Nordic Covered Bonds 2017 – 2018
Nordic Covered Bonds 2017 – 2018
NORDEA BANK AB (publ) 2017 Marketing Material 09/2017 NORDEA BANK AB (publ) 2017
Nordic Covered Bonds 2017-2018
Table of contents
INTRODUCTION ...... 7
ISSUER PROFILES DENMARK ...... 9 BRFKREDIT ...... 10 DANMARKS SKIBSKREDIT ...... 13 DANSKE BANK ...... 16 DLRKREDIT ...... 19 NORDEA KREDIT ...... 22 NYKREDIT REALKREDIT ...... 25 REALKREDIT DANMARK ...... 28
ISSUER PROFILES FINLAND ...... 31 AKTIABANK ...... 32 BANK OF ÅLAND PLC ...... 35 DANSKE BANK PLC ...... 38 NORDEA MORTGAGE BANK PLC ...... 41 OP MORTGAGE BANK ...... 44 SP MORTGAGE BANK ...... 47 THE MORTGAGE SOCIETY OF FINLAND ...... 50
ISSUER PROFILES NORWAY ...... 53 DNB BOLIGKREDITT ...... 54 EIKA BOLIGKREDITT ...... 57 MØREBOLIGKREDITT AS ...... 60 NORDEA EIENDOMSKREDITT ...... 63 SPAREBANK 1 BOLIGKREDITT ...... 66 SPAREBANKEN SØR BOLIGKREDITT ...... 69 SPAREBANKEN VEST BOLIGKREDITT ...... 72 SR-BOLIGKREDITT A/S ...... 75
ISSUER PROFILES SWEDEN ...... 78 DANSKE HYPOTEK ...... 79 LANDSHYPOTEK BANK ...... 82 LÄNSFÖRSÄKRINGAR HYPOTEK ...... 85 NORDEA HYPOTEK ...... 88
NORDEA MARKETS | 4 SWEDISH COVERED BOND CORPORATION ...... 91 SKANDINAVISKA ENSKILDA BANKEN AB ...... 94 STADSHYPOTEK ...... 97 SWEDBANK MORTGAGE ...... 100
LEGAL FRAMEWORK ...... 103 DENMARK ...... 103 FINLAND ...... 105 NORWAY ...... 107 SWEDEN ...... 109
THE COVERED BOND MARKET ...... 111 DENMARK ...... 111 FINLAND ...... 116 NORWAY ...... 119 SWEDEN ...... 122
MACROECONOMIC CONDITIONS...... 125 DENMARK ...... 125 FINLAND ...... 127 NORWAY ...... 129 SWEDEN ...... 131
RATING - APPROACHES AND METHODOLOGY ...... 133
COUNTRY COMPARISON ...... 138 COVERED BOND LEGISLATION ...... 138 ADVANTAGES AND DISADVANTAGES ...... 139
CONTACT PERSONS ...... 141
NORDEA MARKETS | 5
NORDEA MARKETS | 6
Introduction
Welcome to the seventh edition of our Nordea Covered Bond Handbook. We continuously highlight the similarities between the Nordic countries and find these far greater than when compared with the rest of Europe. One important area in this respect that we watch closely is the booming Nordic housing markets. These have been on a rising trend driven in particular by Norway and Sweden. After a prolonged housing market downturn in Denmark, the largest Danish cities are now also seeing large price increases, and the Finnish market also appears to be slowly getting back on track. Our locally based macroeconomists will provide you with in-depth insight into the development of these markets. Likewise our analysts cover the latest trends and developments in the Nordic covered bond markets, enabling you to take stock of market opportunities and potential risks. Looking ahead, the major event to watch for will be the ECB’s tapering of its purchase programme and not least the particularities concerning covered bond purchases. The levels of monthly covered bond purchases are currently very low and could even be viewed as insignificant, but the same cannot be said about the size of the ECB’s covered bond portfolio. Any tapering of purchases is likely to impact yields and spreads; if not directly then indirectly via the impact on government bonds. Here Nordic covered bonds denominated in local currencies other than euro could provide a shelter, as only Euro-area covered bonds are included in the ECB’s purchase programme. Even so, the Nordic region will not be immune in case of substantial market movements in the Euro area. Our core area is the Nordic region and through our presence in each of the Nordic countries, we have thorough knowledge of each of the four Nordic markets. The Nordea Covered Bond Handbook should be viewed as a useful tool for seeking information about Nordic covered bonds. However, including the Nordic covered bond markets in their entirety is beyond its scope. And we would actually prefer that you contact us so we can give you the full story of the Nordics and tell you what the current market movers are. We hope you will find our Seventh edition of the Nordea Covered Bond Handbook interesting and informative.
I would like to thank all the Nordic desks for contributing to the publication, and not least a special thanks to Mikkel Holck Petersen for his work on updating this year’s version of our Nordic Covered Bond Handbook.
Uffe Kalmar Hansen Chief Analyst [email protected] +45 5547 1752
Please see the last page for a list of contacts.
NORDEA MARKETS | 7
NORDEA MARKETS | 8
Issuer profiles Denmark
BRFkredit
Danmarks Skibskredit
Danske Bank
DLR Kredit
Nordea Kredit
Nykredit Realkredit
Realkredit Danmark
NORDEA MARKETS | 9 BRFKREDIT
BRFkredit
Key points Strengths Weaknesses First mover advantage on Danish ground for High share of ARMs and IO loans in recent issuing EUR bonds. years.
High-quality cover pool consisting only of Borrowers financed via ARMs are exposed to Danish mortgages. interest rate risk.
The merger with Jyske Bank will continue to Quite high LTVs compared to Nordic peers strengthen BRFkredit through its wide (69.0% and 66.8% in pool B and E, respectively). distribution network.
Company profile Less than 10 years ago BRF was the third-largest covered bond issuer in Denmark, but its market share has decreased over time due to a weak distribution network. However, from 2014 to 2016, its market share has increased from 8.6% to 9.9% of outstanding Danish covered bonds with a modest increase of 0.2%-points throughout 2016 and thus BRFkredit is now the fourth- largest issuer of covered bonds in Denmark. After more than 10 years of collaboration on common funding of mortgage loans, Jyske Bank took full ownership of BRFkredit’s shares from BRFholding A/S in February 2014. The merger came into force by the end of April 2014. The merger has strengthened BRFkredit in which it continues to issue all of the BRFkredit mortgage bonds. The deal enhanced BRFkredit distribution power and thereby the combined lending volume.
Figure 1: Structure of BRFkredit Figure 2: Market share
Source: BRFkredit, Bloomberg
NORDEA MARKETS | 10 BRFKREDIT
Financial performance BRFkredit reported historically high profits for 2016, which was primarily driven by an increase in value adjustments and a decrease in loan losses. The merger of BRFkredit and Jyske bank in 2014 continues to influence the results of BRFkredit positively due to its extensive distribution network. Profits increased by 44.6% throughout the year, while net interest income declined by -3.3%. Impairments for loan losses heavily decreased by -131.1%. Capitalization ratios remained stable as both the capital ratio and the core capital ratio amounted to 19.0% at end-2016. Regarding the key ratios, one should acknowledge the fact that BRFkredit is not directly comparable to the financial groups which the other Danish issuers are a part of, because BRFkredit only focuses on mortgage financing. Nonetheless, both profitability and efficiency significantly improved as the return on equity increased by 2.3%-points and the cost to income ratio declined by -14.2%-points. Overall, BRFkredit has strong operations and a sound financial position.
