The second dose of cheap cash from the European Central Bank at the end of this month should spread more broadly across financial markets than the first, sweeping money into non-bank corporate bonds.

This is in part because banks are expected to use the proceeds from the Feb 29 auction to pay down their own debt even further than they have done already. Long-term investors, big holders of bank bonds, will be pushed elsewhere as a result.

Peripheral euro zone government bonds, such as those in Spain and Italy, have been by far the biggest visible beneficiaries of the ECB's offer of nearly half a trillion euros in December. Benchmark Italian borrowing costs have fallen as much as 150 basis points.

But the banks have actually used most of the cheap ECB money to pay off their own debt.

Reuters polls now suggest that at the ECB's second auction, known as the Long Term Refinancing Operation (LTRO), banks will take up at least 500 billion euros of low-priced loans, pushing the total three-year cash injection to around 1 trillion euros.

This total represents nearly 140 percent of bank debt maturing this year and more than half of total refinancing requirements in 2012-2015 of around 1.7 trillion euros.

And since banks are busy paying off debt before a European deadline in June to plug a 115 billion euro capital hole, they are more likely to repay and retire their existing debt than roll them over.

This implies that what is currently a very large asset class - the 800 billion euros European bank bond market - is going to shrink.

If you are in a deleverage cycle to the tune of 1.5 trillion euros in the next two years, the chances are that the current holders of European bank debt will be repaid and not rolled over, said Bill O'Neill, chief investment officer of EMEA at Merrill Lynch Wealth Management.

They may want to plough back into European banks, but they may want to look at smaller, higher yield credit, which will be the beneficiary. Liquidity could flow into the non-financial sector, or more higher yielding financial credit sector.

DECEMBER VS FEBRUARY

Market estimates show banks deployed a bulk of the December loans to deleverage, rather than for so-called carry trades in which they use low interest loans to buy higher-yielding peripheral debt.

Barclays Capital estimates out of 489 billion euros, about 350 billion euros consisted of banks rolling over existing ECB loans to benefit from the lower interest rates charged, leaving new net borrowing of about 150 billion euros.

After setting aside money for future maturing debt, Barclays

reckons around 50 billion euros was used for carry trades. It expects banks to use 160 billion euros from the second LTRO to cover future maturing debt.

JP Morgan's estimate of net borrowing is a bit higher at 190 billion euros. Of this, it thinks euro zone banks had around 110 billion for carry trades.

It expects banks to borrow around 205 billion euros on a net basis in February, of which they will use 95 billion euros on their maturing debt.

A Goldman Sachs survey found more than one in half of respondents expect the primary usage of funds to be paying down outstanding bank bonds, while a minority expects banks to engage in new sovereign bond carry trades.

A paying down of debt on a large scale would result in a reinvestment dilemma for current holders of European bank debt, the bank said in a note to clients.

Insurance companies, pension funds and large asset management firms would need to find alternative investment opportunities. The scale of European bank bonds, as an asset class, is so large that it is comparable only to sovereign bonds or the combined size of all other non-financials corporate bonds outstanding.

CREDIT THAW

The ECB money is already lowering credit risks for banks and some of this is beginning to filter through to the wider corporate bond market.

The iTraxx five-year senior financials index - which measures credit risk premium for a basket of bank credit - has fallen to around 230 basis points from around 330 in December. Its non-financial index also saw a similar narrowing of spreads since December.

In the European credit market, high yield is by far the most sought-after category, with year-to-date inflows of $2.2 billion, or over 3 percent of total assets held by funds investing in this asset class, according to Bank of America.

Total assets of European investment grade credit funds have risen 1.8 percent since January, thanks to a rally in bank credit, while European equity funds fell 0.1 percent and money market ones dropped 1 percent.

There's a very good value in non-banking credit, Didier Saint-Georges, member of the investment committee at French asset manager Carmignac Gestion.

(Editing by Jeremy Gaunt.)

(Changes title and company division in 9th para)

Quantitative easing