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Issuers Feed Demand For Subordinates

High-grade financial institutions are increasingly taking advantage of investor demand for extra yield by issuing more subordinated debt, and the trend is expected to continue in the coming months if the historically tight spread environment remains pervasive.

High-grade financial institutions are increasingly taking advantage of investor demand for extra yield by issuing more subordinated debt, and the trend is expected to continue in the coming months if the historically tight spread environment remains pervasive. "Interest in issuing subordinated debt is strong in times of spread compression and we should see a steady flow of new issuance," said Edward Marrinan, head of North American investment-grade strategy at J.P. Morgan Securities.

The Aug. 17 dollar-denominated issue from Royal Bank of Scotland--$950 million of a tier one-type instrument, 5.512% callable in 2014--is indicative of subordinated debt's appeal to U.S. investors, said one banker.

The difference in spreads between lower tier-two and tier-one bonds is roughly 45 basis points, or 10-15bps narrower than historical norms. The levels are compressed because investors are more comfortable taking on subordinates now given the benign credit environment and an appetite for extra yield, according to bankers. Marrinan noted an added incentive for corporates is subordinated debt allows them to meet regulatory capital requirements at a less onerous cost than equity.

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