The Covered Bond Report

News, analysis, data

Annuity structure allows Jyske negative coupon milestone

Jyske Realkredit is issuing the first Danish fixed rate covered bonds with a negative coupon in a milestone for the market, although due to its callable annuity structure, the coupon is a less complicated and dramatic development than it might initially seem, according to its head of mortgage ALM.

Jyske Realkredit, the Danish mortgage credit institution of Jyske Bank, on Monday announced that it is issuing two new covered bonds out of its capital centre E, a 30 year with a 0.5% coupon maturing on 1 October 2050, and a 10 year with a minus 0.5% coupon maturing on 1 October 2030.

The negative coupon comes as an increasingly large proportion of European government and covered bond markets trade at negative yields, but represents a first in terms of the covered bond carrying a negative fixed rate coupon. Several fixed rate benchmarks have been sold at negative yields in euros, but have been priced above par with zero or marginally positive coupons, with negative coupons deemed a practical as well as psychological barrier, with the necessary market infrastructure not in place.

News that Jyske is issuing a fixed rate negative coupon bond therefore generated excitement among some market participants and observers.

“It seems fair to say that nothing is impossible anymore,” said a covered bond analyst.

However, Anders Lund Hansen, Jyske’s head of mortgage ALM, told The CBR that the move is “a lot less dramatic than some people have made out”.

“That doesn’t change the fact that having a negative coupon on callable bonds is a milestone,” he added, “not only for Jyske, but for the entire Danish mortgage industry.”

Jyske’s negative coupon is a fixed rate callable annuity bond, rather than a bullet structure, and under Danish mortgage system’s balance principle quarterly principal repayments from borrowers are passed to bondholders. On Jyske’s new issue, these will exceed any negative coupon payments that otherwise would be required to be made, meaning that bondholders simply see their redemption payments reduced by the amount of the negative coupon.

“People have a hard time getting their heads around how the negative coupon works,” Jyske’s Hansen told The CBR, “but this is because their immediate reaction is to think about a bullet structure, which this isn’t – it’s an annuity. Initially I had the same thought, can this actually work?

“But as soon as you sit down and look at the cashflows, you can of course see that a negative coupon is easily doable because the instalments and hence redemptions on the cashflows from the borrowers to the investors are quite substantial on a 10 year annuity.”

Jyske and other Danish mortgage credit institutions have already been operating a similar procedure on floating rate notes, with Cibor and Cita fixings having been in negative territory for some time. VP Securities, which handles payments on the Danish issuance, already has systems in place for these FRNs and will use these to handle Jyske’s 10 year callable until a system for handling fixed rate bonds is in place.

“It’s a minute technical factor and investors won’t notice a thing,” said Hansen. “We just wanted to inform them upfront.”

There has been much discussion about the extent to which negative yields are affecting demand for covered bonds, but Hansen (pictured) does not expect the negative coupon to significantly impact demand for Jyske’s 10 year callables.

“We saw a small change in the investor community when we introduced the zero percent 10 year callable, because some investors have mandates stating that they must buy interest bearing products,” he said, “so the mere fact of us introducing a zero percent cut them off from our investor base.

“I can’t rule out that some investors will turn their backs, saying, enough is enough, a negative coupon bond is not something that I would invest in. But I think it will be a smaller shift than when we introduced the zero percent 10 year callables some time ago – it’s just another step down this road. And if we look at the segment of borrowers using the 10 year mortgage product, it is roughly one-tenth of our 30 year product, so it’s not a segment we have massive issuance into.”

Jyske took the decision to launch the negative coupon issue when its outstanding zero percent 10 year callable bond traded above par.

“We can’t then just decide to issue above par with a negative yield because that is not allowed under Danish mortgage legislation,” said Hansen. “We need to have a bond that is below par to be able to grant new loans.

“So it was a question of either closing the 10 year mortgage product – which could be done because it is not the most popular product, with most borrowers opting for the 30 year – or introducing this this negative coupon.”

Jyske was the first Danish mortgage credit institution to proceed with a zero coupon issue.

“Not long after that we started preparing a possible fixed rate bond with a negative coupon,” said Hansen, “making sure we had all systems in place. It is not important for us to be first, but it is important for us always to have the best possible product offering to our clients.”

The zero percent 2030 callable bond was opened on 26 February and DKK950m (EUR127m) has been issued. The product is typically used for second mortgages or for those remortgaging who do not want to extend the maturity of their loan, according to Hansen, but not usually considered appropriate for buying new properties.

A funding official at another Danish mortgage credit institution echoed Hansen’s thinking when asked if other issuers could follow Jyske into negative coupons.

“I don’t know if we are going to do it, but potentially we could do,” he said. “If we don’t have an alternative because we are not allowed to tap callable covered bonds above par, then yes, we would most likely open the next coupon, and that would be negative.

“Having said that, it’s a 10 year bond, which is not the benchmark mortgage product, so to speak, that you would use for financing mortgages for your average homeowner. There is some volume in it, but it’s not massive.”

He said that while Jyske might be offering the first negative coupon fixed rate callable, the opening of 30 year callable fixed rate products paying 0.5% coupons by all the Danish issuers better highlighted the interest rate environment.

“We have seen massive prepayments in our fixed rate mortgages over the summer,” said the funding official. “It’s the biggest prepayment term ever, of something like DKK185bn (EUR24.8bn) for 1 October, so we are issuing enormous amounts of fixed rate callable covered bonds these days to refinance the loans.

“The new bonds we are issuing in primary now have a 1% coupon, but if they all go above par, we could see the 50bp bond become quite big pretty quickly.”

E-mail this article's headline, intro and link

Leave a Response

Please note: comment moderation is enabled and may delay your comment. There is no need to resubmit your comment.