Lloyds led the way into a new era for sterling bank issuance with a £750m three year FRN covered bond today (Wednesday) that is the first benchmark from a financial institution to be linked to SONIA, with a £1.4bn book a sign of investors’ “surprising” readiness.

The deal is only the second benchmark sized-bond linked to the Sterling Overnight Index Average (SONIA) in the rate’s current guise, following a £1bn five year FRN for the European Investment Bank (EIB) in June that followed more than a year of preparatory work.

The backward-looking SONIA rate has been put forward by the Bank of England to replace Libor as the primary sterling interest rate benchmark in bond, loan and derivatives markets, with Libor to be phased out by 2022.

Lloyds Bank’s deal replicates the structure used by EIB, with the coupon determined by compounding SONIA daily.

“If you look at the evolution of the market, it makes sense that you start with SSAs and then move down into the covered bond arena,” said a syndicate banker at one of the leads. “Lloyds is a brilliant name to open this market given it is a UK champion, it’s got big investor sponsorship, and it’s an established covered bond issuer.”

The UK issuer announced a mandate for the deal on Monday afternoon and – with leads Lloyds, HSBC, RBC and TD – gathered feedback from investors on technical aspects of the deal yesterday (Tuesday), announcing in the afternoon that they had received a number of IOIs and that the deal could proceed today.

The deal was launched this morning with guidance of the SONIA plus 45bp area. After around one hour and 30 minutes the leads announced that books had surpassed £1bn. The spread was subsequently set at 43bp and the size at £750m (EUR832m) with books over £1.2bn, excluding joint lead manager interest. The final book stood at over £1.4bn.

“The strategy of the extended execution process paid off, because the books opened with significant momentum, said the lead syndicate banker. “£1.4bn is a big sterling book – that doesn’t often happen.”

Accounts in the UK and Ireland were allocated 95% of the deal and Europe 5%. Banks took 70%, asset managers and pension funds 25%, and central banks and official institutions 5%.

Bankers said this was similar to the book composition that would be expected in a typical Libor-linked sterling covered bond.

“The investor response has been very strong and there are clearly a number of accounts that are keen to get engaged in this new product, which is basically readying the market for a post-sterling Libor world when they stop being published in 2021,” said another syndicate banker at one of the leads. “This deal will surely get a lot of attention from Lloyds’ peers.”

Syndicate bankers said the deal paid a premium of around 2bp for the new structure.

They estimated that an equivalent sterling covered bond linked to three month Libor would have been priced at around 25bp. The three year basis swap between SONIA and three month Libor was seen at around 16bp today.

“Fortunately there has been a reasonably liquid SONIA-three month sterling Libor basis market that has been used for some time and is fairly liquid out to five years,” said a syndicate banker. “This means it is fairly straightforward to compare the spreads.”

The EIB’s £1bn five year was priced at SONIA plus 35bp.

Syndicate bankers said issuing a SONIA-linked bond brings with it a number of challenges in terms of setting up new systems, but that much of the groundwork had been laid by the pioneering EIB transaction and that the number of accounts unable to participate in the new issue was surprisingly low.

“That previous work was also a done with a very similar investor base, those that do target triple-A assets,” said one. “Of course, not every buyer is ready and set up to buy this type of trade and a number of investors are still working within their own internal models and systems, making sure they have a SONIA-based curve set up to value these notes and that they are comfortable holding this type of risk.

“But we have had some secondary trading in the EIB line that gives confidence around the more technical amounts of valuations not just in the primary but on the secondary market.”

Other issuers are likely to be encouraged to follow Lloyds in issuing SONIA-linked sterling bonds to prepare for the post-Libor world, banker said, although they said further issuance may not come in the very near term due to the amount of time required to update prospectuses.

“This is a great trade, and Lloyds’ leadership has paved the way for others,” added one of the lead syndicate bankers.

Bonds have been fixed to SONIA before, but not since 2010 and not since the Bank of England reformed the rate in April of this year, strengthening the rate and substantially increasing the number of transactions it references.