresh round of capital. It’s a big ask.
As for the company’s creditors, they are understandably concerned. They include four of Spain’s five biggest lenders, Santander, BBVA, CaixaBank and Banco Sabadell, as well as European heavyweights like Barclays, Société Générale, and Deutsche Bank. Also on the long list of creditors, albeit featured less prominently, is the ECB, which owns an unspecified amount of Dia’s outstanding debt.
During is corporate bond-buying days that were part of its QE, the ECB didn’t disclose by name what it was buying, or the amounts. But it does disclose a list of its current bond holdings (you can download the list here). And those holdings include three bonds issued by a certain Distribuidora Internacional de Alimentos — Aka Dia — that are scheduled to mature in 2019, 2021 and 2023. Their total face value is €905 million.
According to sources cited by El País, the ECB, through its corporate bond buying program, holds at least €200 million — just over a fifth — of that debt. In October, those bonds carried investment-grade status. Today they are ranked well into junk territory (Caa1 from Moody’s, CCC+ from S&P’s; see the WOLF STREET color-coded cheat sheet for the different rating scales). The main reason for the downgrades was the third and final profit warning, released in late November.
The fallout for bondholders has been brutal. Bonds that were trading at around 100 cents to the euro at the beginning of the year, in large part thanks to the ECB’s support, are now trading at 68 cents, 60 cents, and 57 cents on the euro, in order of maturing date (2019, 2021 and 2023). In other words, the ECB’s “investment” in Dia has lost over a third of its value.
The meltdown at Dia bears ominous echoes of the Steinhoff scandal of 2017, when the ECB ended up selling its position in the bonds of South African retailer Steinhoff at a multi-million euro loss after it was revealed that the company had engaged in highly dubious accounting practices. Many are now wondering whether it will do the same with Dia.
This is testament to the boggling extent to which corporations in Europe have come to depend on the ECB’s largesse, which is scheduled to end in the next few days. The ECB, under its corporate sector purchase program, or CSPP for short, has snapped up over €176 billion of European corporate debt. That’s the equivalent of roughly a fifth of all eligible euro corporate bonds issued since June 2016, when the program was first launched.
At the program’s peak, the central bank was gobbling up over €2 billion of corporate debt a week. Some of the biggest names, from BMW to Daimler in Germany, to Spain’s Telefonica and Gas Natural, to Italy’s Eni, and to France’s Engie and Sanofi, have had as many as 15 bond issues bought up by the ECB over the last two and a half years.
Even after tapering its purchases earlier this year, the ECB was still buying corporate bonds at a rate of over €1 billion a week. It’s only in the past five months that average weekly purchases slipped below that amount. According to the FT, the ECB’s corporate bond buying could shrink to as little as €400 million a month in 2019 as it would only replace maturing bonds to keep the balance level.
That has already had a big impact on the price of corporate debt — and yields have surged. The average yield of euro-denominated junk bonds, according to the ICE BofAML Euro High Yield Index (chart), has more than doubled over the past 12 months, from the low point in November 2017 of around 2.1% on average, to 4.7% currently, which is still historically low, but a lot higher than it had been.
Europe’s corporate bond market is already feeling the pressure from the absence of the ECB, which will continue to impact the price of debt for many of Europe’s largest companies.
Many investors are clinging to the hope that the worst of the coming pain is already priced in, but a lot of the companies that have benefited from the central bank’s largesse are already finding it more difficult and more expensive to borrow by issuing new debt. Even a colossus like Volkswagen has seen its spreads against German government debt widen by around 100 basis points since the start of 2018.
The quality of corporate debt as a whole continues to deteriorate, with bonds that are rated BBB- (the lowest investment-grade category) now accountingfor half of all investment-grade debt in Europe, compared to just 19% a decade ago. This BBB- debt is just waiting for a downgrade to junk. And funding for companies that have been downgraded to junk and that need new funding to survive is becoming more difficult and more expensive and perhaps impossible to get as the ECB is stepping away as relentless buyer. By Don Quijones.