Table 1: Key figures for BRFkredit
Source: BRFkredit Annual Report 2016
Cover pool composition BRFkredit has a total lending volume of DKK 290bn, which includes loans in capital centres B, E and the general capital centre. Pool B contains ROs at a value of DKK 19.8bn, whereas Pool E contains SDOs for a value of DKK 265.0bn. The cover pools primarily consist of DKK-denominated mortgage loans, primarily residential (72.6% in pool B, 86.9% in pool E) and commercial (27.4% in pool B, 13.1% in pool E). The weighted average LTV across all asset classes is 69.0% in pool B and 66.8% in pool E. S&P’s WAFF*WALS is 13.8% for pool B and 7.0% for pool E, which is higher than for most domestic peers.
ALM and risk The majority in both cover pool loans and outstanding bonds are DKK-denominated, however recently BRFkredit started issuing EUR bonds which makes the lender vulnerable to currency- and interest risk, but this risk is adequately hedged. Regarding refinancing risk, this is held by the borrower as well. The main risk faced by the issuer is credit risk, which is, however, limited by the legal right to execute a forced sale of the property in case of default on the loan.
Ratings All covered bonds are AAA-rated by S&P, while the issuer rating of BRFkredit is A-. S&P changed the outlook from negative to stable following the merger announcement of Jyske Bank and BRFkredit. S&P believes the combined entity will have business and risk positions that reflect the industry and economic risks associated with the Danish economy. In addition, the merger has and should continue to improve the relevant key ratios (SFR and BLAST). Potential improvements in capitalization could offset a lower likelihood of government support.
NORDEA MARKETS | 11 BRFKREDIT
Graphs and statistics
Table 2: Cover pool statistics
Source: BRFkredit, S&P
Table 3: Rating by S&P
Source: S&P
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning Q4 2016
Source: BRFkredit
NORDEA MARKETS | 12 DANMARKS SKIBSKREDIT
Danmarks Skibskredit
Key points Strengths Weaknesses Enjoys strong loyalty from private investors. Low rating compared to many of its domestic peers (DSF´s covered bonds are rated A by S&P). Only Nordic issuer of covered bonds backed by ship mortgages. Issues ROs (not SDOs).
DSF is owned by a consortium consisting of The shipping industry can be highly correlated PFA, PKA and Axcel. with the business cycle and the industry has performed poorly in recent years. High loan diversification on vessel type.
Company profile Danmarks Skibskredit (DSF) was established in 1961 to provide funding for ship owners. The company primarily operates in Denmark, but also provides loans to foreign shipping companies. DSF was granted the right to issue SDOs from 1 June 2007. However, the company has so far not utilized this right given by the Danish act on covered bonds. The majority of DSF´s shares (86.6%) were acquired by a consortium consisting of the leading Danish private equity fund Axcel and the two pension companies PFA & PKA through the holding company Danmarks Skibskredit Holding A/S in the fourth quarter of 2016. The consortium is equally weighted among the three owners. The Danish Maritime Fund holds 10% of the shares and the remaining shares are held by minority shareholders. DSF is allowed to provide loans up to 70% of a ship’s market value. However, it can provide loans for the remaining 30% if secured against other collateral. DSF carries out an update of the market values every 6 months of all financed vessels and verify that any agreed requirements on maximum loan-to- value ratios are complied with. Furthermore, physical inspections of the financed vessels are made on a spot-check basis. DSF has always adhered to the specific balance principle which ensures strict limits on interest rates, currency and interest rate risks. DSF mainly finances its operations through issuance of plain vanilla bullet covered bonds primarily denominated in DKK (89.5% of issued amount) and a smaller amount in USD (10.5% of issued amount).
Figure 1: Structure of the Danmarks Skibskredit Figure 2: Market share
Source: Danmarks Skibskredit, Bloomberg
NORDEA MARKETS | 13 DANMARKS SKIBSKREDIT
Financial performance DSF´s profit after tax has been under pressure in recent years and continued this trend throughout 2016 as it decreased by 54.5%, resulting in a decrease in the return on equity to 2.5% from 5.3% in 2015. This was primarily attributable to a massive increase in loan losses (1226%) caused by the poor market conditions in offshore and the dry bulk segment, which resulted in loans being restructured to create a buffer for the borrowers in order to survive the poor market conditions. Net interest income declined by 5.5% due to lower lending, while value adjustments improved as it amounted to DKK 124m compared to DKK -177m in 2015. The improvement was due to a reduction of the credit spread on mortgage bonds. Efficiency improved excluding loan losses as the cost to income ratio declined to 11.9%, while capitalization hardly changed and thus remained adequate during the year.
Table 1: Key figures for Danmarks Skibskredit
Source: Danmarks Skibskredit Annual Report 2016
Cover pool composition The value of DSF’s cover pool is DKK 41.8bn. Overcollateralization stands at 22.5%, which is above the level required by law of 8% of risk-weighted assets. Lending to one specific borrower is substantially larger than the rest and represents approximately 20% of the total lending at year-end 2016, against previously 35-40% of total lending. Due to this lending distribution there is concentration risk. This is mitigated by risk diversification focusing on diversification on vessel types on each loan. The five largest debtors represented 32% of total loans in 2016 vs. 34% in 2015. The five largest loans at year-end 2016 were secured by mortgages in 77 vessels comprising 8 vessel types.
ALM and risk DSF has accommodated itself to the specific balance principle, however it does not apply pass- through in contrast to the rest of the Danish covered bond issuers (except for Danske Bank). This implies that Danmarks Skibskredit stick to statutory fixed absolute limits for the size of allowable interest rate, foreign exchange and liquidity risks when there is a difference between payments on loans and funding. Under these rules, the company is prevented from assuming any noteworthy interest rate, foreign exchange or liquidity risk in connection with its lending operations. Due to the application of the specific balance principle, the most significant risk facing DSF is credit risk on the company’s cover pool loans. This is the risk of losses arising due to collateral not covering the residual debt if the customers default on their loans. This risk is handled by a high level of overcollateralization (22.5%) and a moderately low LTV of 68% (shipping assets).
Ratings DSF terminated its rating agreement with Moody’s on 12 Februrary 2016. Standard & Poor’s now performs the ongoing credit assessement of DSF. DSF’s issuer rating by S&P is BBB+, while its covered bonds are rated A. S&P´s outlook for DSF is negative, which reflects the current difficulties in the international shipping and offshore markets, which could lead to further deterioration of DSF´s asset quality. S&P expects the new ownership could expand the group´s funding possibilities, especially outside of Denmark, which could offset its lack of access to funding from central banks. Overall, the change in ownership is expected to have limited influence on the operations of the company as it is expected that the company will maintain its conservative risk profile.
NORDEA MARKETS | 14 DANMARKS SKIBSKREDIT
Graphs and statistics
Table 2: Cover pool statistics
Source: Danmarks Skibskredit
Figure 3: Loan portfolio by mortgaged vessels 2016 Figure 4: Debtor distribution by country 2016
Source: Danmarks Skibskredit Annual Report 2016 & Risk Report Q4 2016
Figure 5: Indexed LTV distribution, Q4 2016 Figure 6: Loan seasoning, Q4 2016
Source: Danmarks Skibskredit
NORDEA MARKETS | 15 DANSKE BANK
Danske Bank
Key points Strengths Weaknesses Largest bank in Denmark and one of the Danske Bank deviates from the Danish pass- largest financial groups in the Nordic region. through system - larger discrepancy between duration of assets and liabilities and higher Investors have recourse against Danske Bank interest rate risk compared to Danish peers. itself, as opposed to specialized mortgage institutions where investors do not have a direct Dynamic cover pool – substitution risk. claim against the parent bank. Refinancing risk. One of just two Danish Euro covered bond issuers.
