Syndicate bankers expect a modest pick-up in euro benchmark issuance next week on the back of PEPP, but said issuers will be considering alternative funding avenues, while investors cautioned on the extent of real money demand and levels issuers might have to pay.

After publishing the legal act for the programme on Wednesday evening, yesterday (Thursday), the ECB began purchases under its Pandemic Emergency Asset Programme (PEPP) slowly on the secondary market, according to syndicate bankers, with orders being placed for Italian and German paper, while the primary market was inactive.

PEPP rules and eligibility criteria are largely the same as for the asset purchase programme (APP), from which it is being treated distinctly. However, most notably, ISIN limits that have been a focus for the public sector purchase programme within APP will not apply under PEPP – something that has reinforced market participant’s view that covered bond buying will not be subject to as much of a ramping up under PEPP as government bonds and corporate securities, which have also experienced an expansion.

“The main focus of the PEPP will likely be on public sector assets,” said Florian Eichert, head of covered bond and SSA research at Crédit Agricole. “Since the ECB will, however, report only one figure for the whole PEPP we will never know just how the purchases are broken down.

“For covered bond purchases, we already expected around €4bn in net and €7bn in gross terms for the expanded APP. The ECB will struggle to add much to that for the PEPP in our view. We expect orders in primary issues to move above the current 40%. The overall volumes in play for the ECB are so vast that it will have to buy whatever it can whenever and wherever it can.”

Syndicate bankers said they expect a modest increase in euro covered bond issuance next week on the back of the PEPP.

However, they emphasised that the majority of issuers will continue to utilise other central bank refinancing programmes, such as TLTROs, meaning a large surge in primary market activity is unlikely.

“All the domestic and ECB measures which have been taken are extremely favourable,” said one, “so, despite the introduction of PEPP, I don’t think we’ll see a huge increase in the number of eligible issuers coming to the market next week. We’ve also seen some very important retained covered bond transactions out of France and the Netherlands recently, so they’re all going to the ECB for repo purposes.”

On Tuesday BPCE SFH launched the sole euro benchmark of the week, a €1bn five year deal that attracted over €1.35bn orders and was deemed encouraging by some syndicate bankers, given a recent lack of core-European supply and an underwhelming euro benchmark from Axa Bank Europe SCF on Thursday of last week (19 March).

Meanwhile, supply in other parts of the fixed income markets surged in the US and Europe this week as equity and credit markets recovered strongly from recent historic losses, culminating in over €25bn of deal in euros yesterday (Thursday), including some €5bn of financial institutions issuance.

However, the syndicate banker noted that with senior preferred new issue levels now being particularly high – Bank of America reopened the euro senior market with a €1.5bn nine year non-call eight HoldCo deal at 365bp over mid-swaps on Tuesday – some issuers could be driven to covered bond issuance, especially considering that the increased ECB presence will be spread-supportive.

Another syndicate banker said that judging by the large order books across many of this week’s transactions, there is clearly sufficient liquidity in the market for new issuance.

“The massive differential covered bonds are continuing to trade at, even to senior preferred, means they will continue be the weapon of choice for some jurisdictions until spreads begin to normalise somewhat,” he added.

However, the first syndicate banker suggested that the secondary market is still highly dislocated, some investors might not participate in deals until the market is more stable, although he said there is a mandate for a European issuer in the pipeline for next week.

“Apart from this, we probably won’t see much else,” he said. “And to be honest, after BPCE, I would have thought more issues would have come, so I’m still quite cautious.”

Investors agreed that PEPP could help bring some stability to the market, although two fund managers said that demand for new issues from their peers is likely to remain constrained while the wider financial markets remain volatile.

“I don’t think the appetite is that high yet,” said one, noting that fund managers’ share of the BPCE trade, for example, was less than a quarter, with bank treasuries having taken the lion’s share of recent supply.

Another fund manager said issuers and lead managers had perhaps not sufficiently their situation into account.

“A real money investor needs to keep its powder dry,” he said. “You don’t know what your clients might do, so you need cash with you.”

They cited the lack of switch opportunities, due to the illiquidity and wide bid-offer spreads of the secondary market, as a further impediment to participating in new issues.

A bank treasury investor was more constructive about any supply coming next week.

“Now we have a little bit more clarity with the PEPP programme – even if covered bonds will not be so involved in this – the market is working better,” he said.

However, alongside some syndicate managers and analysts, they expect new issues to continue to be priced at elevated spreads, with secondary levels moving towards these new levels rather than vice versa – particularly for jurisdictions from which there has been no supply.