CoCos Become Rating Lever as Nordic Banks Adjust Buffers

Nykredit Realkredit A/S, Europe’s biggest issuer of mortgage-backed covered bonds, is planning to use its first sale of contingent convertible notes to bolster its rating after meeting capital requirements.

The Copenhagen-based lender, which is preparing a 500 million euro ($685 million) issue of Tier 2 CoCos that will be written down and canceled if a 7 percent capital adequacy requirement is breached, will use the securities “to get the best possible issuer rating relative to costs,” Chief Financial Officer Soeren Holmsaid in an interview. He said the lender may opt not to replace all of the 1.5 billion euros in hybrids maturing next year.

Nykredit is set to become the second major bank in Denmark to issue CoCos after Danske Bank A/S (DANSKE), the country’s largest lender, sold additional Tier 1 convertible debt in March. Investors bid 17 times the 750 million euros sold, as early issuers of the new securities benefited from pent-up demand.

Standard & Poor’s upgraded the Danske note a month later, giving it the lowest investment grade of BBB-. Fitch Ratings said this week Nykredit’s Tier 2 issue will probably get a BBB rating, pending final documentation for the note.

‘A Balance’

“It’s always a balance to see how high you need to go on capital before it pays off on bond ratings,” Holm said. “We’re not legally obligated to issue more and may only be compelled to do so due to market and rating conditions.”

Since Danske sold its CoCo in March, the yield has dropped to trade at about 5.5 percent yesterday, versus a March high of 5.72 percent, according to data compiled by Bloomberg. The spread relative to the government yield curve was 466 basis points yesterday, compared with a March high of 517 basis points, based on bid values.

Nykredit, which has a stable issuer rating of A at Fitch, a negative A+ rating at S&P and an unsolicited stable Baa2 rating at Moody’s Investors Service, won’t have the same coupon deferral option that Danske’s additional Tier 1 note carries.

“We don’t know how much more we’ll issue,” Holm said. “It all depends on how much capital strength we want to show as we actually don’t need to issue and could let the hybrids just expire.”

Fitch said Nykredit’s CoCo rating will mainly depend on the lender’s credit worthiness as an issuer.

“The notes’ rating is also sensitive to a wider notching if Fitch changes its assessment of the probability of the notes’ non-performance risk relative to the risk captured in Nykredit Realkredit’s Viability Rating.”

(Source: Bloomberg)