Will the European Central Bank embark on a new covered bond purchase programme? Should it? And, if so, what lessons can be learned from the first programme? The Covered Bond Report surveyed market participants after a media report suggested CBPP II is under consideration.

A Bloomberg report published yesterday (Monday) cited an unnamed euro-area central bank official as saying that ECB policymakers are likely to next week debate restarting covered bond purchases along with other measures to ease monetary conditions.

The article also stated that “the official said ECB policy makers haven’t decided on the size of the potential new covered-bond purchase program”, a comment that one market participant took as a sign that a new programme was more than simply one option among many but was the subject of concrete discussions.

The ECB between July 2009 and June 2010 carried out a Eu60bn covered bond purchase programme (CBPP) that market participants credited with spurring the reopening of the benchmark market in 2009 and supporting it thereafter.

A spokesperson for the ECB would not comment on the media report in response to questions from The Covered Bond Report.

Market participants’ views on the likelihood of the ECB launching a second covered bond purchase programme were mixed, but according to some bankers anticipation of just such a move has already had a positive impact. After more than three weeks without new euro benchmark supply, two new issues were in the market this (Tuesday) morning (see separate story).

A DCM banker said that sentiment was much more positive today, with short positions being unwound in anticipation of possible confirmation by the ECB of covered bond buying.

But another covered bond banker was sceptical about the likelihood of such a move. He said that it was important to take into account substantial differences between the prevailing spread complex and that which existed in 2009 when the ECB launched its Eu60bn purchase programme, and that he doubted a covered bond purchase programme would achieve the desired effects given where sovereign and bank CDS spreads are at the moment.

“It may lead to some spread tightening, but the moves would have to be massive for spreads to reach levels at which banks could issue and break even,” he said. “I don’t doubt that the ECB is considering it – as they will be every approach that has even the slightest potential of succeeding – but I doubt that buying covered bonds would achieve the effects they are after.”

He noted that the ECB is buying Greek and Italian government debt via its Securities Markets Programme (SMP), but that spreads are still very wide.

“This isn’t a banking crisis,” he added. “It’s a sovereign debt crisis.”

But others said they saw good reasons why the ECB should renew its purchases of covered bonds, although they suggested tweaks should be made to a CBPP II to strengthen its impact.

Richard Kemmish, head of covered bond origination at Credit Suisse, noted three reasons why it would make sense for the ECB to launch another covered bond purchase programme, including the expectation that – based on experience of the previous scheme – it could help divert supply into the public market that would otherwise be presented as repo collateral with the ECB.

“The last purchase programme and comments on the covered bond market on behalf of ECB officials since then have clearly sent a message that the ECB believes in the market,” he said. “But at the same time it is also nervous about the huge amount it owns as repo collateral.

“Anything that could open, or open further, the public market and get the banks that are using covered bonds as repo collateral to issue into the market will massively reduce the risk positions the ECB is focussed on.”

He also said that the purchase programme in operation in 2009-2010 had an “enormous” impact despite, at Eu60bn, its small size, in particular compared with the figures being debated in the context of rescue solutions for the sovereign debt crisis.

“The purchase programme was clearly popular in Germany”, he added, “as it endorsed the quality of the country’s favourite asset class, and relaunching it, or starting a new one, would be looked upon favourably by the German public. And that can only be a good thing when the opinion of the man on the Strasse is so important to everything the ECB is trying to do.”

Kemmish said that there was one main argument against the ECB restarting a purchase programme, and that that was captured in a January 2011 ECB report on the impact of the scheme, namely that the increase in covered bond issuance triggered by the CBPP had come at the expense of issuance of “uncovered bonds”.

“But given the state of the senior unsecured market at the moment that objection falls away,” he said. “You won’t be reducing the amount of senior unsecured deals being printed, although you may be replacing an overreliance on retail deposits and ECB repo funding.”

Mauricio Noé, head of covered bonds at Deutsche Bank, said that a covered bond purchase programme was “by deduction the next best thing” after government guarantees, which are conceptually “no longer an option”.

Renewed buying of covered bonds would be a “meaningful” move, he said, given that the Eu60bn programme of 2009-2010 had beneficial effects reaching beyond the euro-zone, with relative value considerations providing a “gravitational pull” on spreads for covered bonds issued by quality institutions outside the euro-zone.

However, he suggested that any renewed buying of covered bonds under a dedicated programme could benefit from purchases being centrally co-ordinated rather than national central banks being left to decide what covered bonds they buy as this would help ensure the scheme benefits the jurisdictions most in need of help.

“It needs to be done in a more even-handed way,” he said. “I’m not sure if that is possible but the Securities Markets Programme seems to be carried out in a centralised manner, and it’s important now given that the outlook for the periphery is even worse this time.”

Announcing a programme of more than Eu60bn would also be a positive move, according to Noé.

“If covered bonds are the only source of funding for banks then Eu60bn may not be enough,” he said. “And if the ECB is looking to deleverage and get people to invest alongside it then announcing a larger programme might be better, even if it doesn’t use it all.

“The unpredictability of central bank action is what drives its effectiveness.”

Royal Bank of Scotland analysts said that if a covered bond purchase programme is announced, there will be three key issues to consider: whether the total amount of the purchase programme will be preannounced, the eligibility criteria for covered bonds qualifying for the CBPP, and the allocation of the purchases amongst the national central banks. The impact of a re-opened CBPP would be greatest for the banking sector, they said, if resources were directed to banks most in need.

A large pre-announced size may provide some initial “shock-and-awe benefit”, they added, but not disclosing the volume of purchases may provide a “constructive ambiguity”, comparable with the approach under the ECB’s SMP.

“We have already observed the potential drawbacks of a preannounced size during creation of the EFSF,” they said.

Ralf Grossmann, head of covered bond origination at Société Générale, said that if a programme is implemented the ECB should refrain from putting too many limits on it, if possible.

“Last time it was a banking crisis,” he said. “This time it is a sovereign crisis, which has spread to the banks. From that respect, the ECB might not want to limit the size – or maturities.”

He said a shift in ECB concerns might also push it toward a less limited programme.

“At the time of the programme the ECB was much more concerned about its balance sheet,” said Grossmann. “Now they have Greek debt, Italian debt, Spanish debt, etc, on their balance sheet.”

He also said that the fewer the details made public by the ECB, the more beneficial such a move would be for the secondary market.

Other analysts noted the possibility of a CBPP being implemented as part of the SMP, with Barclays Capital analysts suggested a “clearer focus on purchase activity towards distressed market sectors (eventually in coordination with SMP activities)” as one of several changes to the ECB’s approach under a new CBPP that might be considered.

Florian Eichert, senior covered bond analyst at Crédit Agricole, said that the effect on different sectors of a second covered bond purchase programme will depend greatly on the way the programme is set up.

“If the programme is structured similarly to 2009-10 with money being allocated based on the ECB capital share, we would expect a strong domestic bias from the national central banks, which would benefit Germany, France and Italy,” he said. “If the programme is part of the SMP, for example, the focus will be more on the most distressed sectors and names.

“In that case Ireland, Italy, Portugal and Spain, as well as weak issuers, would benefit the most.”