Company profile Danske Bank is the largest bank in Denmark with around 3.5m costumers and a significant share of lending to the business and public sector in Denmark. It offers a wide range of financial services such as deposits and loans, investment management, mortgage finance and pension & insurance. Danske Bank is a result of several large banking mergers, most recently in 2006 when the Finnish Sampo Bank was acquired. Today, Danske Bank operates in all Nordic countries plus Northern Ireland, Luxembourg, Poland and the Baltics. However, from the beginning of 2016 Danske Bank Northern Ireland will operate as a separate business unit. The group has a total of approximately 5m private customers and some 19,000 employees. Danske Bank is the only universal bank issuing covered bonds in Denmark. It currently operates three active capital centres. Capital Centre I includes international mortgages, currently Norwegian and Swedish, and Capital Centre D is based on domestic mortgages. Capital Centre C is established to comprise combined mortgages, though it currently only consists of Norwegian and Swedish mortgages, with a high degree of commercial assets.
Figure 1: Structure of the Danske Bank Group Figure 2: Market share
Source: Danske Bank, Bloomberg
NORDEA MARKETS | 16 DANSKE BANK
Financial performance From 2015 to 2016 the Danske Bank Group experienced an increase in net profit of 51.3%, but noting that the increase is a more modest 12% if excluding goodwill impairment charges. Despite low growth and negative interest rates in Denmark, the underlying business remained robust and benefited from the Group´s diversified business model. The improved results were driven by improvements in net interest income (+2.9%), net trading income (+25.7%) and very low impairment charges (-105.3%). However, the cost level also improved partly due to decreases in operating expenses, depreciation and partly due to lower net contribution to the Danish Resolution Fund and the Guarantee Fund, which resulted in a decrease in the cost to income ratio to 47.2%. As a result of the improved net profit, the return on equity increased to 13.1% compared to 11.6% for the previous year. Danske Bank has a long term goal of a return on equity larger than 12.5% and thus exceeded their long term goal at end-2016. The Group is well capitalized.
Table 1: Key figures for the Danske Bank Group
Source: Danske Bank Group Annual Report 2016
Cover pool composition The three pools of Danske Bank have a value of DKK 61.4bn (pool C), DKK 33.8bn (pool D), and DKK 116.7bn (pool I). The issuance of SDOs denominated in DKK from Danske amounts to DKK 25bn. The weighted average LTVs in pool C, D, and I are in line with domestic peers at 54.8%, 55.3% and 54.2%, respectively. The WAFF*WALS values assigned by S&P are low compared to domestic peers: 11.3% for pool C, 4.0% for pool D and 4.2% for pool I. Pool I and D mainly comprise residential mortgages, while pool C is mainly based on commercial mortgages. Pool C has the highest credit enhancement (actual CE) at 27.11%.
ALM and risk In contrast to the other Danish issuers, Danske Bank is exposed to both interest rate risk and refinancing risk because they do not issue covered bonds in the format of the pass-through system, but instead in the traditional European format. There can therefore also be currency risk if not adequately hedged, because of the bonds being denominated in several currencies. Interest rate and currency risks are sufficiently hedged. Credit risk is assessed as being low due to the strong Danish legislation.
Ratings The covered bonds issued by Danske Bank are assigned AAA/AAA by S&P/Fitch, and Danske Bank Plc’s covered bond programme also received an Aaa rating by Moody’s. Danske Bank’s long-term rating by Moody’s/S&P/Fitch is A1/A/A. Moody´s recently upgraded the issuer credit rating to A1 from A2 due to Danske Bank´s strong performance. The short-term rating by Moody’s/S&P/Fitch is P- 1/A-1/F1. Moody´s have a positive outlook for Danske Bank, while both S&P and Fitch have a stable outlook. Amongst other things, this takes into account a moderate assessment of government support.
NORDEA MARKETS | 17 DANSKE BANK
Graphs and statistics
Table 2: Cover pool statistics
Source: Danske Bank, S&P
Table 3: Rating by S&P
Source: S&P
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Danske Bank
NORDEA MARKETS | 18 DLR KREDIT
DLR Kredit
Key points
Strengths Weaknesses DLR has a strong loan-loss agreement with Exposure to the Danish agricultural sector. shareholder banks. Small institution - suffers from low liquidity Loyal customer base. compared to other Danish issuers.
High quality cover pool. Uncertainty of DLR´s business position following BRF and Jyske Bank merger as Jyske Bank is largest loan-providing owner.
Borrowers financed via ARMs are exposed to interest rate risk.
Company profile Dansk Landbrugs Realkreditfond (DLR) is the sixth-largest mortgage lender in Denmark. The specialist mortgage bank was established in 1960 and specializes in agricultural and commercial mortgages. The formation of DLR took place at the initiative of the Danish Bankers Association (Finansrådet) to construct better funding for agricultural commerce, in particular to bridge generational handovers and longer-term investments. Prior to 2000 DLR was encompassed by its own legal framework. However, it was included in the Danish Mortgage Act 1 July 2000. In 2001 DLR changed its company form from a trust to a private limited company. DLR has 64 shareholders, which primarily consists of local and regional banks. These banks also play an active role in DLR’s distribution network. Throughout the financial year 2016 DLR repurchased shares of DKK 970m from Financial Stability and the Danish Central bank. DLR has an agreement with all shareholder banks, which requires loan-providing banks to put up an individual loan loss guarantee. This guarantee covers 93% of DLR’s loan portfolio, which limits the risk of its business model substantially. The merger between Jyske Bank and BRF creates some uncertainty for DLR’s business position as Jyske provides a substantial number of loans. This could however be balanced by other owner banks preferring DLR Kredit for loans. At end-2016, Jyske Bank remains a significant shareholder of DLR.
Figure 1: Structure of the DLR Group Figure 2: Market share
Source: DLR Kredit, Bloomberg
NORDEA MARKETS | 19 DLR KREDIT
Financial performance Despite an increase in loan losses of 188.18%, but noting that other impairments was lower than the previous year, DLR’s profit after tax increased by 21.0% for the financial year 2016. This was primarily due to a continuation of decreasing interest rates, which resulted in value adjustments of the investment portfolio of DKK 136m compared to a loss of DKK 45m last year. Net interest income decreased by -1.3% and efficiency slightly improved as the cost to income ratio amounted to 25.6%. DLR´s capital declined by DKK 925m during 2016 due to repurchases of shares (DLR bought DKK 970m shares back from Finansiel Stabilitet & Danmarks National Bank) and due to the implementation of IRB models for calculating the risk exposure for credit risk on the portfolio for agricultural production (this resulted in a decline of DKK 676m in the capital base), but capitalization ratios increased as DLR´s credit risk substantially declined by more than 17.5% and operations positively influenced the capital base by DKK 726m.
Table 1: Key figures for DLR kredit
Source: DLR Kredit Annual Report 2016
Cover pool composition The value of the pool in capital centre B (pool B) is DKK 154.8bn, while the value of the pool in capital centre G (pool G) is DKK 14.6bn. Both of the pools mainly consist of commercial assets (agricultural loans) with this type of asset accounting for 72.0% of pool B and 77.5% of Pool G. The rest of the cover pool assets are residential mortgages and other assets. The actual CE for Pool B and Pool G is respectively 18.6% and 13.0%. Most of the residential and commercial assets of Pool B and G are located outside the capital region which is due to DLR’s focus on agriculture lending and its focus on local banks. The average LTV in Pool B was 56.5% and in pool G was 51.8% at end-2016.
ALM and risk Due to the pass-through system, the issuer is not exposed to interest rate risk, or currency risk. The main risk for the issuer to be concerned about is credit risk – the risk that the borrower does not repay the loan. The Danish agricultural sector has been pressured in recent years, but the price of a range of agricultural products has started to increase, which has positively influenced the sector. DLR has a high exposure towards agriculture, but has continued to perform well despite the poor market conditions in the agricultural industry due to its diversified business model and the guarantee structure.
Ratings On 12 May 2015 the long- and short-term counterparty credit ratings on DLR have been placed on credit watch with negative implications relating to the upcoming implementation of the BRRD bail in the regime of Denmark. Two months later, in July 2015, this was however removed. On May 19 2017 Standard & Poor’s upgraded the BBB+ long-term credit rating for DLR Kredit by one notch to A- with a stable outlook. Covered bonds issued from both capital centres are rated AAA by S&P (outlook: stable). The AAA ratings reflect the RRLs of a and JRLs of aa.
