Bank of Israel sees its corporate bonds plan as sharing in virus-related risk

Central bank intends to intervene, for the first time ever, in the corporate bond market, buying bonds for a total of NIS 15 billion, in a bid to aid the pandemic-hammered economy

Shoshanna Solomon

Shoshanna Solomon is The Times of Israel's Startups and Business reporter

The governor of the Bank of Israel, Amir Yaron, attends a press conference in Jerusalem, March 31, 2019. (Yonatan Sindel/Flash90/File)
The governor of the Bank of Israel, Amir Yaron, attends a press conference in Jerusalem, March 31, 2019. (Yonatan Sindel/Flash90/File)

As the Bank of Israel on Monday held its key lending rate at a low of 0.1% and downgraded its growth forecasts for the economy for the year, it also said it is launching a plan to buy, for the first time ever, corporate bonds on the secondary market for a total of NIS 15 billion ($4.34 billion), in a bid to aid the economy struggling with the impact of the coronavirus.

The aim of the plan, the central bank said in a statement, is to “ensure the continued orderly functioning of the corporate bond market,” and to keep the economy going, by making it cheaper and easier for companies to issue corporate debt and raise the funds necessary to keep their businesses going while freeing up sources of credit for all other industries.

The central bank has already been buying government bonds and intervening in the foreign exchange market.

The corporate bonds the central bank plans to acquire will be only of those of companies rated A- and higher, and does not include foreign companies’ bonds, bonds with an equity component, or bonds that are not indexed to the shekel and are not fixed rate, the statement said.

A stock market ticker in the lobby of the Tel Aviv Stock Exchange, March 15, 2020. (Flash90)

Seventy-five percent of the bonds traded on the market meet the Bank of Israel criteria, the statement said. The market value of corporate bonds in Israel is approximately NIS 341 billion, so the NIS 15 billion acquisition plan represents some 4% of the total bond market.

“A new player has entered the market with deep pockets and is signaling that it is prepared to buy bonds for a not-small amount,” Yaniv Pagot, an economist who is a strategic adviser to institutional investors. “This is a statement that the central bank is here, and if there is a need, it will interfere in the market.”

The purchases of the central bank will push up demand for these bonds, causing their price to rise and their yields — the interest rate companies need to pay investors who buy the bonds — to drop.

This will make it cheaper for the companies to raise money for their business activities, while at the same time create added funds in the market, those from the central bank to the bond sellers, that can be used to be invested in other instruments.

The move comes as the US Federal Reserve has announced a similar policy. In June, the Federal Reserve said is expanding its activities into corporate credit, to buy individual corporate bonds, in addition to the exchange-traded funds it is already buying. The program in the US will allow the Federal Reserve to buy up to $750 billion worth of corporate credit.

Yaniv Pagot, an economist who is a strategic adviser to institutional investors (Courtesy)

Pagot, the economist, said he thinks the timing of the announcement by the Bank of Israel is to preempt possible panic in the market that could stem from a second wave of the coronavirus pandemic, which is forcing the government to pull the reins on the easing of the economy.

“It is creating some sort of certainty in the market, in case fear comes back to take hold of the market,” he said.

Daily coronavirus infections again surged past the 1,000 mark in Israel on Tuesday, with more than 6,000 new cases confirmed in the past week, according to the Health Ministry, as a host of new virus restrictions were set to shut down bars, nightclubs, gyms and event venues.

The number of active cases grew to a new record of 12,717, with the death toll since the start of the pandemic reaching 338.

The Bank of Israel announcement on Monday had an immediate impact on corporate bond spreads — the interest rate differential between the spreads of corporate bonds and government bonds.

Indeed, the spreads on the Tel-Bond 60 Index, made up of 60 corporate bonds, tightened by about 40 basis points on Monday after the announcement, and by an additional 30 basis points by midday on Tuesday. Bond spreads reflect the relative risks of the two bonds being compared. The higher the spread, the higher the risk associated with the bond.

But what about Mrs. Cohen?

There are risks associated with the central bank’s new policy, said Pagot. The first one is that should the corporations default or the price of the bonds drop, then the Bank of Israel would incur a loss.

The second is that the Bank of Israel is interfering with market forces, because by buying the bonds it is taking on some of the risk that should be otherwise shouldered by investors.

“When the Bank of Israel says it won’t allow yields in the corporate market to rise, then it is distorting the real risk in the market, and in that investment,” Pagot said. “In practice, it takes on itself the risk that should be on the investor.”

A third drawback, he said, is that the move could increase inequality: people who have bonds in their portfolio will be able to sell them at a profit to the central bank, whereas those who don’t have a securities portfolio will not be able to benefit from this policy.

“The investors that enjoy this move are those with greater liquidity and high net worth individuals,” he said. “But what about Mrs. Cohen, who doesn’t have money to pay her bills and doesn’t own corporate bonds in her portfolio – how will she benefit from this policy? This increases inequality; they are increasing economic polarization.”

Self-employed and small business owners participate in a rally in Jerusalem on March 30, 2020 (Yonatan Sindel/Flash90)

The Bank of Israel, however, believes that the move is right in light of the current situation in the economy, and even if there will be corporate defaults, it is a cost it will be able to withstand. The benefit to the economy would be hopefully far higher than the risk involved.

On average, companies with a credit rating of A- or higher have usually a low default rate, in Israel of about 1%. In addition, the NIS 15 billion in funds earmarked by the central bank for the program is a relatively small activity on the balance sheet of the Bank of Israel. The foreign exchange reserves the central bank holds, through its interventions in the foreign exchange market, are around $150 billion, and have a far larger impact on the profit and loss of the central bank.

In addition, the central bank believes that at this time of crisis, part of its duty is to shoulder some of the risk present in the economy, and help businesses weather the storm — by making it cheaper for them to raise money and thus enable them to grow and employ people — more than it would do in normal circumstances.

With regard to the move deepening inequality, the central bank likely believes that even Mrs. Cohen will eventually benefit from the policy, indirectly — because Mrs. Cohen could be someone who is employed by the corporation that has raised the cheaper funds or because even if she works elsewhere, the firm she works for will indirectly benefit from the added liquidity available in the market, as the central bank buys the bonds.

Gloomy outlook

In its updated forecast for the economy, the Bank of Israel said the nation’s  economy this year will contract by 6%, compared to a previous forecast of a 4.5% contraction. The new forecast is on the assumption that there is no further worsening of the restrictions on activity. For 2021, the central bank foresees economic growth of 7.5%.

In 2020, the government budget deficit is expected to be about 12 percent of GDP, as a result of the loss of about NIS 55 billion in income due to the slowdown in activity, and an increase of about NIS 60 billion in expenditures in order to finance unemployment benefits and assistance measures announced by the government, the central bank said in the statement on Monday.

The Bank of Israel added that it is renewing a plan under which it will provide the banking system with fixed-rate loans at a 0.1 percent interest rate, for a term of 3 years, with the goal of increasing the supply of bank credit to small businesses to assist them in getting through the coronavirus crisis.

The plan was first implemented on April 6, 2020, and was in operation until the end of May. Through it, banks were provided with loans for a total of NIS 4.6 billion against credit they extended to small businesses.

The central bank has now decided to renew the plan without limitation on the total amount of the loans, and to keep it in operation until further notice, the statement said.

The central bank also said it will allow banks to put up mortgage portfolios as collateral for credit, as well as highly liquid assets such as government bonds, to enable banks to extend added credit under this plan while maintaining high liquidity.

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