Iceland’s rarity is a blessing and a curse

Iceland’s long-awaited sovereign green bond appeared at first to tick every box an issuer could have hoped for.

Four years in the making, the €750m 10 year transaction generated a final order book of €7bn, allowing for it to be priced comfortably inside initial guidance at 95bp over mid-swaps. Almost 280 accounts participated in the 4.5% March 2034 green debut, led by BNP Paribas, DZ Bank, JP Morgan and Nomura.

As it was under no funding pressure, Iceland enjoyed the luxury of being able to choose its timing, launching in mid-March in a benign market environment. This, coupled with Iceland’s scarcity value and the strength of its green credentials, made the deal’s success a virtual certainty.

What was more surprising was the performance of Iceland’s issue in the secondary market, where the bonds tightened by between 25bp and 30bp within a couple of months.

A harshly critical view would be that this suggests the bonds were mispriced. A fairer interpretation is that it illustrates how challenging it is to find fair value for a credit issuing into a virtual vacuum in terms of immediate comparables.

Myriam Zapata, SSA DCM ESG specialist at BNP Paribas, says that the right price is — by definition — the level at which investors are prepared to buy. “Investor feedback suggested that fair value was around 105bp, which is why we started at 110bp,” she says.

“We don’t have much to compare Iceland to,” says Zapata. “The Nordics are the obvious benchmarks. But they issue in their own currencies. For euro issuance, the closest comparables are some of the central and eastern European sovereigns.”

That’s an imperfect comparison at best. The liquidity profile of some of the CEE issuers might be similar to Iceland’s. But there the similarities end. Economically, politically, socially and ecologically, Iceland and central Europe have very little in common.

Nor was Iceland’s own curve much help as a pricing guide. This year’s green trade was its first euro issue since early 2021, when it had priced a €750m 0% April 2028 note at 48bp over mid-swaps.

Reykjavik-based bankers are understandably frustrated that the irregularity of the sovereign’s presence in the market, an inevitable by-product of the size of the economy, compromises its pricing power.

“Iceland’s government, corporate and household debt are all low by international standards, and we have been consistently out-growing other Nordic economies for the last 20 years,” says Sturla Pálsson, director of markets at the Central Bank of Iceland. “So, on the basis of all our economic fundamentals, fair value on our bonds is much tighter. In these markets, a 10-year benchmark for the Republic of Iceland at 95bp over swaps is clearly an extremely good deal for the investor.”

Pálsson adds: “If we could make a soft commitment to be in the new issue market every year, it would be much easier for us to come out with IPTs [initial price thoughts] that would tighten less in the bookbuilding process and improve our bargaining power with the investor base.”

However, he says: “This is an unavoidable trade-off, because as a small economy we don’t want to accumulate too much government debt in foreign currencies.”

Another reason why Iceland’s green bond presented an unusual pricing challenge is that its sustainability profile is very different from virtually every other country in the world. As Zapata says, Iceland is regarded very highly from an environmental and social perspective. It has no fossil fuels to speak of and is a recognised leader in renewable energy, which is used to heat every home on the island.

Iceland has no scope for deforestation, because the Vikings chopped down all its trees a thousand years ago. It can’t spend money on weapons because it has no army.

And although female workers staged their first strike since 1975 last year, Iceland has topped the World Economic Forum’s global gender gap rankings for well over a decade.

All this makes Iceland a global role model for environmental and social standards. This raises the question, posed by a number of investors on the roadshow, why Iceland needed to step down the green bond route at all.

Pálsson agrees that if you strip out the aviation and fisheries sectors, which can give a distorted impression of Iceland’s environmental profile, it probably produces fewer emissions than virtually any other economy. This makes Iceland one of the last countries in the world that could be accused of greenwashing.

But Pálsson says that while Iceland is clearly some way ahead of many other countries from the perspective of sustainability, it still has plenty to do, which meant there was a long list of use of proceeds from this year’s green issue.

“There are multiple ways in which we can improve on our environmental performance,” he says. “One example we are looking at is strengthening the [electrical] links to our harbours to allow trawlers, cargo ships and cruise liners to connect to the local grid rather than use diesel.”

With no shortage of sustainable infrastructure projects to be financed, says Pálsson, the benefits of issuing in green format comfortably outweighed the costs associated with the pre- and post-issuance documentation and reporting.