NORDEA MARKETS | 20 DLR KREDIT
Graphs and statistics
Table 2: Cover pool statistics
Source: DLR Kredit, S&P
Table 3: Rating by S&P
Source: S&P
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: DLR Kredit
NORDEA MARKETS | 21 NORDEA KREDIT
Nordea Kredit
Key points Strengths Weaknesses Financially strong group, leading provider of High share of ARMs. financial services in the Nordic region. The two cover pools are exposed to large Benefits from a strong distribution network commercial loans – concentration risk. through Nordea´s operations in Denmark. Borrowers financed via ARMs are exposed to With approximately 100 employees Nordea interest rate risk. Kredit benefits from low operating costs. Moderate profitability. Strong capitalization.
Company profile Nordea Kredit is the third-largest specialized covered bond issuer in the Danish market with 13% of the outstanding covered bonds. Nordea Kredit is subject to regulation by the Danish FSA. It is a fully- owned subsidiary of the Nordea Group, which is the largest financial institution in the Nordics and Baltic Sea region with operations in Sweden, Denmark, Finland, Norway, the Baltics, and Russia. Nordea is the result of several large mergers of Danish, Finnish, Swedish and Norwegian banks. Nordea sets a significant footprint in Nordic banking as Nordea holds a leading market position with 11m retail customers, 600,000 corporate customers and approximately 650 branches. Nordea Kredit benefits from a strong distribution network via Nordea´s operations in Denmark. Nordea Bank Danmark A/S merged into Nordea Bank AB (publ) on 2 January 2017 after which Nordea Kredit is a subsidiary of Nordea Bank AB (publ).
Figure 1: Structure of the Nordea Group Figure 2: Market share
Source: Nordea, Bloomberg
NORDEA MARKETS | 22 NORDEA KREDIT
Financial performance Nordea Kredit reported an improved profit after tax for the year by 14.7% compared to the previous year, which was primarily due to higher results from items at fair value. However, 2015 was negatively affected by a non-recurring cost of DKK 234m due to the implementation of a hedge covering the negative interest on certain bond series that was not passed on to borrowers. Excluding this implementation, Nordea Kredit´s profit after tax only increased by 2% during 2016. Net interest income increased by 7.2%, while loan losses increased by 21.1%. Profitability slightly improved as the return on equity amounted to 7.9%, while efficiency remained extremely strong as the cost to income ratio amounted to 11.3%. Capitalization is strong and improved further throughout the financial year 2016. Thus, Nordea Kredit should have no problems regarding the increased regulation in the banking industry and should be more than capable to meet its financial obligations.
Table 1: Key figures for Nordea Kredit
Source: Nordea Kredit Realkreditaktiselskab Annual Report 2016
Cover pool composition Nordea Kredit has two capital centres issuing covered bonds; centre 1 consisting of ROs and centre 2 consisting of SDROs. The cover pool of centre 1 has a value of DKK 15.0bn while the cover pool of centre 2 has a value of DKK 438.6bn. The average indexed LTVs in the two pools are 58.7% in pool 1 and 67.2% in pool 2 and the collateral scores are 11.4% and 12.8% respectively, which is fairly high compared to the other Nordic issuers. This is partly due to the high concentration of commercial assets in the pools (17.3% in pool 1 and 22.2% in pool 2). However, the dominating assets in the pools are residential (60.0% and 44.6%).
ALM and risk Due to the Danish pass-through system, the issuer is not exposed to interest rate risk, or currency risk. The main risk for the issuer to be concerned about is credit risk – the risk that the borrower does not repay the loan. This risk is to some extent related to the interest rate risk of borrowers holding ARMs, as increasing interest rates might lead to higher default rates in the pools.
Ratings All covered bonds issued by Nordea Kredit are given Aaa/AAA ratings by Moody’s/S&P. Nordea Kredit does not have a stand-alone rating, but Nordea Group’s long-term ratings by Moody’s/S&P/Fitch are Aa3/AA-/AA-. In June 2015, Nordea Bank’s outlook was upgraded to stable by Moody’s due to a resilient pattern, good operational efficiency and healthy asset-quality metrics. These positive factors are partly counterbalanced by Nordea Bank’s high reliance on market funding.
NORDEA MARKETS | 23 NORDEA KREDIT
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody’s investor service, S&P
Table 3: Ratings by Moody´s and S&P
Source: Moody’s investor service, S&P
Figure 3: Indexed LTV, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Moody’s investor service
NORDEA MARKETS | 24 NYKREDIT REALKREDIT
Nykredit Realkredit
Key points Strengths Weaknesses Largest issuer of Danish covered bonds in Dependence on other banks to originate terms of outstanding amount. loans.
Enjoys a strong working relationship with a High share of ARMs and IO loans in the pools, number of local Danish financial institutions. compared to other Danish issuers.
Danish pass-through system – limited Borrowers financed via ARMs are exposed to currency, interest rate and refinancing risk for interest rate risk. the issuer.
Planning IPO in near future, which will strengthen its access to capital markets and thereby its capitalization.
Company profile Nykredit Realkredit (NYK) is Denmark’s largest issuer with 38.6% of the covered bond market. In mid-March 2014, Nykredit lost its main distribution partner, Jyske Bank, who exited from the Totalkredit partnership. At the end of 2013, Jyske Bank customers accounted for some 7% of Nykredit Group’s mortgage loans. NYK estimates the net impact of revised contractual terms, including an estimated additional decline in the lending portfolio and loan refinancing volumes, to increase the earnings of Totalkredit and Nykredit by a total of some DKK 200m. NYK is owned by Nykredit Holding, the second-largest financial group in Denmark. NYK dates back to 1851. Since its origination Nykredit has diversified into real estate and banking but mortgage financing is still its primary business. In 2003 NYK acquired Totalkredit, which is a wholly-owned subsidiary of NYK. The Nykredit Group is in contact with more than 1.1 million customers including about 615,000 personal customers served by local and regional banks under the Totalkredit partnership. Totalkredit expanded throughout 2016 as they gained 18,000 new customers.
Figure 1: Structure of the Nykredit Group Figure 2: Market share
Source: Nykredit Realkredit, Bloomberg
NORDEA MARKETS | 25 NYKREDIT REALKREDIT
Financial performance Net interest income and net fee income decreased by respectively 3.43% and 4.2%. Nevertheless, profit after tax increased massively by 67% between 2015 and 2016, which resulted in an improved profitability as the pre-tax return on equity increased to 10.3% compared to 7.6% for the previous year. Nykredit´s cost level continues to decline and is among the lowest in the Danish banking industry with a cost to income ratio of 46.90%. In its underlying operations, both Nykredit Bank and Totalkredit expanded their loan portfolios, while loan losses declined by 26.09% due to improvements in the Danish economy. The result was also positively influenced by a large decline in impairments of intangibles assets. Capitalization slightly worsened for the Group and might be pressured by the implementation of BASEL IV, which has been stated as the reason for the Group´s upcoming IPO. The IPO and the improved access to market funding, should result in an improved capitalization in the future.
Table 1: Key figures for Nykredit Realkredit Group
Source: Nykredit Realkredit Group Annual Report 2016
Cover pool composition Nykredit issues covered bonds from seven capital centres: Centre C, D, E, G, H, I and the general capital centre. The most important centres are D, E, G, H, and I, where pool I is the most recent. D is closed meaning that no new loans are made from this pool. The values of the cover pools are in the ranges of DKK 8.64bn-610.65bn. Pool H is the largest pool and pool I is the smallest pool. Pool H and E have the lowest actual credit enhancement (actual CE) in Standard & Poor’s overview, both below 6% which is low compared to domestic peers. Pool I has the highest actual CE at 29.09% and the others lie in between with the average actual CE across the pools being 14.4%. All pools consist mainly of residential mortgages, except for pool D and G where most of the assets are commercial loans.
