Around Eu35bn of euro benchmark covered bond issuance is expected in the second half of the year, implying that 2017 supply could fall short of many initial forecasts after TLTROs cut into H1 issuance. Net supply is seen remaining negative, supporting spreads as the prospect of ECB tapering nears.

Euro benchmark covered bond supply totalled Eu77.7bn in the first half of the year, down substantially from the Eu92.85bn issued in the first half of 2016. On the back of around Eu81bn of redemptions, net supply has been slightly negative.

The fall versus H1 2016 was attributed to political risks in the first half of this year – with events such as the French and Dutch elections narrowing issuance windows – and take-up of the fourth and final tranche of second series of the ECB’s targeted longer-term refinancing operations (TLTRO II). In March, the ECB announced that it allocated Eu233.5bn to Eurozone banks – almost double the amount many market participants had expected.

The trend contrasts with the senior non-preferred/HoldCo market, where H1 supply rose from some Eu43bn in 2016 to Eu59bn this year.

“Overall, the market coped better than expected through the political risks earlier this year,” said a syndicate banker. “At the end of 2016, we had all been talking about the potential for the French and Dutch elections, Brexit, president Trump and who knows what else to cause real problems.

“There were periods when the market went quiet, but those risks never really materialised. Instead, the TLTROs had the biggest impact for covereds.”

Peripheral banks were estimated to have taken a large share of the TLTRO II funding, and benchmark covered bond issuance from the periphery has been especially slim this year, with just Eu7bn sold year-to-date – two deals apiece from Italy (Eu2.5bn), Spain (Eu2.5bn) and Portugal (Eu2bn).

The year-to-date supply represents well over half of the Eu110bn-Eu125bn of euro benchmark supply expected by analysts this year. Earlier this year, some lowered their forecasts from the higher end of this range to the lower end, in response to the ECB’s TLTRO announcement and disappointing volumes in the first quarter.

Analysts at LBBW revised their 2017 supply outlook on Friday, now expecting Eu110bn, having initially forecast Eu120bn.

“As a result of the huge take-up of the last TLTRO II tranche, fewer issues came to the market, especially in the periphery,” said Karsten Rühlmann, senior investment analyst at LBBW. “In light of this, we have revised down our issuance forecast in particular in those countries – Italy from Eu6bn to Eu4bn; Spain from Eu9bn to Eu5bn.

“Canadian issuers (Eu2.5bn) have also held back so far in the euro benchmark segment and we have therefore also adjusted our outlook for them, from Eu9.5bn to Eu6bn.”

A syndicate banker expects issuance in the second half to be slightly higher, pushing the 2017 closer to the Eu120bn mark.

“If we get just Eu30bn, or thereabouts, that would be at the modest end of expectations,” he said. “Our analysts expect slightly more.”

Joost Beaumont, senior fixed income strategist at ABN Amro, expects net supply to remain negative this year.

“We still expect around Eu34bn of new issuance of euro benchmark covered bonds in H2, while redemptions will total Eu37bn,” he said. “As a result, negative net supply will be Eu3bn in the second half and Eu8bn for 2017 as a whole.

“This stands in stark contrast to H2 last year, when net supply turned heavily negative – at Eu26bn – on the back of the TLTRO II.”

If net supply does indeed remain negative, bankers expect this to counteract widening pressure in covered bond spreads that may arise in the second half of the year as the market eyes an end to the ECB’s covered bond purchases. Many market participants expect the ECB to provide more information on potential tapering of QE after the summer.

“Heading into the summer break, we have seen that demand for covered bonds has the most part has remained strong,” said a syndicate banker. “That is simply because investors more cash then there has been supply.

“I think that imbalance between supply and demand is here to stay for now.”