Hypo Noe is set to issue Austria’s first benchmark soft bullet covered bond, having adopted the structure after observing that it has become accepted by investors and noting proposals to allow maturity extensions in Germany, its head of liquidity management told The CBR.

Hypo Noe Gruppe Bank AG is on the second leg of a two week European roadshow ahead of an expected Eu500m no-grow public sector covered bond issue, which will have a six or eight year maturity. The deal would be its first benchmark covered bond since September 2014, when it sold a Eu500m seven year mortgage-backed issue.

This comes after Hypo Noe amended the base prospectus for both its public sector and mortgage covered bond programmes last June to allow for soft bullet issuance, becoming the first Austrian issuer to do so – although in 2015 Austrian Anadi Bank, formerly Hypo Alpe-Adria-Bank, inaugurated a conditional pass-through programme that it has not issued any benchmarks off.

Markus Payrits, head of liquidity management at Hypo Noe, told The Covered Bond Report that the issuer has adopted the structure because it sees a clear trend of investor demand for soft bullet issuance.

He also noted that the Austrian bank took the decision after observing that the Association of German Pfandbrief Banks (vdp) has proposed that maturity extensions be allowed under the German Pfandbrief Act, and added that its target was not to achieve a “quick, short term” rating advantage by getting lower overcollateralisation requirements from Moody’s (which is expected to rate Hypo Noe’s awaited issue Aa1).

Payrits noted that there is no official definition of soft bullets in the Austrian Pfandbrief Act, under which Hypo Noe issues its covered bonds.

He highlighted that under Hypo Noe’s definition, the extension period is a maximum of 12 months with the possibility of quarterly (partial) repayments. Within this 12 months the coupon will change into floating (three month Euribor plus re-offer spread), floored at zero. He added that the soft bullet structure will only become effective in the event of the issuer’s default – and hence was not at the issuer’s discretion – and said the structure should help the trustee achieve the highest possible recovery rate during the extension period.

The soft bullet amendment is valid only for Hypo Noe’s new issuance, and the terms and conditions of its outstanding bonds have not changed. The issuer has two small soft bullets outstanding, as in August 2016 it issued a Eu100m soft bullet floating rate note out of its public sector pool, before it issued a Eu3m private placement out of its mortgage pool last week.

Karsten Rühlmann, senior investment analyst at LBBW, noted that Austria is one of the last covered bond segments to join the soft bullet trend, along with Germany, Luxembourg and the Spanish single cédulas market.

However, he said other Austrian issuers are unlikely to follow Hypo Noe’s example.

“Our research has revealed that Hypo Noe is currently the only Austrian institution that has included the option to issue soft bullet bonds in its base prospectus,” he said. “Against this backdrop and after talks with several Austrian issuers, we do not currently expect Hype Noe’s initiative to result in a turnaround in the Austrian market.”

Hypo Noe issues covered bonds under the Austrian Pfandbrief Act, one of three pieces of legislation governing different covered bond types in the country. Rühlmann noted that this law features only limited provisions on the management, and that issuers can include rules on liquidity tests and on the implementation of cover calculations on a present value basis in their articles of association.

“Setting up soft bullet structures is a further cheap alternative to manage liquidity and funding costs,” said Rühlmann. “In its reports on Austrian issuance programmes, the rating agency Moody’s often levels criticism at the lack of such extension structures.

“Against this backdrop, Hypo Noe’s introduction of a soft bullet structure may be viewed as a response to that criticism. However, our understanding is that most of the outstanding bonds should consist of soft bullets initially until the structure is reflected in a corresponding rating.”

Rühlmann suggested that one reason for other Austrian issuers deciding against amending their programmes for soft bullet issuance is that should long-standing efforts to create a new, unified Austrian covered bond framework progress, the new law could include more detailed rules on liquidity management.