ALM and risk Looking at the lifetime of assets and liabilities and the shares of fixed rate loans/bonds, the implications of the Danish pass-through system are clear. There is limited refinancing risk and limited interest rate risk for the issuer. As loans and bonds are denominated in the same currency, there is also limited currency risk. There is credit risk for the issuer to be considered. Especially in the pools with a high concentration of the same type of loans (residential or commercial), one should be aware of the credit risk.
Ratings All covered bonds from Nykredit are assigned an AAA-rating by S&P. NYK long-term has an A/A rating from S&P/Fitch. The long-term outlook assigned by both S&P and Fitch is stable as S&P has upgraded the outlook for NYK. The rating reflects that NYK is the leading Danish mortgage lender, its strong asset quality and capitalization, and its reliance on wholesale funding, while the moderate profitability is negatively influencing the rating.
NORDEA MARKETS | 26 NYKREDIT REALKREDIT
Graphs and statistics
Table 2: Cover pool statistics
Source: S&P, Nykredit Realkredit
Table 3: Rating by S&P
Source: S&P
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Nykredit Realkredit
NORDEA MARKETS | 27 REALKREDIT DANMARK
Realkredit Danmark
Key points Strengths Weaknesses Second largest issuer in the Danish covered High shares of ARMs in the cover pools. bond market in terms of outstanding volume and strong distribution network via Danske Bank and Borrowers financed via ARMs are exposed to the real estate agency Home. interest rate risk.
Danish pass-through system – limited Dependent on the parent bank, Danske Bank currency and interest rate risk for the issuer. A/S.
Improving efficiency and profitability.
Company profile Realkredit Danmark is the second-largest specialized mortgage bank in Denmark with a market share of 26.1% of the outstanding volume. Realkredit Danmark is a wholly owned subsidiary of Danske Bank A/S. Danske Bank is a result of several large banking mergers, most recently in 2007 when the Finnish Sampo Bank was acquired. Today, Danske Bank is present in 16 countries, but mainly operates in the Nordic countries plus Ireland, Northern Ireland, Luxembourg, Poland and the Baltics. The group has over 5m private customers and approximately 19,000 employees. Realkredit Danmark dates back to 1851 and was a part of Kreditforeningen Danmark. In January 1993, Kreditforeningen Danmark was converted into a limited company, Realkredit Danmark A/S. A group structure was established in which Foreningen RealDanmark owned all the shares in RealDanmark Holding A/S, which in turn held all the shares in Realkredit Danmark A/S. In 1998 collaboration between Realkredit Danmark and BG Bank resulted in the creation of BG Kredit A/S. Later that year Realkredit Danmark and BG bank formed the holding company RealDanmark A/S, which became the parent company of Realkredit Danmark and BG Bank. In 2001 RealDanmark A/S merged with Danske Bank, with the latter as the continuing company and the two units, Realkredit Danmark and BG Bank, operating under their known brand names (Danske Bank absorbed BG Bank in 2007).
Figure 1: Structure of the Realkredit Group Figure 2: Market share
Source: Danske Bank A/S, Bloomberg
NORDEA MARKETS | 28 REALKREDIT DANMARK
Financial performance Realkredit Danmark reported an improved profit after tax for the financial year 2016 as it increased by 7.5% in comparison to 2015. Loan losses has declined quite a lot in recent years and continued this trend throughout 2016 as loan losses decreased by 57.9%, which has significantly influenced the results in recent years. The declining trend in impairments is caused by the improving macroeconomic trend, including rising property prices, but also reversal of charges previously made against facilities to business customers. Both profitability and efficiency has been improving in recent years, but capitalization decreased during 2016, however it remains adequate. Despite the strong results and an improving net interest margin, Realkredit Danmark´s net interest income declined due to lower income from loans and other amounts due.
Table 1: Key figures for Realkredit Danmark
Source: Realkredit Danmark Annual Report 2016
Cover pool composition Realkredit Danmark issues bonds from capital centre S, capital centre T and a general capital centre, with the cover pools in centre S and T being the most significant ones. These cover pools have a value of DKK 257.48bn (pool S, SDROs) and DKK 501.60bn (pool T, SDROs) and have an actual credit enhancement of 8.4% and 8.5%, respectively. The WAFFxWALS are in line with other Danish issuers at 5.74% and 6.29% respectively for Pool S and Pool T.
ALM and risk Both cover pools mainly consist of fixed rate loans at 95% (pool S) and 80% (pool T) defined as loans with a fixed rate for at least one year. For pool T most of these loans (80%) are adjustable-rate mortgages (ARMs) financed by fixed-rate bullets, while 15% of the loans in pool S are ARMs financed by fixed-rate bullets. There is therefore limited interest rate risk for the issuer as well as limited currency risk. The main risk faced by the issuer is credit risk, which is considered low due to the strong Danish legislation.
Ratings All outstanding covered bonds issued by Realkredit Danmark currently have an AAA-rating from S&P. Fitch assigned capital centre S an AAA, but capital centre T an AA+. Realkredit Danmark does not have its own issuer rating from S&P/Moody´s (though it is rated A by Fitch). However, Danske Bank’s long-term rating by Moody’s/S&P/Fitch is A2/A/A. S&P and Fitch agrees on a stable outlook, whereas Moody´s holds a positive outlook. In June 2015 Moody’s upgraded Danske Bank’s long-term credit rating from baa1, to A2, which reflects the progressive strengthening of the bank’s performance in recent years. This includes an improvement in capitalization, asset quality and profitability.
NORDEA MARKETS | 29 REALKREDIT DANMARK
Graphs and statistics
Table 2: Cover pool statistics
Source: S&P, Realkredit Danmark
Table 3: Rating by S&P
Source: S&P
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Realkredit Danmark
NORDEA MARKETS | 30 Issuer profiles Finland
Aktia Bank
Bank of Åland plc
Danske Bank plc
Nordea Mortgage Bank Plc
OP Mortgage Bank
SP Mortgage Bank
The Mortgage Society of Finland
NORDEA MARKETS | 31 AKTIA BANK
Aktia Bank
Key points Strengths Weaknesses Solid bank with a diversified network in A small issuer with a modest market share of Finland. the Finnish covered bond market.
High-quality cover pools consisting of One old pool (pool 1). Finnish residential mortgages. High degree of floating rate loans in the Covered bond program issued by Aktia cover pool. Bank in June 2013 has obtained an Aaa-rating.
Company profile The Aktia Group is the fourth-largest banking group in Finland with activities in banking, insurance and real estate. With the aim to streamline the group structure, the listed holding company Aktia plc merged with the subsidiary Aktia Bank on July 1, 2013. The new structure of the Aktia Group is illustrated in the figure below with Aktia Bank being the group’s current issuer of covered bonds. Because the merger took place within the Group and Aktia plc owned 100% of the shares in Aktia Bank plc, the merger had no direct effect on the results for the Aktia Group. The full-scale implementation of Aktia´s core banking system was completed during the first quarter of 2017. This is expected to result in cost-effectiveness and an enhancement of of Aktia´s digital services. Previously, all covered bonds from the Aktia Group were issued by Aktia Real Estate Mortgage Bank (AREMB) - a specialist mortgage bank - on the basis of two cover pools (pool 0 and pool 1). As of November 2011, covered bonds issued by AREMB were under review for downgrade by Moody’s, and in October 2012 a downgrading from Aa1 to Aa3 took place. This was primarily due to a downgrading in issuer rating of the parent company, Aktia Bank, from A1 to A3 (February 2012), but was also explained by the fact that AREMB is only partly owned by Aktia Bank, and there is a substantial number of unrated owners. In the wake of the downgrading, AREMB stopped issuing bonds from pool 0 and 1. Instead, Aktia Bank was granted concession by the FSA to operate as a mortgage bank and launched its first covered bond program in June 2013 with a cover pool consisting only of Finnish residential mortgages. The rating of the covered bond program now only relies on the rating of one issuer, Aktia Bank, and the program has obtained an Aaa-rating by Moody’s.
