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16-01-2023

The Covid pandemic in the market: infected, immune and cured bonds

Author: Andrea Zaghini

Published in: Journal of Financial Services Research

Abstract

In this paper, I analyze the developments in the euro-area primary bond market during the Covid-19 pandemic. The most surprising effect is the significant increase in the share of investment-grade bonds from 15% to 40%. Over the first phases of the crisis (from mid-February to mid-March), these bonds enjoyed a negative premium of 60 to 80 basis points. However, the premium disappeared when the market conditions further deteriorated. There is also evidence that the firms most exposed to the changes in the business model brought about by the pandemic experienced an increase in the cost of issuance of around 30 basis points. By contrast, there is no evidence that supports the existence of an increased cost for companies headquartered in countries with weak public finances, or evidence of a premium in favor of green bonds that were expected to be the backbone of a possible “green recovery”.

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The most relevant change to the eligibility framework concerned the expansion of the purchases to non-financial commercial paper, that was announced together with the PEPP on 18 March, 2020. For further details see the ECB press releases: https://www.ecb.europa.eu/press/pr/date/2016/html/pr160421_1.en.html, https://www.ecb.europa.eu/press/pr/date/2020/html/ecb.pr200318_1~3949d6f266.en.html

After 18 March, 2020 the ECB can purchase marketable debt instruments that have an initial maturity of 365/366 days or less with a minimum remaining maturity of at least 28 days. The six-month minimum remaining maturity requirement continues to apply for marketable debt instruments with an initial maturity of at least 367 days.

The bonds for which the two criteria do not coincide are only 51 worldwide and 24 in the Eurosystem market. Including them in either the IG or HY segment does not change neither qualitatively nor quantitatively the results of the paper.

Note that the country of nationality is the country in which the main company business is carried out. However, mostly for tax purposes, the place of official incorporation may be different. The Cayman Islands and Bermuda are the most frequent tax heavens for euro-area companies, while Ireland, Luxembourg and the Netherlands are the favourite euro-area countries of incorporation by companies of foreign nationality.

In other words I dropped other 11,087 bonds from the 15,581 available.

Note that in the latter case, the ISIN starts with a couple of letters different from the ones already selected (CA for Canada, CH for Switzerland, US for the United States… ), and the bond cannot be purchased by the ECB under CSPP/PEPP rules.

For an analysis of the policy measures taken to sustain banks’ lending conditions after the pandemic outbreak in the euro area see Altavilla et al. (2020).

The ASW development should be compared, for instance, with the much smoother development of secondary market price indexes (as the iBoxx index), which are instead constructed on bonds with the same characteristics and trading volumes.

Note that given the cross-sectional nature of the dataset, the fixed effects cannot be used at the bond level.

The 31 sectors are: Aerospace, Agribusiness, Alcoholic Beverages, Auto/Truck, Bank, Chemicals, Computers & Electronics, Construction/Building, Consumer Products, Defense, Dining & Lodging, Finance other, Food & Beverage, Forestry & Paper, Healthcare, Holding Companies, Insurance, Leisure & Recreation, Machinery, Metal & Steel, Mining, Oil & Gas, Professional Services, Publishing, Real Estate/Property, Retail, Telecommunications, Textile, Tobacco, Transportation, Utility & Energy.

The rating of the issuer is first linearized between 1 (CC/Ca) and 20 (AAA/Aaa), so that when the same bond receives more than one assessment from Moody’s, Fitch and Standard&Poors they can be averaged. Then the average is transformed into a set of dummy variables. I also add a dummy tracking the firms whose rating is not available at all.

In addition, by looking at the amount placed, it emerges that the 86 corporations under analysis first increased the bond financing via eligible bonds from a share of 33% before the ECB corporate purchases to 48% during the CSPP programme. Then, significantly diminished it to 31% over the lockdown period, in a way weakening the sheltering provided by the ECB steady demand. Eventually, they strongly returned to the eligible segment by placing up to 56% of their total issuance in the last PEPP period.

Note that the early proposal of Recovery Fund by the French and German governments to create a fund at the EU level to deal with the recovery in the countries most hit by the pandemic is dated only 18 May, 2020, within the sample but almost at the end of it.

While non statistically significant, the very large and negative coefficient estimated over the lockdowns period is due to the extremely small number of placements in that period: only two bonds were issued by corporations from the GIPS group.

A different branch of the literature looks at the ESG score of the issuers instead of the green label of the bonds. See for instance Halling et al. (2020), Ferriani (2022), Seltzer et al. (2022).

Greenwashing is the practice of channeling proceeds from green bonds towards projects or activities having negligible or even negative environmental benefits.

On 22 April, 2020, the ECB introduced a rating freezing of the pre-Covid rating for the general collateral eligibility, however the measure was not extended to the corporate purhcase programmes.

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Title: The Covid pandemic in the market: infected, immune and cured bonds
Author: Andrea Zaghini
Publication date: 16-01-2023
Publisher: Springer US
Published in: Journal of Financial Services Research
Print ISSN: 0920-8550
Electronic ISSN: 1573-0735
DOI: https://doi.org/10.1007/s10693-022-00394-z