Banks Sidestep Negative Rates in Europe With Bond Price Buffers

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Europe’s banks have a solution to prevent coupons on their floating-rate notes turning negative: make bondholders give them more money upfront.

Banks issued 5.1 billion euros ($5.8 billion) of the securities priced at a premium this year, the most for any six-month period since the first half of 2011, according to data compiled by Bloomberg. ING Groep NV and Lloyds Banking Group Plc were among issuers that sold 2.5 billion euros of the bonds in May, the most for any month since June 2010, the data show.

The borrowers are asking for more money in advance to keep coupons above zero and to sidestep time-consuming discussions with investors over what happens when interest payments are negative. Benchmark euro rates fell below zero for the first time on record earlier this year, a distortion that’s resulted from the European Central Bank’s unprecedented efforts to stimulate the region’s economy.

“Negative coupons create all kinds of headaches, so adding a spread is a very easy way to get around all that,” said Kimmy Samuelsson, head of long-term funding at Swedbank AB in Stockholm. “While it is impractical and legally questionable for a borrower to claim a coupon from an investor, adding an extra 50 basis points or so and issuing above par to compensate for the elevated coupon means we don’t have to test this theory.”

Swedbank Premium

For the 250 million euros of three-year notes it sold in March, Swedbank charged investors 101.5 cents on the euro, or 1.5 cents more than they will receive if they hold the notes to maturity. The issuer increased the floating-rate coupon to offset the higher issue price.

The Swedish lender is paying 68 basis points more than the three-month euro interbank offered rate, or Euribor. That equates to 50 basis points more that the economic level at which Swedbank was prepared to pay for three-year funding, Samuelsson said.

Euribor, the average cost Europe’s banks say it costs them to lend to each other, is the benchmark rate for a notional amount of more than $180 trillion of debt contracts including asset-backed securities, derivatives, corporate bonds and loans.

The three-month rate fell below zero in April for the first time since Bloomberg started collecting the data at the end of 1998 and was set at minus 0.013 percent on Tuesday. The one-month gauge is at negative 0.063 percent, according to the European Money Markets Institute.

Payment Demand

Sub-zero rates have evoked differing responses from issuers, creating uncertainty over what happens to floating-rate debt.

While Nordea Bank AB said in May it plans to charge investors on some new mortgage bonds if rates turn negative, holders of Banco Popular Espanol SA’s asset-backed bonds weren’t asked to make a payment in April when coupons on the debt dropped below zero.

Debt issuers from Volkswagen AG to a subsidiary of Rabobank have sought to reassure investors they won’t have to pay by inserting clauses into their deal documents that put a floor on how low the interest rates can fall.

There’s a growing consensus that in the majority of cases the bond market is not set up to enable payments from bondholders to issuers, according to Michael Amorgianos, Standard Chartered Plc’s head of European medium-term notes in London. Even so, you can’t rely on an implicit floor, he said.

ING, Lloyds

ING sold the year’s largest floating-rate note priced at a premium on May 29, Bloomberg data show. By pricing its bonds above par and paying a higher coupon, the bank is reducing the likelihood that the obligation to pay interest could transfer to the investor.

Investors paid 101 cents on the euro for ING’s 1.33 billion-euro two-year bonds last month and received a spread over Euribor of 65.5 basis points, which is about 50 basis points more than the lender’s funding level for two-year notes, according to said Bas Iserief, the bank’s Amsterdam-based head of long-term funding and investments.

“We issued bonds at 101 cents with a coupon of 65.5 basis points more than Euribor, and we don’t think we’ll get to negative 66 basis points except for in some Armageddon scenario,” said Iserief.

LLoyds sold 600 million euros of two-year notes at 101 cents on the euro on May 20, Bloomberg data show. The bank will pay 66 basis points more than three-month Euribor for the debt.

“Market participants are creative in responding to challenges,” said Suzy Margretts, a senior director of medium-term notes issuance at Lloyds in London. “Issuing above par is a solution that suits a number of issuers as well as investors. However, we are in unchartered territory and other ideas may surface.”

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