First quarter euro covered bond issuance fell short of expectations, coming in almost Eu20bn below the same period last year, with the disappointing start and the anticipated impact of high TLTRO II take-up on Eurozone supply prompting some analysts to lower their forecasts for 2017 by Eu10bn.

Euro-denominated benchmark covered bond supply stands at Eu46.7bn year-to-date, compared to Eu64.85bn in the first quarter of 2016.

2017 supply already lagged that of last year after a lacklustre February, and new issuance of just Eu11.5bn this month fell short of expectations of Eu15bn-Eu20bn and is down from Eu17.35bn in March 2016.

Redemptions of around Eu61bn therefore resulted in negative net supply of around Eu14.3bn in the first quarter of 2017.

The shortfall versus forecasts has to a large extent been attributed to take-up of the fourth and final tranche of second series of the ECB’s targeted longer-term refinancing operations (TLTRO II), which was almost double what many market participants had expected. On Thursday of last week (23 March), the ECB announced that it had allocated Eu233.5bn to 474 Eurozone banks. Although the ECB does not release distribution statistics, figures released by certain banks and analysts’ estimates indicate that the take-up was as expected particularly high among peripheral institutions.

“You cannot put it all at the door of the TLTROs,” said a syndicate banker. “But you do get the sense speaking to issuers that after that, a lot of euro area banks have a lot less need for funding.”

Cristina Costa, senior covered bond analyst at Société Générale, noted that year-to-date issuance from Eurozone financial institutions of Eu29bn is 30.5% down year-on-year.

Only half of the 14 new euro benchmark offerings in March came from Eurozone issuers. Just one came from the periphery, a Eu1.5bn dual tranche, eight and 12 year offering for Crédit Agricole Cariparma on 14 March, which was in turn only the second peripheral benchmark of the year.

The only new euro issues publicly in the pipeline are also from non-Eurozone countries. Commonwealth Bank of Australia and Yorkshire Building Society have been on the road this week marketing potential euro benchmarks (see separate article).

Since the announcement of the TLTRO II take up last week, many market participants have lowered their expectations for euro covered bond issuance in the rest of the year, also citing the disappointing year-to-date supply.

At the end of last year, most analysts’ forecast Eu120bn-Eu125bn of 2017 euro benchmark issuance. The first quarter supply of Eu46.7bn stands at 39% of the lower end of this range.

“We know that in many of the previous years, the first quarter has set the tone and usually provided a big chunk of the total supply that year, before things slow down in the second half” said a syndicate banker. “It’s not an exact science, of course, but I think it’s fair to expect less this year based on how the first quarter has gone.”

Michael Spies, covered bond and SSA strategist at Citi, lowered his forecast from Eu121.5bn to Eu112.5bn this week. He said the revision is mainly driven by lower supply expectations from Spain and Italy, which he revised down by Eu6bn and Eu1bn, respectively.

Spies cautioned that extrapolating full-year supply from Q1 can be inaccurate, noting that in the first quarters of 2014 and 2015 euro benchmark supply totalled Eu39.875bn and Eu41.5bn, respectively, and that full-year supply ended up at Eu114.5bn and Eu144.2bn.

“For this year, we would however re-scale our full-year expectation to the lower end of these two outcomes,” he added.

Analysts at Société Générale lowered their issuance forecast from Eu125bn to Eu115bn.

“Given the high take-up, we expect issuers to lower their funding needs for the year, with senior unsecured funding mainly impacted but also covered bonds,” added Costa. “Given that the cover pool is finite, many issuers may wish to save their assets for rainy days, and if they do come to the market, they may issue long-dated tenors and come towards the end of the year for prefunding.”

The anticipated lower levels of supply in the coming quarter is expected to drive a continuing tightening of spreads, which will be further supported by the redemption of some Eu19bn of euro benchmarks in April.

Starting from Monday, the ECB will lower its monthly target for buying under its asset purchase programme (APP) from Eu80bn to Eu60bn. Market participants do not expect this to result in a substantial reduction of CBPP3 purchases in the near term.