The “known unknown” of a TLTRO III could determine whether euro benchmark issuance over- or undershoots a EUR138.5bn average forecast for 2019, with redemptions, credit growth, new issuers and relatively cheap funding expected to outweigh negative effects of the ECB’s retreat.

“Never underestimate supply.”

This is the number one lesson of 2018, according to SG analysts, and a glance back a year to 2018 forecasts could explain why: full-year euro benchmark issuance in 2018 came in at some EUR136bn, much higher than a EUR107bn average forecast based on 13 banks’ research at the end of 2017. Some analysts had forecast less than EUR100bn of issuance, with even the highest falling short, at EUR122bn.

Perhaps chastened by past experience, the average forecast for 2019 euro benchmark supply, based on figures from 15 banks, is EUR138.5bn – which would represent a marginal increase on 2018. The most bullish expect EUR150bn or more, while the lowest forecast is EUR120.5bn.

Euro benchmark covered bond supply and SG 2019 forecast

Note: 2018 supply as of 20/11/18; Source: SG

DZ Bank analysts are among those at the upper end of forecasts, expecting EUR150bn, which covered bond analyst Thorsten Euler says would be the highest volume since 2011.

Six factors cited by DZ broadly take in the key drivers of 2019 supply cited across analysts’ research irrespective of whether they arrive at the higher or lower end of expectations: higher maturities compared to 2018; the ECB’s dwindling influence on the covered bond market; alternative types of funding; early refinancing of TLTRO II funds; solid economic growth; and new issuers.

Although flat-to-higher gross supply relative to 2018 is forecast for 2019, lower net growth is incorporated into analysts’ forecasts, with some EUR103bn of redemptions in the coming 12 months meaning around EUR35bn of growth in outstandings is anticipated – down on near EUR50bn of net growth in 2018 – the highest since 2011 – which was on the back of EUR88bn of redemptions.

The turn of the year marks the end of net increases to the European Central Bank’s Asset Purchase Programme (APP), but the Eurosystem will continue to have a “stabilising effect” on the market in 2019, in the words of UniCredit analysts. Based on an assumption that APP maturities are reinvested in the same asset class, the euro benchmark segment will experience around EUR21bn of reinvestment activity through 2019 – around half of 2018’s gross purchases under CBPP3.

Analysts are unanimous in sharing the wider consensus view that spreads will continue to widen in 2019 on the back of the declining ECB participation. This already convinced some issuers to prefund in 2018 and a busy start to 2019 is anticipated.

“We expect issuance activity to once again be frontloaded in the New Year,” say Commerzbank analysts, “since many banks will likely want to become active sooner rather than later again given the political uncertainties and the trend towards wider spreads.

“Sufficiently strong and stable investor interest for such lively supply is likely to require sustained generous spread premiums. This should keep covered bond spreads under pressure in early 2019.”

BayernLB senior covered bond analyst Emanuel Teuber notes that while increasing spreads typically have a dampening effect on new issue activity, this will be a less critical factor in 2019.

“We do not expect the relative attractiveness of covered bonds as the cheapest source of funding for banks (after deposits) to suffer compared to other bonds,” he says.

Existing and possibly new longer term refinancing operations from the ECB are deemed key to whether 2019 supply is nearer the upper or lower end of expectations – BBVA analysts describe any decision on “TLTRO III” as “the crucial known unknown”.

More than EUR380bn of the first tranche of TLTRO II needs to be repaid by June 2020 and this is expected to contribute to upward pressure on supply, particularly among peripheral issuers, with Spain and Italy having taken the biggest shares.

“Admittedly, the transactions are not scheduled to mature before 2020/21, and the interest conditions are so attractive that most banks would probably prefer to stick to the transactions for longer,” say Commerzbank analysts. “Nevertheless, the regulatory advantage of the TLTRO funds would theoretically already be reduced ahead of their redemption, and early refinancing would help banks avoid concentration risks at the final maturity date.”

However, they and others note that expected new ECB facilities could limit the impact of TLTRO II refinancing on covered bond supply. Indeed, NordLB analysts’ expectation of such measures contributes to their forecast of EUR120.5bn for 2019 – the lowest of the 15 banks surveyed.

“Surprisingly unattractive conditions for a follow-up tender would above all likely mean that the covered bond issuance volume would be much higher,” they say. “In purely numerical terms, our forecast would increase by EUR15bn-EUR20bn versus the basis expectation.”

Balance sheet reduction is another natural way for banks to deal with the expiry of the ECB facilities, but most analysts expect strong credit growth to support overall covered bond supply in the coming 12 months.

“Credit growth, particularly in the EU, seems to be growing dynamically again, although the extremely strong first-half growth rates are now likely to have slowed to some extent,” says Teuber at BayernLB. “Some banks may also have adopted a slightly more defensive positioning in response to a slow cooling of the global economy, and have scaled back lending to some degree.

“However, there is no sign of this yet in most European countries, partly because many banks are still in search of profit given that interest rates remain low. We therefore expect credit growth to continue next year. This is also borne out by reports published recently by the ECB and the EBA.”

Analysts note that euro benchmark supply in 2018 benefited from non-EU issuers opting for European issuance to the detriment of US dollar supply due to developments in the cross-currency basis swap. While the evolution of the basis swap in 2019 remains to be seen, the impact of new issuers is expected to continue.

Crédit Agricole analysts note for example that Brazilian issuers, who have just started issuing covered bonds locally, could add to the new jurisdictions in international markets in 2019, with Japan and Korea having entered the euro market for the first time in 2018. They also highlight that should just 20% of existing issuers who were not active in 2018 revisit the market in the coming year, this would contribute some EUR10bn of supply, assuming they match the past 12 months’ average deal size of EUR767m.

Photo: ECB/Flickr