The announcement of a tapering of QE and its anticipated end in December are expected to provide for a supportive six months for covered bond issuance, with only moderate widening foreseen, but a banker suggested the prospect of a January without CBPP3 could pull supply into Q4.

Following a meeting of its governing council in Riga yesterday (Thursday), the ECB announced that, subject to incoming data confirming its medium-term inflation outlook, the monthly pace of its net asset purchases will be reduced from EUR30bn to EUR15bn after the end of September and until the end of December 2018, when net purchases will be brought to an end.

Prior to yesterday’s announcement the ECB’s position had been that net purchases would continue until at least the end of September.

Hawkish comments from ECB officials in recent weeks had raised expectations that the ECB could announce a firm end date or at least a tapering of its QE purchases in either its June or July meetings. Some analysts and ECB-watchers had expected a longer extension of the programme into next year or had expected the ECB to avoid providing a specific end date, given recent political risks, although some deemed yesterday’s announcements to still be relatively dovish – pointing to the data caveat and the language of ECB president Mario Draghi in the following press conference.

“They have kept their options open as they have said it is conditional, and they have also sugar-coated it with talk of reinvestments and lower rates for longer,” said Bernd Volk, head of covered bond and SSA research at Deutsche Bank.

Syndicate bankers said the timing of the announcement, coming a month earlier than many had until recently expected, and the certainty it provides means that issuers could now have a longer than anticipated window to tap the market before the summer break. LBBW today announced a mandate for a EUR500m green Pfandbrief expected early next week (see separate article), and other issuers – including Eurozone and non-Eurozone issuers – are said to be considering launching deals in the coming weeks to make use of the pre-summer window.

Although some expect further frontloading of supply, bankers said market conditions should remain supportive for new issuance for the rest of the year.

“I think there is no need to rush per se, and transactions should keep going fairly well,” said a banker. “There is still enough time for issuers to come to the market.

“There is perhaps an artificial sense of urgency introduced by having these reduced purchases from September, but the volumes they are targeting in that quarter are fairly stable and not reducing, so this should still provide at least another six months of stable issuance, by and large.”

However, the banker said he is concerned that the covered bond market will start the new year without the support of net CBPP3 purchases.

“The start of the year is always a busy time and price discovery is always an important topic – just looking at this year, we had uncertainty already and it took only a few days from the start of the year for the first trades to suffer,” he said. “Price discovery without CBPP3 and in heavy traffic could be especially challenging.

“I think we could therefore see quite a lot of trades suffer.”

He added that some issuers could therefore be inclined to carry out pre-funding at the end of this year, resulting in a busy final quarter.

The ECB did not disclose details on how purchases under its specific purchase programmes will be reduced after its overall monthly target is lowered to EUR15bn. Since the ECB’s monthly target was lowered from EUR60bn to EUR30bn at the start of this year, net CBPP3 purchases have accounted for 6.5%-11.1% of monthly net APP settlements.

Volk expects CBPP3 to maintain this share between October and December, implying monthly net purchases of EUR975m-EUR1.67bn.

“However, I assume the ECB wants to stay flexible and CBPP3 purchases also depend on new issuance volumes,” he said. “The ECB probably does not know themselves yet.”

Sverre Holbek, senior analyst at Danske Bank, estimated that net CBPP3 purchases in October and November will account for around 6% of APP buying, falling to 2% in December, translating to around EUR2bn of net purchases in the fourth quarter, with gross purchases of around EUR6bn. He suggested that purchases will decline steadily towards the end of the year based on purchase patterns in previous years, noting that CBPP3’s contribution to APP purchases has typically been limited in December.

The ECB has reduced the size of its typical orders for CBPP3-eligible deals twice this year, first from around 50% of the expected issue size to 40% in March, and then from 40% to 30% in April.

Ted Packmohr, head of financials and covered bond research at Commerzbank, expects the 30% order ratio to be maintained for the time being, based on a calculation of the ECB’s purchase needs.

“Whether it will make an adjustment in September/October in the course of the general halving of APP purchases is likely to depend to a large extent on the issuance activity post summer break,” he said. “Should there be a wave of supply prior to the APP halving, which would flush significantly more volume into the ECB’s portfolio than expected, we could imagine a further slight reduction in its order quota.”

The ECB said it also intends to continue reinvesting the principal payments from maturing asset purchase programmes (APP) holdings for an extended period of time after the end of the net asset purchases, “and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation”.

ECB president Mario Draghi said the governing council did not discuss reinvestments yesterday and will address its reinvestment policy later on.

Analysts noted that in addition to net APP purchases, expected reinvestments implied by scheduled APP portfolio redemptions from October to the end of the year amount to around EUR45bn. Gross purchases will therefore still be substantial, they said. Danske’s Holbek estimates that CBPP3 redemptions will total around EUR23bn in 2019.

“From that perspective the gross purchase flow should slow to circa EUR2bn per month in 2019, compared with an estimated EUR4.4bn so far this year,” he said.

The market reaction to yesterday’s announcement was muted, with the exit said to have been mostly priced in, and covered bond spreads remained stable. Analysts said widening pressure was being countered by the promise of ongoing net purchases and reinvestment of redemptions, and noted that – though the timing of the announcement surprised some – the potential end of net purchases this year had been much-discussed.

Some analysts expect covered bond spreads to widen over the course of the year, however, as the ECB’s presence in the market is reduced, with peripheral spreads expected to be particularly affected.

“A limited widening in spreads is likely to occur when the Eurosystem will further reduce its order size in primary deals, which will then induce issuers to pay somewhat larger new issue premiums,” said Joost Beaumont, senior fixed income strategist at ABN Amro. “This could occur for instance after September, when net purchases will be halved.

“However, like we saw in mid-March, a widening of less than 10bp is likely to already attract investors back into the market.”

Volk agreed that covered bond spreads could widen as the ECB exits, but said the main risks to spreads are political.

“The reduction of CBPP3 purchases will not be without an effect, but I do not think it will be dramatic,” he said. “If at the end of the year there has been no further materialisation of political risks, spreads should still be somewhat tighter than they were the day before CBPP3 was announced, supported by CBPP3 redemptions and years of ultra-low rates strongly having reduced alternatives for investors.”