An “astonishing” take-up of the final series of TLTRO II is expected to be a major dampener of covered bond supply this year, with the remaining needs of Eurozone banks revised sharply down. The supply-demand imbalance is set to intensify, supporting spreads.

The ECB announced yesterday (Thursday) that it allocated Eu233.5bn to 474 banks under the fourth and final tranche of its second series of targeted longer-term refinancing operations (TLTRO II). Taking repayments from previous tranches into account, the net allotment was Eu217bn.

The take-up is substantially higher than expected. Analysts’ forecasts for the gross allocations ranged from Eu75bn-Eu170bn, while a Bloomberg survey produced a median estimate of Eu110bn.

It is by far the second highest allotment in any of the TLTROs, behind only the first tranche of the second series in June 2016, which replaced payments made under the first series.

“The demand for today’s tender was most likely helped by the extremely favourable interest rate offered, especially as market expectations have increased that the ECB could hike its deposit rate,” said analysts at ABN Amro. “The question now is what banks will do with the amounts borrowed.”

The announcement of the TLTRO II in March 2016 was considered one of the major contributors to a slump in covered bond issuance in the second half of last year, particularly reducing supply from peripheral issuers, which would face higher new issue yield levels. The higher take-up of the final tranche is expected to have a similar effect this year.

The ABN Amro analysts said the risks have now increase that euro benchmark issuance will fall short of their current forecast for 2017, of Eu110bn-Eu115bn in total and Eu65bn-Eu70bn for Eurozone banks.

“As such, it is likely that negative net covered bond supply will be larger than the currently estimated Eu5bn,” said Joost Beaumont, senior fixed income strategist at ABN Amro.

Maureen Schuller, head of financials research at ING, described the “astonishing” allotment as being “a significant supply negative for covered bonds”. She noted that year-to-date euro covered bond supply is already almost Eu20bn below that in the same period last year – at Eu45.2bn today, down from Eu64.85bn.

Once again, peripheral covered bond issuance is expected to be most affected. Schuller noted that prior to the latest tranche, peripheral banks had taken over half of the liquidity offered under the TLTROs. As of the beginning of February, Eurozone banks had drawn Eu586bn from the operations, of which Eu332bn had been allocated to Italian and Spanish banks.

A Eu1.5bn 10 year cédulas for CaixaBank on 3 January and a Eu1.5bn dual tranche, eight and 12 year OBG offering for Crédit Agricole Cariparma on 14 March are the only benchmark peripheral covered bonds to have been sold this year, despite relatively high redemptions.

Syndicate bankers, too, are now contemplating the prospect of quieter primary markets ahead.

“Well, I guess I will continue to have less problems selling my bonds, but rather might struggle with the volume of business there might be,” said one.

None of the euro benchmark covered bonds this week – from Swedish Covered Bond Corporation, National Australian Bank, Toronto-Dominion and PKO Bank Hipoteczny – were from Eurozone banks, and nor are most of those in the public pipeline – Austria’s Hypo Noe is the only exception. Bankers suggested non-Eurozone issuers will continue to be more active than Eurozone peers.

“Looking at the rates available from the TLTROs, why would you go for covered funding if you have that option?” asked one.

However, some syndicate bankers were optimistic that Eurozone issuers will simply focus their issuance into the longer dated maturities that could not be obtained through the TLTROs.

“Not every bank was involved, and I don’t think all of those that were will now simply through their issuance plans out the window,” said one. “Besides, you cannot refinance a 10 year covered bond with two year ECB money.

“There will be deals to come.”

The increased expectation of net negative supply and subsequently intensified demand is expected to drive further performance in spreads, which have already tightened throughout the year. There was no immediate reaction in covered bond spreads to the release of the TLTRO figures.