HSBC analysts believe the ECB could end its covered bond buying in 2016 to avoid “destroying” the market, citing recent low CBPP3 volumes, but other analysts said an early exit is unlikely. Meanwhile, secondary market settlements increased last week.

The European Central Bank on 3 December announced that the earliest end-date of its asset purchase programme (APP) was being pushed back from September 2016 to March 2017.

However, contrary to the expectations of many other market participants, analysts at HSBC expect the ECB to stop purchases under its third covered bond purchase programme (CBPP3) in 2016.

Frank Will, head of covered bond research at HSBC, notes the ECB has a 33% issue limit on how much of an issue it can buy for bonds falling under its public sector purchase programme (PSPP) to safeguard market functioning and price formation. Although the issue limit for CBPP3 is 70% and the Eurosystem has occasionally bought more than 33% of covered bonds, the same thinking on the part of the ECB can be applied to the covered bond market, he argues.

The Eurosystem holds about 24%-25% of outstanding Eurozone covered bonds, according to Will, and he estimates that if the current run-rate of purchases is maintained, this share would reach 33% in April 2016 and by March 2017, the APP’s new earliest end-date, would breach 50%.

“The ECB don’t want to own 50%, as that would destroy the market, and I think they are concerned about their long term impact regarding the infrastructure of the product,” he said. “Would banks need three portfolio managers in that kind of market, for example, or would they need three people in origination working on covered bonds?”

Will said the HSBC analysts’ view is based on CBPP3’s impact as a major driver of spread movements in covered bonds and of market liquidity, and on the higher market impact the CBPP3 has had so far compared to that of the PSPP.

“In light of the aforementioned market share trend, the dried-up liquidity in the secondary market and the heavily distorted market prices, we expect the ECB to start shifting the focus of the Eurosystem’s asset purchases away from the covered bond product to other asset classes in the first half of 2016,” he said.

Will said it is more likely the ECB would reducing weekly purchase volumes than stop buying entirely, as a sudden exit could send major shock waves through the market, while a gradual decrease would allow for a smoother adjustment of spread levels.

“One elegant solution with less disturbing market effects would be, in our view, the shifting of the entire CBPP3 purchases to the primary market while completely stopping secondary market activities,” he said.

Will added that it is difficult to predict exactly when the ECB will decide its market position is too dominant, but said it was an issue market participants must be cognisant of.

“If we are wrong, and they continue buying, what’s the upside? Spreads might tighten in by another 5bp or so,” he said. “But if we’re right, there could be some significant spread widening there.

“At one point they will have to stop, so do we have the exit discussion in 2016 or 2017? Our concern is that more and more covered bond investors position themselves for a change in the ECB purchase behaviour before the March 2017 deadline, as this would result in spread widening.”

Will added that low CBPP3 purchase figures for November, combined with record high PSPP volumes, might be the first indications of that covered bond purchases are being reduced.

However, other analysts said that lower purchase volumes were not a sign that CBPP3 will be phased out.

“In my view, the ECB are less concerned with the share they hold in the market as long as we have a spread level that allows for private sector investors to see at least some value,” said Florian Eichert, head of covered bond and SSA research at Crédit Agricole. “When we were at the very tight levels a few weeks ago there was no one happy to buy apart from them.

“At the current levels we do see some private demand and the CBPP3 in turn has seen more secondary buying the last two weeks.”

Eichert said he believes monthly CBPP3 volumes could remain at Eu7bn-Eu8bn.

Analysts at DZ Bank agreed that an early CBPP3 exit is unlikely, noting that the ECB has indicated the purchase programmes will only be terminated early if its 2% inflation rate target for the Eurozone were to be reached before the end-date.

“Since recent data suggest that this is very unlikely to be the case in the coming year, one may assume that the ECB will also continue its covered bond purchases throughout 2016,” said Günther Scheppler, analyst at DZ.

ECB figures released yesterday (Monday) afternoon show that settled and outstanding purchases under CBPP3 increased Eu1.896bn, from Eu139.923bn to Eu141.819bn, in the week to last Friday.

Analysts estimated the ECB bought Eu400m-Eu470m of last week’s settled issuance, implying average daily secondary market purchases of Eu285m-Eu300m.

They noted this is an increase from Eu150m-Eu200m in the previous reporting period, and one of the highest secondary figures since the share of secondary market purchases began to fall in September.

Separate ECB figures released yesterday show the PSPP portfolio increased Eu13.599bn last week. Analysts noted the portfolio growth was down from a record high of Eu16.459bn in the previous reporting period, but that purchases were still above average.