The ECB has purchased €54bn of eligible benchmark covered bonds since the latest programme began in late October 2014. Unless the ECB changes course and scales back the rate of buying its eventual exit could prove disruptive, as the buyers it is now pushing out may not be ready to jump straight back in at short notice.
The CBPP3 portfolio grew by €2.95bn, the ECB reported on Monday. In total, this was slightly less than €3.3bn that analysts at Barclays had expected and suggested the eurosystem had, for the second week running, been less aggressive in its rate of secondary purchases. The slower rate of purchasing represents a welcome development, but it is early days and may not be sustained. If the ECB carries on buying at the same average overall rate of €590m its action will swamp the market with destabilising ramifications.
The nominal value of the CBPP3 eligible bonds allowed into Markit iBoxx index stands at €561.6bn. Of this about €180bn will be redeemed by September 2016, when the buying programme is officially scheduled to end, and about €150bn of new issuance could be expected. Based on these assumptions and a few others, analysts at Crédit Agricole say the ECB could end up owning 37.5% of the CBPP3 eligible market by September 2016 if it continued buy at the same overall rate.
This would mean 37.5% of the private investors that had been in that particular market would no longer be there. As these buyers are likely to be invested in an alternative asset class, they may not have the resources to re-engage with covered bonds when the ECB eventually leaves. In December 2014 Fitch warned as much, saying that 58% of the investors it had survey would switch into other asset classes. These investors “may not be willing or able to readily return”, said the agency at that time.
The one major saving grace for covered bonds is that they are the only bank finance instrument that benefits from the structural regulatory bank demand driven by their eligibility to the liquidity coverage ratio. The cumulative effect of this regulation is that it has resulted in a vast increase in the need for high-quality liquid assets. Covered bonds are likely to remain on banks’ liquidity buffer shopping lists because they help reduce correlation between banking systems and sovereign credit more than any other alternative high-quality liquid asset. But if the ECB does not scale back its purchases, banks could be the only non-public investors left.