The covered bond market, long established, standard, slow moving, boring even (but in a good way) isn’t exactly renowned for being the fastest of the financial markets to embrace change. So, when an issuer actually makes innovation work to better fund their business, and at the same time makes their investors happy that’s praiseworthy. And that is exactly what NN Bank, issuer of GlobalCapital’s Best Pioneering Deal of the Year, managed to do last June.
NN Bank had been a popular, if small, issuer of conditional pass-through covered bonds since 2017. But as the business grew, and as more home buyers demanded long dated, fixed rate mortgages they soon realised the limitations of the market for conditional pass through securities and how a more traditional soft-bullet structure might better meet their funding needs.10
NN Bank treasury identified two particular areas for improvement. Firstly, as Niek Allon, head of treasury, puts it: ‘Soft bullet covered bonds is just a larger market. With the funding needs that we have going forward covered bonds will be our most important capital markets instrument…and when you think about it, soft bullet is just a much larger market.”
The theory worked in practice when they came to issue their first soft bullet transaction in June 2020. Allon estimates that around half of the investors were new to NN Bank.
The other advantage is duration, says Rolf-Pieter ter Horst, funding manager at NN Bank. “Conditional pass through bonds are only proven up to 10 years...now we have managed to do up to 20 years [in soft bullet format].” This is important as NN Bank‘s Dutch mortgage clients increasingly want to lock in current low rates for longer periods, stretching the asset side duration.
With the funding needs that we have going forward covered bonds will be our most important capital markets instrument…and when you think about it, soft bullet is just a much larger market.
One of the traditional advantages of a conditional pass through structure, at least from an issuer’s perspective, is its greater collateral efficiency; it simply needs less over-collateralisation. But according to Ter Horst, for them this is no longer the case, their soft bullet programme is actually constrained by the Dutch law requirement for a minimum of 5% collateral, more than that asked for by the rating agencies but less than the level they have committed to on their conditional pass through programme.
To NN Bank the advantages of switching to a soft bullet structure were compelling. But how to do it?
For Ter Horst, communication was key: “we pre-announced in a press release, explained the reasons, the size we will need, and the extent of the duration”. They were also open to investor calls. The feedback that NN Bank got was that investors really appreciated the transparency about their intentions.
Another important part of the communication strategy, and one that NN bank has been at pains to repeat, is that there is nothing wrong with their old conditional pass through bonds, it had helped fund NN’s business in its early phase, the structure is very robust and NN bank remains fully committed to the old programme and would do what was necessary to maintain it.
When the deal did come to market it was a resounding success, launching at 15 over mid-swaps it attracted a €1.75bn order book. Although very helpful, cost wasn’t a main motivation of the programme – Allon estimates that this represented a saving of 8 to 10 basis points. Crucially, the relative value discussions were conducted based on other soft bullet Dutch issuers – de Volksbank in particular was a helpful recent precedent – rather than the issuer’s existing conditional pass through bonds.
From the realisation that a soft bullet programme is needed, to that first successful deal it took six months to get the necessary documentation, regulator approvals and operational processes in place. But they could never have known that it would be a success, as far as NN bank knew they would be the only issuer in the world to have parallel soft bullet and conditional pass through programmes (others have issued both structures, but from the same programme, an approach impossible under Dutch law). “Embarking on that process takes a bit of courage,” says Allon.
The acid test of a debut deal though isn’t the deal itself but how well it sets the issuer up for subsequent funding. Since their debut deal NN Bank have been back to the market four times, three times in €500m benchmark format, once in a smaller club deal and, crucially, all of the follow on transactions have been for the longer maturities that NN Bank need – up to 20 years for their longest deal – and all four deals have been well over-subscribed. This proves that, for NN Bank, even in the conservative and slow moving covered bond market, a little bit of innovation, managed properly, can be a good thing.