Figure 1: Structure of the Aktia Group Figure 2: Market share
Source: Aktia Bank Debt Investor Presentation Q1/2017, Bloomberg
NORDEA MARKETS | 32 AKTIA BANK
Financial performance Profit after tax declined by 4.4% in 2016 and the balance sheet also declined by 4% in 2016. From 2015 to 2016, net interest income fell by 1.8% amounting to a total of EUR 95.6m. Write-downs on credits and other commitments increased a lot measured in percentages, but continue to be at a low overall level. The bank has a relatively high cost-to-income ratio compared to peers due to increasing operating expenses, but the bank’s ambition is to improve this by at least 10%-points in the long term. Tier 1 capital ratio (core capital ratio) fell to 19.5% in 2016 from 20.7% due to increased lending and the capital ratio also declined by 0.8%-points. Aktia Bank has a relatively high reliance on wholesale funding.
Table 1: Key figures for Aktia Bank plc
Source: Aktia Bank plc Annual Report 2016
Cover pool composition
Aktia Bank was granted mortgage bank concession in 2013 and have since have issued covered bonds from one cover pool existing only of Finnish residential mortgages. The pool now has a value of EUR 2.10bn and a high asset quality with an average LTV of 55.4%, a collateral score by Moody’s of 5.3% and a high overcollateralization of 36.6%. The old cover pool, pool 1, issued by AREMB has a strong asset quality as well, which is further supported by its promise to maintain an overcollateralization in the pool of 12% (this is only 10% for the new pool). The average indexed LTV level for residential assets in pool 1 is 47.5%.
ALM and risk
Similar to the rest of the Finnish issuers, mortgage loans in the cover pools (the new pool as well as pool 1) are primarily floating-rate loans, while the covered bonds are issued as fixed-rate bonds resulting in exposure to interest rate changes if not adequately hedged. In pool 1 36.1% of the pool assets are fixed-rate loans, whereas 100% of the outstanding covered bonds are fixed-rate bonds. These numbers are 6.3% and 100% for the new pool. Due to a higher weighted average life (WAL) of the cover pools compared to the outstanding bonds, there is a refinancing risk associated with the pools as well. As all assets in the cover pools as well as the outstanding bonds are EUR-denominated the pools are not exposed to currency risk.
Ratings Previously, all covered bonds from the Aktia Group were issued by Aktia Real Estate Mortgage Bank (AREMB) – a specialist mortgage bank – on the basis of two cover pools (pool 0 and 1). However, a downgrade from Aa1 to Aa3 by Moody´s in October 2012 resulted in AREMB halting issuance. The new covered bond program has obtained an Aaa-rating by Moody’s. In July 2016, Moody’s affirmed Aktia Bank plc’s credit rating at A3 for long-term deposit and senior unsecured debt and P2 for short- term. Additionally, the outlook changed from stable to positive.
NORDEA MARKETS | 33 AKTIA BANK
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody´s investor service
Table 3: Rating by Moody´s
Source: Moody´s investor service
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning as of Q4 2016
Source: Moody’s investor service
NORDEA MARKETS | 34 BANK OF ÅLAND
Bank of Åland Plc
Key points Strengths Weaknesses High quality cover pools with relatively high Concentration risk due to focus on retail and overcollateralization. private banking in Finland and Sweden.
Business operations in economically robust Limited but improving geographic, franchise, regions in Finland. and earnings diversification.
Sound financing profile benefitting from Still low earnings capacity and cost efficiency. stable customer deposits.
Company profile The Bank of Åland Plc (Ålandsbanken) is a commercial bank and banking group. It has its main market in Åland, but it operates throughout Finland and Sweden. The group was founded in 1919 and further extended its operations through an acquisition of Kaupthing Bank Sverige AB in 2008. Today it has over 700 employees, about 90,000 customers and is the fifth largest issuer of covered bonds in Finland, with a 2.4% market share. The Bank of Åland Group has a total of five subsidiaries and are connected to banking in various ways. On the Åland Islands, the Bank of Åland is a bank for all residents. In Finland and Sweden, however, it has a niche strategy targeted to entrepreneurs, wealthy families and individual customers with sound finances. Bank of Åland grants long term loans to Finnish and Swedish households. These loans are used as the collateral in the two cover pools of the group, Cover Pool FIN and Cover Pool SWE. Bank of Åland is committed to maintain a liquidity buffer covering 180 days of contractual outflows from the covered bonds issued. The liquidity buffer consists of contractual inflows and liquidity assets in the cover pool.
Figure 1: Structure of the Bank of Åland Group Figure 2: Market share
Source: Bank of Åland Annual Report 2016, Bloomberg
NORDEA MARKETS | 35 BANK OF ÅLAND
Financial performance From 2015 to 2016, the Bank of Åland experienced a decrease of 19% in profit after taxes, which can mainly be explained by an increase in loan losses throughout the year (+32.9%). A large part of the impairments were related to provisions for two corporate commitments at the Special Funding unit in Helsinki (70.7%). Net interest income increased by 2.1% due to an improved margin, but this was more than offset by a decrease in net commission income, net income from financial items carried at fair value and IT income. As a result of the worsened profit after tax, Bank of Åland reported a lower profitability for the year as the return on equity amounted to 9.10% compared to 12.0% for the previous year. Thus, the bank no longer exceeds its long-term goal of a 10% return on equity. Efficiency also worsened as the cost to income ratio increased by 3%-points, but overall capitalization remained stable.
Table 1: Key figures for the Bank of Åland Plc
Source: Bank of Åland Plc Annual Report 2016
Cover pool composition
The Bank of Åland has two covered bond programmes, Cover Pool FIN and Cover Pool SWE. Cover Pool SWE is the most recently launched (2014). Cover Pool FIN consists primarily of residential mortgages (90%), whereas Cover Pool SWE consists of a combination of residential mortgages (65%) and commercial assets (35%). Cover Pool FIN and Cover Pool SWE have a value of EUR 1,542m and SEK 2,501m respectively. The average LTV for both pools is; 57% (Cover Pool FIN) and 59% (Cover Pool SWE). Both pools also maintain high overcollateralization compared to domestic peers of 46.3% (Cover Pool FIN) and 41.6% (Cover Pool SWE).
ALM and risk
Similar to the rest of the Finnish issuers, mortgage loans in both of the cover pools are primarily floating-rate loans. In Cover Pool FIN 96% of the loans in the cover pool are floating rate loans, while the largest part of the issued bonds are fixed-rate bonds. This results in an exposure to interest rate changes if not adequately hedged. Cover Pool SWE shows a slightly more modest mismatch as 89% of the loans in the cover pool are floating rate loans, while none of the bonds are issued as fixed-rate bonds. Thus, this pool has less exposure to interest rate changes. In Cover Pool FIN, all assets in the cover pools as well as the outstanding bonds are EUR-dominated. In Cover Pool SWE on the other hand, all assets in the cover pool as well as the outstanding bonds are SEK-dominated. Thus none of the pools are exposed to currency risk.
Ratings Both cover pools have obtained an AAA-rating from S&P. This reflects the strong institutional framework and legislation in the Finnish and European financial sector, as well as high credit quality and strong liquidity in the Bank of Åland´s cover pool. S&P raised its short-term counterparty credit rating on Bank of Åland to A-2 from A-3 at November 17, 2016. Also, S&P affirmed the long-term rating of BBB and revised the outlook on the long-term rating to stable from negative, which is especially due to the improved economic conditions in Finland.
