Primary market primed after ECB QE beats expectations

Jan 23rd, 2015

The sovereign QE programme unveiled by the European Central Bank yesterday (Thursday) afternoon is expected to stimulate new issuance next week after having surprised market participants with its size and further buoyed an already tightening market.

Financial institutions issuance had slowed ahead of the ECB’s announcement — with four covered bond benchmarks in euros this week versus 14 last week — but syndicate bankers were confident that primary market activity will resume at its normal pace next week on the back of a continued rally.

“Central bankers are continuing to buy the drinks and the party goes on in Europe,” said Vincent Hoarau, head of FIG syndicate at Crédit Agricole CIB. “After the long-awaited announcement of QE and with the tone unchanged today and the tightening trend continuing, a lot of financial institutions will hit the market on Monday on the back of the global market rally — if Greece does not spoil the party.

“Looking ahead, we will see a further convergence and compression of the periphery versus core Europe, a flattening of the long end of the curve, and a resurgence of higher beta instrument in primary, starting with AT1 and Tier 2 issuance from second tier banks.”

Another banker also cautioned against getting too carried away ahead of Greek elections on Sunday.

“It is extremely positive, of course, but don’t forget there is Greece,” he said. “To be honest, things are a touch too rosy to me. It has been going in only one direction for one week now, and I think a correction is overdue, and anything that disappoints on Sunday or Monday morning may push everyone to take profit, so we have to be very careful.

“I don’t want to be pessimistic, but I would not put a trade in the market first thing on Monday morning. I would wait and make sure that the market really is opening in the right direction, and not stable at 8am and then everything red at 8.15.”

This week’s covered bond issuance comprised seven year deals from Portugal’s Caixa Geral de Depósitos and Germany’s Commerzbank, alongside three and five year issues from Canada’s Bank of Montreal and CIBC, respectively. CIBC’s deal on Wednesday was the last before the ECB’s announcement and an expected hiatus in issuance, but the momentum that supported last week’s hectic activity continued through into this week’s supply.

Supply from Nordic banks could be back on the agenda from Wednesday, when Nordea kicks off the fourth quarter reporting season from the region’s financial institutions.

Yesterday’s ECB announcement by president Mario Draghi revealed a programme targeting bonds issued by EU governments, agencies and public institutions that will, from this March until at least September 2016, purchase Eu60bn of assets per month, “encompassing the existing purchase programmes for asset-backed securities (ABS) and covered bonds”.

In the following Q&A session, Draghi said it would be difficult to provide a precise estimate of how the target will be divided between public and private assets.

“First of all the size of the market for ABS is relatively small, although we think it will expand in the coming months,” he said, “and the covered bond programme has done quite well, much better than the other programme, but also we don’t know what the market size will be next year.

“What you could look at is basically the past behaviour as an inference for the future behaviour of our purchases.”

Some analysts said the scale of sovereign bond buying could ease the pressure on CBPP3, but suggested purchasing volumes would be reduced only slightly.

“We don’t think that the amount of covered bonds being purchased under CBPP3 will be reduced substantially but we expect the ECB to slightly reduce the daily purchase volume,” said one, calculating that the contribution of the new purchasing programmes would leave CBPP3 and ABSPP to provide Eu10.8bn towards the monthly Eu60bn target.

“With Eu350mn of weekly ABS purchases, this would leave Eu2.36bn of weekly covered bond purchases, slightly lower than the average recorded since the start of CBPP3,” he said.

A covered bond trader said that most prominent in covered bond flows yesterday afternoon was buying of higher beta names. However, he noted that while Caixa Geral de Depósitos’s Eu1bn seven year benchmark, launched at 64bp over mid-swaps on Monday was a basis point or two tighter alongside credits such as Monte dei Paschi di Sienna, they were still underperforming peripheral government bonds by 5bp-10bp.

“We expect the QE effect to be positive for our market as investors are crowded out of the most liquid and highly rated assets into the next best thing and the initial underperformance will tilt the RV scales back in favour of covereds,” said the trader.

The covered bond analyst said that the trend would vary between core and peripheral segments, with covered bonds looking more attractive in some than others.

“This should sooner be the case for core and semi-core segments,” he said. “For peripheral segments, we think that covered bond underperformance might last a bit longer as current levels are still relatively rich, with several government bonds trading cheaper than covered bonds. That’s particularly the case for the Italian market.”

A syndicate banker said that longer maturities could prove attractive.

“As you would expect, peripheral covereds and sovereigns have rallied and the important thing here is that what Draghi is trying to achieve is to flatten the curve, or flatten rates across maturities,” he added. “So you’re seeing quite a decent curve flattening already in German govvies, in swaps and in the peripherals sovereign space as well.

“The good thing about that is that it’s going to be positive for covereds in the sense that flattening the curve even more will entice investors to push further, so they don’t get crowded out even more. Everyone is going to be forced to buy 10s, 12s and 15s so we could potentially see more longer dated issues come to market, on the back of demand from private investors.”


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