Untested Debt a Hit as Investors Hunt Yield in Sub-Zero Terrain

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Investors combing the AAA rated Nordic region for assets that’ll return more than zero in the post-Brexit world are piling into the newest type of bank debt, undaunted by its novelty.

QuickTake Negative Interest Rates

That’s according to Nykredit Realkredit. One of Europe’s biggest covered bond issuers, the Copenhagen-based mortgage lender sold on Friday a new type of senior unsecured debt for the second time in less than two months amid strong demand, according to Nicolaj Legind Jensen, senior vice president in group treasury.

The U.K.’s vote to leave the European Union means interest rates are likely remain below zero for longer than previously expected, creating demand for even novel securities like Nykredit’s so-called senior resolution notes. Nykredit issued them for the first time in June, and they’ve “performed very well on the secondary market,” Jensen said .

“We’ve seen very strong demand for this type of bond,” Jensen said by phone Thursday, after the bank announced the sale. “That’s why we’re coming back to the market.”

Nykredit on Friday sold 500 million euros ($554 million) in the notes, just a month after the first offer priced. Since those 0.875 percent coupon bonds began trading in June, the yield has fallen, declining to a low of 0.47 percent. The spread had tightened to 122 basis points after pricing at 150 basis points over benchmark German debt.

The second issuance was oversubscribed by almost five times, Jensen said Friday. “Investors continue to show support for this new asset class.”

Nykredit is the first bank globally to offer the Tier 3 notes, according to S&P Global Ratings. The bonds are intended to function like senior debt while a bank is in good health but which can be written down if it goes into resolution. The bank needs to issue about 2 billion euros in the securities to meet regulatory requirements, Jensen said.

Nykredit’s second issuance was for bonds with a maturity of five years, compared with the earlier three years. The bank wanted to ensure that not all securities matured at the same time, and there’s also “strong demand for 5-year maturities from investors” amid negative rates, Jensen said.

“The shorter you go, the more likely you are to get a negative or very small coupon,” he said.

In fact, investor demand helped push the coupon on the new bond below the June issuance, to 0.75 percent.

Yields are evaporating as the ramifications of the U.K.’s vote begin to hit the markets and Europe’s economy. Denmark’s central bank probably won’t raise its key rate above minus 0.65 percent until the end of next year, according to Nordea Bank. Denmark’s 10-year government bond yield fell Wednesday for the first time below zero.

Coupons on Danish covered bonds with maturities of as long as 30 years are down at 2 percent, lower than U.S. Treasuries with similar maturities. Investors in shorter-maturity mortgage bonds are paying homeowners to borrow. In some cases, only bank fees push borrowers’ payments above zero.

“The negative yield does tend to make investors prefer the longer maturities,” Jensen said.

Demand is building even as confusion reins over how the securities compare with those issued by banks in other countries. The European Union is requiring banks to hold enough capital to absorb losses and in some cases to be resolved and even recapitalized. But it’s left to individual countries to decide what instruments are eligible.

The differences have left some investors facing “navigational challenges when hopping countries in Europe,” according to a June 30 note from Scope Ratings. Denmark has yet to decide on its banks’ requirements for own funds and eligible liabilities, or MREL.

Nykredit has said it will use the instruments to meet requirements from rating companies and local regulations for mortgage banks, and then eventually MREL, if needed and the notes qualify. S&P on Friday upgraded Nykredit’s outlook to stable from negative, citing the bank’s progress in building up additional loss-absorbing capital.

Investors have “done their homework,” Jensen said. “The investors are very well aware of the risks they’re taking.”