European banks: The ECB comes with new gifts

·      As widely anticipated, the ECB today decided to increase the size of the pandemic emergency purchase programme (PEPP) by €500bn to €1,850bn. The programme will now at least be active until the end of March 2022. The extension and increase of the PEPP gives the ECB room to buy a further €72bn per month under this programme until the end of March 2022. The public sector purchases will, in our view, remain the most important focus area of the PEPP. Meanwhile, the monthly purchases of €20bn per month under the asset purchase programme (APP) will remain intact. As the €120bn envelope ends this year, these extra monthly APP purchases (also mostly public sector focused) could shift to the PEPP. In terms of the ECB’s monthly covered bond buying efforts, we don’t expect that either the end of the €120bn envelope or the PEPP’s expansion and extension will make much of a difference.

·      The ECB today announced that it will further recalibrate the terms of its third Targeted Longer-term Refinancing Operations (TLTRO-III) programme. Firstly, the special interest rate period is extended by 12 months to June 2022. Secondly, three additional tranches are to be added to the operation that will be conducted between June and December 2021. Thirdly, the total amount that banks can draw from the operations was increased from 50% of eligible loans to 55% of eligible loans. And lastly, in order to provide an incentive for banks to sustain the current level of bank lending, the recalibrated TLTRO-III borrowing conditions will be made available only to banks that achieve a new lending performance target of 0% between October 2020 and December 2021.

·      We make following conclusions based on the TLTRO-III term changes: (1) the effect on bank bond supply in 2021 is negative due to a combination of the extended special interest rate period leading to smaller early prepayments of TLTRO-III in 2021 and new tranches providing new opportunities to increase TLTRO at the expense of bond funding, (2) the introduction of new tranches and the higher available amount per bank will together result in a higher total size of the TLTRO-III programme in 2021 and provide funding for banks until end-2024, this will further limit bank bond supply in 2022, (3) bank earnings are supported by the lengthening of the favourable TLTRO-III special interest rate period, which is especially beneficial in the current environment of lower for longer interest rates and (4) reaching the new lending targets will likely to be more difficult than reaching the old lending benchmark targets. While the levels are similar the substantial government measures in place have supported lending development this year, we consider that this effect may not carry into 2021 in a similar magnitude.

·      We lower our supply estimates for covered bonds and preferred senior unsecured in 2021 to €100bn and €53bn respectively, from €115bn and €58bn. The lengthening of the special interest rate period for the TLTRO-III in combination with the addition of the new tranches and a higher TLTRO allowance per bank will together act as a limit for funding driven bank bond supply next year and well into 2022. The abundant amount of liquidity available at banks will, in our view, remain constructive to the performance of bank bonds in the first half of 2021.