“The fact that we decided to issue a green bond underlined how serious the government is about meeting the commitments we have made on sustainable development,” says Pálsson.

“In terms of placement, I think we achieved the best of both worlds,” he adds. “We had about 277 names in the book, and although we were only able to allocate bonds to less than half of them, having our debt held by about 150 investors globally is very healthy for an economy the size of Iceland.”

The success of the sovereign’s green bond reflects a more general strengthening of demand for scarce Icelandic credits.

Among the three banks that aim to maintain as regular a presence in the market as their modest financing requirements allow, Landsbankinn was first out of the traps with a deal this year, in early March. Its €300m 5% May 2028 green senior preferred transaction via ABN Amro, Barclays, Bank of America and Goldman Sachs was priced 40bp inside initial price thoughts, at 225bp over swaps.

Later the same month, Íslandsbanki completed its first euro issue of 2024, with a €300m 4.625% March 2028 senior preferred transaction via ABN Amro, Bank of America, Morgan Stanley and Nomura. Pricing was tightened to 185bp, compared with initial guidance of 230bp over swaps.

In May, Arion Bank benefited by being the last of the trio of Icelandic banks to access the senior market in euros, issuing its slightly longer deal at a tighter spread than either of its compatriots. Arion priced the €300m 4.625% November 2028 senior preferred issue via ABN Amro, Barclays, Morgan Stanley and JP Morgan at 175bp over mid-swaps.

“I believe it was the strongest book for any Icelandic issue for more than a decade,” says Theódór Friðbertsson, head of investor relations at Arion. “The deal was more than eight times oversubscribed, and the number of investors surpassed our expectations. So did the geographical diversity of demand, which came from more than 25 countries.”

“Only a year ago we were issuing at around 400bp,” Friðbertsson adds. “When rates were at their lowest, the best pricing we achieved was around 65bp over for a senior preferred issuance.”

Others agree that the pricing levels commanded by Icelandic banks have been almost absurdly volatile in recent years, with wild gyrations in secondary market spreads entirely uncorrelated with economic fundamentals.

William Symington, head of international funding at Íslandsbanki, points to the example of the €300m three year green senior preferred bond his bank launched at the beginning of 2022.

“We priced at a spread of 83bp, and by the end of 2022 the bond was marked at 500bp over,” he says. “During that time, the Icelandic economy and banking sector prospered. But it was a very bearish rate environment, and investors were running scared from financial assets and being highly prescriptive about what they wanted to buy and at what level.”

No wonder funding officials at Iceland’s three banks watch their pricing levels with a mixture of bemusement and exasperation.

“Of course we get somewhat frustrated by the volatility of our spreads, which are mostly unrelated to Iceland’s economy or to the credit quality of the banks,” says Hreiðar Bjarnason, CFO at Landsbankinn.

For the foreseeable future, it is hard to see how Iceland’s banks can free themselves from paying a surcharge for their relative illiquidity by increasing their supply in international markets.

“Since 2008 the Icelandic banks have had a purely domestic focus, which means that our loan growth is significantly linked to expansion of the domestic economy,” says Bjarnason.

This inevitably restricts the banks’ scope for increasing their presence in the euro covered bond market. “Our mortgage portfolio is exclusively in Icelandic krónur, so there is a regulatory as well as a risk appetite-related limit to the volume of covered bonds we can issue in euros,” says Bjarnason.

Among other options for diversifying their international funding strategies, the green bond market is one that the Icelandic banks are monitoring closely.

Symington says that Íslandsbanki contemplated issuing its most recent euro transaction in green format. “But the market was so hot we took the view it would be better to save our green allocations for a rainier day,” he says. “In any case, we were able to tighten pricing from initial price thoughts to such a degree that any potential greenium would have been irrelevant.”

Besides, Symington says that the green label probably provides more of a pricing advantage for issuance in Scandinavian currencies than in euros. This is an important consideration for a bank like Íslandsbanki that regards currencies such as the Swedish krona and Norwegian krone as important sources of funding.

Friðbertsson says that Arion plans to build on its existing green framework with an updated version that will also include social categories. “When it comes to eligible assets we had more or less utilised most of them in our existing senior green bonds, although we did [hold a tender offer for] one of our green bonds in parallel to our recent issuance,” he says. “Some of our other green bonds are also approaching maturity which will further free up eligible assets. Our intention is that the share of sustainable assets will continue to grow as a percentage of our total loan book, but that will obviously take time.”