UniCredit reopened the Italian covered bond market yesterday (Wednesday) with a Eu1.5bn dual tranche OBG that included a ground-breaking public euro FRN benchmark, and an official at the issuer said it was an innovative transaction offering many benefits.

The deal marked the UniCredit group’s third visit to the euro debt capital markets this year, after UniCredit SpA sold a Eu1.25bn seven year senior unsecured bond on 7 January and UniCredit Bank Austria priced a Eu500m 10 year covered bond on Monday.

It is the first obbligazioni bancarie garantite (OBG) issue of the year and only the third peripheral covered bond of the year, with the senior unsecured market having been the focus for peripheral supply so far.

The Eu1.5bn dual tranche transaction was split between a Eu500m three year floating rate note (FRN) and a Eu1bn 10 year fixed rate issue and was lapped up by investors. Leads Crédit Agricole, Credit Suisse, Danske, ING, Natixis and UniCredit built a combined order book of around Eu3.6bn, post-reconciliation, with nearly 250 accounts involved, according to one of the leads.

Both tranches were well oversubscribed, although demand was strongest for the 10 year fixed rate tranche, amounting to around Eu2.2bn, while some Eu1.4bn of interest was registered for the FRN.

Waleed El Amir, UniCredit

The 10 year OBG was priced at 98bp over mid-swaps and the FRN at 57bp over three month Euribor, the tight end of guidance that followed two spread revisions. Marketing of the FRN started at the 65bp over three month Euribor area before guidance was set at 60bp-63bp over and then the 60bp over area, while the fixed rate tranche was first pitched at 105bp-110bp over mid-swaps before official guidance was set at the 105bp over area and then revised to 100bp-105bp over.

Syndicate bankers away from the leads were positive about the transaction, saying it was “a great deal”, although one questioned the need to push pricing to inside 100bp over.

Waleed El Amir, head of strategic funding and portfolio at UniCredit, said that the transaction surpassed the issuer’s expectations, and vindicated what was a difficult call to proceed with the deal given a shaky market backdrop.

Broader market conditions deteriorated somewhat late Monday and early Tuesday, with heavy supply, especially of peripheral senior unsecured debt, taking its toll on spreads, but the correction proved short-lived and sentiment quickly improved.

“It wasn’t an easy call for us but we felt that the weakness was in the peripheral senior unsecured and core covered bond market, and that the peripheral covered market was pretty healthy,” said El Amir. “I was surprised by how well the deal went.”

At 98bp over, the 10 year fixed rate tranche came 5bp inside where a one year shorter UniCredit OBG was trading at the time of pricing, according to El Amir, beating the issuer’s expectation.

“The double-digit spread is phenomenal,” he said. “In 2012 we priced a seven year at 295bp over, so the rally and growth in confidence in Italian credit has been incredible.”

And while the issuer was convinced that the FRN tranche would be well received, the pricing of that was also better than expected, said El Amir.

The dual tranche structure is unusual in euro benchmark covered bonds, and the FRN was said to be unprecedented, with floating rate covered bonds hitherto limited to private, sub-benchmark size deals.

Syndicate bankers involved in UniCredit’s deal as well as others are referring to the FRN as a new product in the euro benchmark covered bond market, with the potential to become more widespread given structural and market shifts.

UniCredit’s El Amir said that the FRN was launched to take advantage of a bank treasury bid in covered bonds for Liquidity Coverage Ratio (LCR) and general investment purposes, and that the issuer felt FRN demand observed in senior unsecured would translate to the covered bond market.

The FRN also targeted accounts positioning themselves for eventual interest rate rises, he added.

The motivation and benefits for the issuer of the dual tranche deal were manifold, according to El Amir.

“It was a very elegant way of doing a large deal, diversifying our investor base, and doing something new,” he said. “It was also a clever way of averaging down the maturity, effectively to seven years.

“It cheapens the cost of funding while from an ALM perspective you stay roughly were you are on maturity, it attracts new investors and you move away from the concentration risk of having the entire deal mature in a single year.”

The issuer discussed doing an FRN on a standalone basis, but felt a dual tranche structure was the best way of testing the new product without exposing itself to too much execution risk, said El Amir.

“We typically issue Eu1bn deals, which may have been a stretch for an FRN and we also didn’t know if we really wanted to do that much for a three year FRN,” he added.

The leads and the issuer discussed sizing the FRN and fixed rate tranches at Eu750m each, according to El Amir, but decided to upsize the 10 year fixed rate tranche and downsize the FRN to stick to the issuer’s tradition of doing Eu1bn fixed rate deals.

Asset managers and banks drove the three FRN, taking 50% and 41%, respectively, followed by 6% for insurance companies and 3% for other accounts, according to one of the leads. Germany and Austria were allocated 30%, Italy 30%, France 11%, UK and Ireland 9%, Iberia 9%, the Benelux 5%, Nordics 2%, Switzerland 1%, and others 3%.

Insurance companies led demand for the 10 year fixed rate OBG, buying 35%, followed by asset managers with 32%, banks 26%, official institutions 4%, and others 3%. France took 33%, Germany and Austria 26%, Italy 9%, the Benelux 9%, UK and Ireland 7%, Iberia 7%, Switzerland 3%, Asia 3%, and others 3%.

UniCredit open to SME covered

Italian banks may soon have another type of law-based covered bond at their disposal, after the Italian government in December approved legislation that foresees a dual recourse bond that would be backed by collateral such as SME loans. The debt instrument is provided for in a December law decree that makes amendments to Law 130, which governs OBGs, but it would be a separate product. (See here for previous coverage.)

El Amir said that UniCredit is open to using the new SME covered bond proposed in the new law decree, but that there are no immediate plans for such a project and that the decision will ultimately depend on whether an SME covered bond would offer better cost of funding than prevailing options.