NORDEA MARKETS | 36 BANK OF ÅLAND
Graphs and statistics
Table 2: Cover pool statistics
Source: S&P, Bank of Åland Covered Bond Data Q4 2016
Table 3: Rating by S&P
Source: S&P
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning as of Q4 2016
Source: Bank of Åland Covered Bond Data 2016
NORDEA MARKETS | 37 DANSKE BANK PLC
Danske Bank Plc
Key points
Strengths Weaknesses Issuer’s credit strength benefits from full Market share of Finnish covered bond market ownership of the Danske Bank Group and the at approximately 13.2%, smaller than that of liquidity support therein. market leaders Nordea and OP-Pohjola Group.
High-quality cover pool consisting of 100% The pool primarily consists of floating rate Finnish residential mortgage loans with a low loans (90%), thus the quality of the pool is average LTV of 51.6%. vulnerable to interest rate hikes.
Company profile Danske Bank Plc (former Sampo Bank Plc) has since 2006 been a fully-owned subsidiary of the Danske Bank Group and is the third-largest bank in Finland with more than 1m retail customers as well as more than 90,000 corporate and institutional customers. The parent company, Danske Bank Group, is one of the largest financial groups in Northern Europe with activities in all Nordic countries, Ireland and large parts of Eastern Europe. Previously, all covered bond activities in the Sampo Bank Group were carried out by Sampo Housing Loan Bank, a mortgage credit bank. In January 2012, Sampo Housing Loan Bank merged with its parent company, Sampo Bank Plc. Thereby, Sampo Bank Plc (the current Danske Bank Plc) assumed all rights and obligations of Sampo Housing Loan Bank and was granted a license for mortgage credit banking operations by the Finnish FSA. The structure of the Danske Bank Group is illustrated below.
Figure 1: Structure of the Danske Bank Group Figure 2: Market share
Source: Danske Bank, Bloomberg
NORDEA MARKETS | 38 DANSKE BANK PLC
Financial performance Danske Bank Plc reported an improved profit for the year which ended at EUR 171m, which is equivalent to an increase of 3% throughout the financial year 2016. This was mainly driven by a large decline in loan losses by almost 91% due to a combination of lower write-offs and higher reversals. Nonetheless, net interest income declined by 2.6%, total assets decreased by 4.5% and efficiency worsened as the cost to income ratio increased by roughly 1%-point. Profitability remained quite stable as the return on equity amounted to 6.7% (2015: 6.6%), while capitalization improved during the financial year 2016 as the total capital ratio and the core capital ratio (tier 1) increased to respectively 20.0% (2015: 18.4%) and 19.2% (2015: 18.3%).
Table 1: Key figures for Danske Bank Plc
Source: Danske Bank Plc Annual Report 2016
Cover pool composition All covered bonds issued by Danske Bank Plc are backed by one cover pool with a value of EUR 5.8bn consisting of 100% residential mortgages. The loans are granted on property in Finland, mostly in Southern Finland, where the country is densely populated. The cover pool is characterized by a low LTV on average (51.6%), though the distribution is quite dispersed with more than 20% of the loans having a LTV above 70%. The collateral score excl. systemic risk assigned by Moody’s is 3.0%, which is in line with domestic peers. Overcollateralization stands at 15.2% with committed overcollateralization of 5%.
ALM and risk As with most of the Finnish peers, the pool primarily consists of floating-rate loans (90%) while the outstanding covered bonds are mainly fixed-rate bonds (60%). Due to this mismatch, there is an interest rate risk which should be hedged. Furthermore, there is refinancing risk as the WAL of the pool is less than that of the outstanding bonds. There is no currency risk as pool assets and outstanding covered bonds are both EUR-denominated.
Ratings All covered bonds issued by Danske Bank Plc are Aaa-rated by Moody’s while Danske Bank Plc’s long-term senior debt rating (and issuer rating) is A1/A by Moody’s/S&P. Moody´s outlook is positive, while S&P currently holds onto a stable outlook for Danske Bank Plc. The improving operating environment in Finland is one of the main reasons for Moody´s outlook.
NORDEA MARKETS | 39 DANSKE BANK PLC
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody’s investor service
Table 3: Rating by Moody´s
Source: Moody’s investor service
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Moody’s investor service
NORDEA MARKETS | 40 NORDEA MORTGAGE BANK PLC
Nordea Mortgage Bank Plc
Key points Strengths Weaknesses High credit quality and part of the Nordea Challenges to parent from tougher financial Group. regulation and decreasing implicit state support. Largest issuer of Finnish covered bonds (44.6% of total outstanding bonds). With 98% of the pool consisting of floating- rate loans, the credit quality of the pool is High-quality cover pool with mainly Finnish vulnerable to interest rate hikes. residential mortgages (93.5%) and low average LTV (57.7%). Dynamic cover pool – substitution risk.
Company profile The demerger of Nordea Bank Finland Plc was completed on 1 October, 2016. As part of the merger process a new Mortgage Credit Institution, Nordea Mortgage Bank Plc, was established. In connection with the demerger all the assets, liabilities and reserves relating to the covered bond funding business of Nordea Bank Finland Plc was transferred to Nordea Mortgage Bank Plc. Thus, Nordea Mortgage Bank Plc continues the covered bonds operations performed earlier by Nordea Bank Finland Plc. Nordea Mortgage Bank Plc is a 100% owned subsidiary of Nordea Bank AB – the largest Nordic financial institutions. Nordea Mortgage Bank operates as a mortgage credit institution with the main purpose of issuing covered bonds. It is licensed by ECB to issue covered bonds according to the Finnish covered bond legislation. Nordea has the largest customer base of any financial services group in the Nordic region with approximately 11 million customers, 600,000 corporate customers and some 650 branches. The group operates in eight home markets; The Nordic region including Denmark, Finland, Norway and Sweden and the new European markets of Estonia, Latvia, Lithuania, and Russia. Nordea Mortgage Bank Plc is the largest issuer of Finnish covered bonds with a market share of 44.6%. Bonds issued by Nordea Mortgage Bond are covered by a pool of loans consisting of Finnish loans, mainly household mortgages. The new legal structure of the Nordea Group is shown below.
Figure 1: Structure of the Nordea Group Figure 2: Market share
Source: Nordea, Bloomberg
NORDEA MARKETS | 41 NORDEA MORTGAGE BANK PLC
Financial performance As Nordea Mortgage Bank Plc is a newly established entity it has only reported results from Oct-Dec, 2016. Therefore, it is more appropriate to look at the financial results of the Nordea Group. The Nordea Group reported an improved profit after tax of EUR 3,766m, which is equivalent to an increase of 2.8% since 2015 and thus the return on equity improved by 0.1%-points and remains strong compared to its Nordic peers. This was driven by decreases in operating expenses and tax payments, which more than offset the decline in net interest income. Loan losses remained at a reasonable level despite an increase of 4.8%, while efficiency worsened due to a proportional larger decrease in total income than in operating expenses. However, capitalization improved throughout the year. Overall, the Nordea Group has reported strong and stable results in recent years.
Table 1: Key figures for the Nordea Group
Source: Nordea Annual Report 2016
Cover pool composition The value of the cover pool is EUR 22bn consisting almost entirely of residential mortgages (93.5%), though qualifying assets may include loans collateralized by both mortgages, state/municipal guaranteed loans, derivative contracts, and substitute assets according to the Finnish Covered Bond Act. The pool is characterized by a reasonably low indexed LTV on average (57.7%) and a collateral score excluding systemic risk of 2.1%, which is in line with domestic peers. The underlying properties are geographically well spread across Finland. However, there is a greater concentration in Southern Finland due to the density of habitation in this area.
ALM and risk Like the rest of the Finnish issuers, mortgage loans are primarily floating-rate loans, while covered bonds are issued as fixed-rate bonds resulting in a mismatch and exposure to interest rate changes if not adequately hedged. As all loans are EUR-denominated, the pool is not exposed to currency risk, but there is refinancing risk due to the mismatch in the weighted average lifetime of cover pool loans and outstanding bonds (16 years and 4.1 years respectively).
