Icelandic banks face long road to recovery

Fri Feb 24, 2012 10:57am EST

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LONDON, Feb 24 (IFR) - Iceland's Arion Bank, formerly known as Kaupthing, has sold the first covered bond since the country's banking sector collapsed in 2008, although market supporters say the country's banks are still unlikely to pique the interest of international investors.

In the wake of the deal that was taken up exclusively by domestic institutional investors, a number of European accounts are still reluctant to look at Icelandic debt.

They say this is not only because of the sovereign's banking and currency collapse, but more so because of the size of the country (population 317,398 according to the World Bank) and therefore the level of work it would take to analyse the credit.

"Iceland is just such a small jurisdiction so it's really not something that international investors would look at," said Daniel Loughney, portfolio manager at Alliance Bernstein.

"I think domestic investors are likely to buy into smaller deals and then Nordic investors could also get involved."

Covered bond syndicate bankers away from the deal also questioned whether investors would be willing to buy Icelandic covered bonds or not.

"Iceland is famous for two things - having a population of 300,000 and having a banking system that went boom a few years ago. I don't think you will see international investors looking at these bonds particularly because the programme is only EUR1bn in size it just wouldn't be worth their while," said one.

STARTING SMALL

The bank launched a EUR1bn covered bond programme two weeks ago that is listed on the Luxembourg and Iceland stock exchange and was arranged by Barclays Capital, Deutsche Bank, UBS and Arion Bank itself.

The bank priced the first deal off the programme last Friday, printing a IKr2.5bn (EUR15m) private placement trade that was "massively oversubscribed" according to Arion.

According to a lead manager the bond had a five-year maturity with a coupon of 3.6% issued at 100% and is callable each year after 2017.

BABY STEPS

And while some are skeptical about Icelandic banks' ability to lure international investors, there are those that think it is an important first step and one that will lead to further issuance and eventually international interest.

"The message is clear - covered bonds are an optimal way for financial institutions from countries in the rehabilitation process to get back into the capital markets," said Ted Lord, head of European covered bonds at Barclays Capital.

"Iceland experienced a total market meltdown and a full nationalisation of the banking system. Despite this, investors in Icelandic covered bonds got their money back in full, on time, and with interest."

Salim Nathoo, a structured finance partner at Allen & Overy that advised the bank on the offering shared that optimistic view and said: "We see this as a good example of the reopening of the Icelandic banking system."

SOVEREIGN GAINS

Iceland has made significant gains in the past year and recovered its investment-grade rating from Fitch last week which has positive implications for the country's banks.

Fitch raised Iceland's credit rating to BBB-minus from BB-plus, adding to the investment grade ratings of BBB- from S&P and Baa3 from Moody's Investors Service. The rating agent praised the sovereign for restoring macroeconomic stability after its 2008 banking and currency crisis.

"When markets are shut it takes the sovereign to get things going, then comes covered bonds and eventually banks gain access to the international markets. Iceland is now following this pattern," said a DCM banker.

In June of last year the Republic of Iceland sold a USD1bn five-year US dollar deal that marked the return of the sovereign to the capital markets having been absent for five years.

Arion is 87% owned by Kaupskil, a subsidiary Kaupthing Bank which was one of Iceland's three banks that collapsed in 2008. The remaining 13% is owned by the government. (Reporting by Aimee Donnellan, Editing by Helene Durand)

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