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ING going soft

22 August 2014
Richard Kemmish

Even the terminology is disparaging. Would you rather hard or soft? With the possible exception of pillows, you’d prefer hard. Hard promises, hard drink, hard bullet.

ING’s ‘soft bullet’ programme launched this month is in parallel with their existing ‘hard bullet’ programme. Apparently there is no intention to issue off it any time soon, so presumably it is for repo purposes? The ECB does not share the market’s prejudice against this structure.

But what intrigued me about this was that they went to the time and trouble to set up a parallel programme for the two options. They didn’t need to according to the documentation of their existing programme. Barclays, to pick just one example, happily run hard and soft off the same programme.

Was this about an abundance of caution?  we want to reassure investors that the existing programme will never go soft (there you are, disparaging reference again).  Was it about inter-creditor issuers? Probably not, any self-respecting inter-creditor deed should be able to cope with both types of structure.

I suspect that if the programme is for repo purposes it will go for a much longer extension, something approaching a conditional pass through structure – again the ECB does not share the market’s prejudice – and get both a material improvement in rating delinkage and collateral efficiency (but more significant inter-creditor problems if you have existing hard bullets off the programme).
The first issuer of extendibles, (er, Northern Rock since you ask) came to market 10 years ago arguing plausibly that it was a more robust structure than the pre-maturity test, particularly in a jump to default scenario. They then selflessly demonstrated that this was the case by jumping to default. Needless to say none of the bonds extended or missed so much as a cent of interest or principal.

Thanks lads, but you really didn’t have to go that far to make your point.

In a bull market, for every investor who disliked soft bullets there were five who didn’t care. In the subsequent bear market other credit topics came to the fore and the hard/soft debate was pushed to the back of the shelf.

Is the debate now back? Has anything changed? I would argue yes, two things.

Most importantly the resolution directive has made the probability of extension far more remote. A failure to pay on the scheduled maturity date used to be an equivalent risk to a default on senior unsecured debt (covered bonds in these structures are senior unsecured debt, they just have secured guarantees. The extension allows the possibility of a grace period on the guarantee). Now though the payment on the covered bond is an exempt payment under the resolution directive – so you can default on the senior and not on the covered bond.

Secondly, as our Geordie friends demonstrated, if a bank failure is idiosyncratic there is no risk of an extension as mortgage pools self-liquidate very quickly (the relic of Northern Rock is sitting on a mountain of cash from redeemed mortgages waiting for the bonds to mature).  Extension risk is a problem when a failure is systemic (hence mortgage borrowers can’t redeem and go elsewhere).
Both of which, to me, suggest that any remaining prejudice against the structure is no longer justified. Soft is good.

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