A modest rise in euro benchmark issuance versus 2014 limited a net fall in outstandings in the first quarter, with QE-inspired spread tightening attracting issuers to the market, according to analysts, counterbalancing the amounts being taken out by CBPP3 and the impact of paltry returns.

Based on differing figures for Q1 redemptions, analysts put net euro benchmark covered bond supply so far this year as being between minus Eu4bn and minus Eu1bn, despite gross issuance having been slightly higher than in recent years, at Eu41.75bn.

Michael Spies, covered bond and SSA strategist at Citi, said “modest” net negative supply, which he put at minus Eu2bn to minus Eu1bn, “is of course quite good”. However, he added that he expects a bigger fall in net supply by the end of Q2.

“In June, where we have a lot of redemptions and you usually don’t get a lot of supply then, you would expect the more substantial effect on net negative supply,” he said.

Joost Beaumont, senior fixed income strategist at ABN Amro, noted that, taking into account the Eu7.5bn of covered bonds bought under CBPP3 in the primary market, negative net supply was effectively minus Eu12bn-Eu11bn.

Analysts identified the ECB’s third covered bond purchase programme (CBPP3) and Public Sector Purchase Programme (PSPP) as key factors having influenced the level of Q1 supply.

Tobias Meyer, covered bond analyst at NordLB said the covered bond purchase programme had been driving demand and pushing spreads down, creating more attractive refinancing conditions for covered bond issuers.

However, he added that QE was also causing counteracting factors, such as driving strong supply in foreign currencies since the depreciation of the euro generally contributes to a more favourable basis swap.

“Nevertheless, the ECB will continue to drive demand through this year and into next year and maintain favourable refinancing conditions that issuers will use if they need to,” he said.

Meyer said that while some new covered bond issues may soon enter negative yielding territory, this would be unlikely to damage supply.

“What would be the alternative? Yields in SSAs and government bonds are really low as well,” he said. “This is the problem in the market and it will only get worse.”

Meyer noted that seven year Bunds are now yielding negative, while in the periphery government bonds are also approaching negative territory, with Ireland yielding negative up to three years.

“Even if covered bonds go there, they should still give some pick up over other comparables,” he said. “They should stay interesting to investors, to people who need safe investments and cannot switch to riskier asset classes.”

Spies also noted that there had been a lot of supply from Germany and Spain, “where issuers have taken advantage of attractive funding levels, particularly at the long end”.

However, he said supply fell some way short of redemptions in the Spanish market, citing net negative supply of minus Eu14bn.

Stephan Dorner, covered bond and SSA analyst at Crédit Agricole, noted that he did not expect the sterling market to be as active as it has.

“This is why euro issuance from the UK is still far behind our estimates and we will probably end up below our Eu11bn estimate,” he said.

“On the other side,” he added, “Austrian covered issuance could end up exceeding our Eu3bn estimate given the non-access to senior markets after recent events, while cédulas issuance is already close to our Eu11bn expectations, as the low yields have made market funding competitive vs. TLTRO money.”

Overall, analysts said their expectations for supply in 2015 remained unchanged, noting that Q1 is often the busiest quarter in terms of primary activity. Meyer said he is still expecting supply to total around Eu131.5bn this year.

“It will be difficult, but we are still optimistic,” he said.

Spies said his expectations for 2015 also remained the same, with strong demand expected to support Eu112bn of euro issuance.

“Despite these very unattractive levels for investors, it is always about relative valuation,” he said.

Noting that Citi expects 10 year Bunds to enter negative yielding territory, Spies said some investors might even switch to the covered bond market.

“Even so, I think it would be sensible to see a bit of a break at the start of Q2,” he said. “That would also fit into this seasonal pattern of front-loading issuance followed by less activity in Q2.”

Cristina Costa, senior covered bond analyst at Société Générale, noted that the outlook for Q2 is less clear because of uncertainties regarding Greece.

“Some issuers have front-loaded issuance and, with spreads at such tight levels, generous new issue premiums are key to getting momentum in order books given the market dynamics,” she said. “In any event, issuance is expected to take a pause until after Easter.”