Record RD FRN reflects mortgage, coupon moves

Realkredit Danmark (RD) sold a Dkr42.4bn (Eu5.68bn) 18 month floating rate note – the largest ever FRN in the Danish covered bond market – in auctions from Monday to yesterday (Thursday), with the size reflecting changes in the type of mortgage being taken out and the maturity a debate over negative coupons in Denmark.

The sales of the FRN were ahead of the 1 July refinancing date and coincide with Nykredit Realkredit ARM refinancing auctions this week.

RD auctioned Dkr10.6bn each day and, according to Jan Weber Østergaard, senior analyst at Danske Bank (RD’s parent), only once has a larger amount of an FRN been sold on a single day, while the Dkr42.4bn total makes it the largest ever floating rate note in the Danish covered bond market.

“The volume of this bond that needs to be refinanced was built up over several years,” said Klaus Kristiansen, executive vice president at Realkredit Danmark. “These borrowers are all corporate borrowers and they have gone from interest reset loans, which are reset every year, into these floating rate bonds, because – for one reason – it is a better match for swap hedging.

“Also, we have tried to build in incentives to go for longer term funding and usually these floating rate bonds are three year funding instead of just one year funding, so we have on top of this put a price incentive to go for this product instead of the interest reset with one year funding. So those two factors explain why this has seen such great demand.”

Kristiansen said that the refinancing is on this occasion being done via an 18 month FRN rather than a three year or longer FRN because of the issue of how to cope with negative coupon rates.

“We have been in negative territory in terms of yields in Denmark, and that has sparked a debate on whether we should issue bonds which could have negative coupon rates,” said Kristiansen. “We can see a need for issuing bonds with no floor so that the coupon could become negative, but right now we do not feel that the investor base is there to absorb these bonds.

“For that reason we decided this time around to issue bonds which are floored at zero percent, but with a shorter term to maturity – 18 months instead of three years – and then in 18 months’ time we expect to be able to refinance the bonds with no coupon floor provided that has become standard by then.”

Because it was selling the FRN over four days, RD did so on a price basis rather than – as it would normally do – a spread basis. The spread was fixed at 20bp and on the first day of sales, on Monday, the price was fixed at 100.30 with a bid-to-cover ratio of 2.41.

Danske’s Østergaard said that the sale appeared to have started OK, with the price very close to what he had forecast (a range of 100.25-100.35). He said that the level reflected a premium versus one year ARM bonds of 12bp-13bp, in line with what he had expected to reflect the floating rate format of the paper and the large volume on offer. He also noted that the concession was consistent with a Dkr7.8bn one year FRN auctioned by Nykredit on Monday of last week (11 May), which he said came with a relatively high premium.

Anders Aalund, chief analyst at Nordea Markets, said the premium initially offered by RD’s FRN versus ARMs – at some 20bp on Monday  when compared with a January 2017 ARM – was higher than he had expected, and that he had forecast a price of 100.45-100.50 that incorporated a premium to reflect the floating rate format, with 100.60 being the level at which the FRN pricing would be at fair value versus an equivalent maturity ARM. He also noted that the size worked in the FRN’s favour to an extent since it made it LCR-eligible as a Level 1B asset.

The differential, however, declined after the first day, with the FRN price rising from 100.30 to 100.33 Tuesday, then 100.36 and 100.39 on subsequent days, while bid-to-covers from Tuesday to Thursday ranged from 2.93-2.95, giving an overall bid-to-cover of 2.81.

Nykredit meanwhile sold Dkr16.4bn of a one year bullet across the first four days of the week, with sales of Dkr1.35bn and Dkr1.8bn of three and five year paper, respectively, due today (Friday), constituting its latest quarterly ARMs refinancing.

Analysts said that the initial pricing on the sales, on Monday, was a few basis points cheaper than expected and implied by secondaries and Lars Mossing Madsen, chief dealer at Nykredit, said that the level was a couple of basis points wider, even if a reduction in tap issuance on the back of lower ARMs supply meant that secondary levels were less useful guides than previously. He put the spread over Cita on Monday at Cita plus 22.7bp, while the yield was 0.04%, and levels improved through the week by around 3bp against Cita and to a yield of minus 0.01%. The bid-to-cover on Monday was 2.33 and 2.42 on Tuesday, before rising to 3.57 on Wednesday and 2.94 yesterday.

The bid to covers and relatively low movement in spreads represented a return to stability after lower than expected demand and dramatic moves witnessed in the last two quarters’ auctions.

“There are no big headlines this time,” said Madsen.