A prolongation of prevailing interest rate levels and new series of TLTROs announced by the ECB yesterday (Thursday) delivered on the dovish expectations that have supported credit markets, although the terms of the TLTROs might require supply expectations to be raised, said analysts.

The European Central Bank’s forward guidance was changed from keeping interest rates at their present levels from “through the summer of 2019” to “at least through the end of 2019”.

Speculation that the ECB would introduce a third series of targeted longer-term refinancing operations (TLTRO III) was confirmed, as it announced them from September 2019 to March 2012, each with a maturity of two years.

“Significant monetary policy stimulus will continue to be provided by our forward guidance on the key ECB interest rates, reinforced by the reinvestments of the sizeable stock of acquired assets and the new series of TLTROs,” said ECB president Mario Draghi.

The deferral of any interest rate rises comes with an extension of the period during which the central bank will reinvest in full Asset Purchase Programme (APP) redemptions, including those under the third covered bond purchase programme (CBPP3).

“Given that reinvestments of covered bonds are likely to increase in coming years, the Eurosystem will remain a dominant player in the covered bond market for the time being,” said Joost Beaumont, senior fixed income strategist at ABN Amro. “This should continue to support the market.”

Under the new TLTROs, banks will be able to borrow up to 30% of eligible loans, as with TLTRO II, meaning that there should not be volume constraints preventing banks from rolling over drawings from the old programme into the new one, noted analysts at Danske.

Details of the terms of TLTRO III are still to come, with the ECB having only said that the rate will be indexed to the index on the main refinancing operations (MRO) and that, “like the outstanding TLTRO programme, TLTRO III will feature built-in incentives for credit conditions to remain favourable”.

However, analysts have already said that market funding should compare favourably to the new TLTROs.

Assuming that it will be possible to roll over funding taken in the first tranche into the last (in March 2021), Danske senior analyst Sverre Holbek, compared the all-in cost of variable rate funding at the MRO rate for 3.5 years from September with current covered bond yields.

Stylised comparison of market funding (3.5 year covered bond) with TLTRO III drawings

Source: Bloomberg, Danske Bank

“It appears that market funding is cheaper for core and stronger peripheral banks, given that they can fund themselves at negative rates in the market,” said Holbek. “This compares with a TLTRO cost of 0.00% if the MTO rate is unchanged for the duration of the entire liquidity operation, or even higher when translating into a fixed-rate equivalent and taking into account the cost of funding the collateral haircut with senior unsecured debt.

“On the bottom line, although some details are still lacking, the terms of the TLTRO III are less attractive than those of its predecessor (variable instead of fixed rated and two year tenor of individual tranches rather than four years),” he added. “From that perspective, we do not expect the launch of TLTRO III to crowd out covered bond issuance to a significant degree in the core covered bond segments.”

Beaumont at ABN Amro agreed that core issuers will not finding the new TLTROs attractive compared to market funding. He noted that the picture is different for peripheral banks.

“Italian covered bonds are yielding zero percent at the very short end, implying that the new TLTRO will be favourable for them, while the ‘break-even’ point for Spanish banks is around the three year maturity,” he said. “Overall, the break-even point seems around 4.5 years.

“As a result, we think that we are likely to see a gradual increase in covered bond issuance due to the less favourable new TLTRO.”

Potential new TLTROs have been seen as a key determinant in the level of covered bond supply in 2019, with NordLB, for example, saying that “surprisingly unattractive” conditions on such tenders could boost issuance by EUR15bn-EUR20bn versus their base expectation of tempting new TLTROs.

Maureen Schuller, head of financials research at ING, meanwhile noted that the ECB’s announcements confirmed the stance the market had been pricing in since the central bank’s 24 January meeting.

“Underlying yield levels and credit spreads did not start to notably fall until the ECB indicated back then that the economic data was weaker than anticipated,” she said after the press conference yesterday. “Today’s meeting affirmed they were right, triggering a 2bp tightening in the iTraxx Financials index.

“Further positive spread responses from the TLTRO III, a.o. for covered bonds will, in our view, depend upon the details to be announced in due course, which would facilitate a more in-depth analysis on supply implications.”