Ratings All covered bonds issued by Nordea Mortgage Bank Plc are rated Aaa by Moody’s. Nordea Group’s long-term ratings by Moody’s/S&P/Fitch are Aa3/AA-/AA-. Nordea has a strong franchise in Finland as one of the country’s leading banks, and it is well integrated within the Nordea group. Nonetheless, the baseline credit assessment (BCA) is constrained by the bank’s high reliance on market funding thus making it more sensitive to changes in investor and market sentiment.
NORDEA MARKETS | 42 NORDEA MORTGAGE BANK PLC
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody’s investor service
Table 3: Rating by Moody´s
Source: Moody’s investor service and S&P
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning as of Q4 2016
Source: Moody’s investor service
NORDEA MARKETS | 43 OP MORTGAGE BANK
OP Mortgage Bank
Key points
Strengths Weaknesses Major financial group in Finland and second Few outstanding issues. largest issuer of Finnish covered bonds. Susceptible to interest rate rises as Well-capitalized group with joint liability approximately 99% of assets in cover pools are between member institutions. variable-rate loans.
High-quality cover asset pools consisting of Dynamic cover pool, and there is refinancing only Finnish residential mortgages. risk.
Company profile OP Mortgage Bank (OPMB) is a specialized credit institution and a wholly-owned subsidiary of the largest provider of financial services in Finland, the OP-Pohjola Group. The aim of OPMB is to raise funds for the member credit institutions of the OP-Pohjola Group by issuing covered bonds collateralized by Finnish residential mortgages. The Central Cooperative and the member banks are jointly liable for each other’s debts and commitments, for instance in the case of liquidation or bankruptcy if debt of the liquidated or bankrupted institution cannot be covered by its funds. The liability is apportioned among the Central Cooperative and the member credit institutions in proportion to the total assets in the most recently adopted balance sheets. Assets in the cover pools of OPMB, however, are ring-fenced for the covered bond investors, and these investors therefore benefit from the joint liability. The structure of the OP-Pohjola Group is illustrated below. In February 2014, the Group made a voluntary public bid for Pohjola Bank’s shares. This contributes to OP Pohjola Group’s target of streamlining its structure and achieving stronger business efficiency. The OP-Pohjola Group strengthened its market position further in 2016, especially in home loans, corporate financing and deposits. OPMB’s market share stands at 31.4% of the outstanding covered bonds in Finland, which makes them the second biggest issuer in the Finnish market.
Figure 1: Structure of the OP-Pohjola Group Figure 2: Market share
Source: OP-Pohjola Group, Bloomberg
NORDEA MARKETS | 44 OP MORTGAGE BANK
Financial performance OPMB´s profitability worsened as the return on equity decreased to 4.80% compared to 5.60% for the financial year 2015, which was driven by a decline in profit after tax, which declined by 11% for the year 2016. Net interest income increased by 3.8%, but efficiency worsened as the cost to income ratio increased by 3%-points. An increase in loan losses also negatively influenced the results for the year. OPBM´s capital increased, but its risk exposure increased proportionally more and thus capitalization ratios declined. However, capitalization ratios remain extremely high as the capital ratio and the core tier 1 ratio both stands at 109.5% (2015: 140.2%). OPMB´s balance sheet expanded as total assets amounted to EUR 11.6bn (+6.9%).
Table 1: Key figures for OP Mortgage Bank
Source: OP Mortgage Bank Annual Report 2016
Cover pool composition Previously OPMB had two cover pools, pool A and pool B, however pool A closed in June 2015 at the maturity of the last issued bond. OPMB’s current cover pool (pool B) has a value of EUR 10.4bn and solely consists of Finnish housing loans. Hence there has never been any commercial, agricultural or public sector loans in the pools.
ALM and risk The relatively new cover pool has low indexed LTVs which average 44% and a low collateral score excl. systemic risk of 1.9%. Since the pool solely contains of Finnish EUR-denominated residential mortgages, there is no currency risk associated with it. Similar to other Finnish issuers, there is interest rate risk if not adequately hedged, as the pool primarily consists of floating-rate loans (97.8%) which are funded with fixed-rate covered bonds. This is however eliminated by hedging with interest rate swaps. Furthermore, the asset pools are exposed to refinancing risk.
Ratings All covered bonds issued by OPMB are Aaa/AAA rated by Moody’s/S&P, while Pohjola Bank’s long term debt rating is Aa3/AA-/A+ by Moody’s/S&P/Fitch. Pohjola Bank holds stable outlooks from all three as S&P recently upgraded their outlook from negative to stable due to improved economic conditions in Finland. With an over-collateralization (OC) of 14.6%, the pool is well collateralized. As of Jan 2016 Moody’s outlook on OP-Pohjola Group remained stable, reflecting that the bank has a strong multi-product franchise and the fact that Finland has a strong macro profile.
NORDEA MARKETS | 45 OP MORTGAGE BANK
Graphs and statistics Table 2: Cover Pool Statistics
Source: Moody’s investor service
Table 3: Rating by Moody´s and S&P
Source: Moody’s investor service, S&P
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning as of Q4 2016
Source: Moody’s investor service
NORDEA MARKETS | 46 SP MORTGAGE BANK
SP Mortgage Bank
Key points Strengths Weaknesses The cover pool is of high quality as it SPMB is one of the smaller issuers of covered consists solely of residential assets backed by bonds in Finland and holds a low market share. high overcollateralization (31.2%). Cover pool loans primarily consist of float- Part of the Savings Banks Group, which is rate loans and thus rate hikes in Finland could one of the largest financial groups in Finland influence loan performance significantly. and was recently, rated A- by S&P. Refinancing risk due to lending longer term Covered Bonds rated AAA by S&P. than funding.
Company profile Sp Mortgage Bank Plc (SPMB) is a part of the Savings Banks Amalgamation founded by the Savings Banks and is in charge of the Group´s covered bond issuance. SPMB does not have its own customer business or distribution network. Rather the Savings Banks that is part of the Savings Banks Amalgamation intermediate and originate residential mortgage loans for SPMB. The Savings Banks have a history dating back more than 190 years in Finland, while the Savings Bank association was founded in 1906. Savings Banks develop long-term customer relations by providing services and solutions based on the customer’s individual needs within banking, asset management, and life insurance among other things. The Group consists of the Savings Banks Amalgamation as well as other companies and institutions owned by the Savings Banks. The Amalgamation is formed by the central institution, which compromises the consolidation of the Group. The Savings Banks´ Union Coop acts as the central institution of the Amalgamation. SPMB was founded as of 20 March 2015, but operations were not initiated before 2016. SPMB received authorisation from the European Central Bank to operate as a residential mortgage credit bank as of March 2016 and operations were started immediately after this. In November 2016, SPMB issued covered bonds of EUR 500m, which received an AAA rating by S&P.
Figure 1: Structure of the Savings Banks Group Figure 2: Market share
Source: The Savings Banks Group, Bloomberg.
NORDEA MARKETS | 47 SP MORTGAGE BANK
Financial performance The Group reported a marginally worsened profit after tax as it declined by 0.7% throughout 2016, which was primarily caused by an increase in impairments of 37.3%. Nonetheless, impairments remain extremely low as they were equivalent to 0.12% of total loans (2015: 0.10%). Net interest income increased by 5.3% which in particularly was driven by more advantageous fund-raising levels. However, this was more or less completely offset by an increase in operating expenses of 7.6% due to expenses in relation to the Group´s card operations. The card operations has previously not been included in the Savings Banks Groups annual report as it was first transferred to this entity in late 2015. Therefore, one should be careful judging the results for 2016 compared to 2015 due to limited comparability. Profitability and efficiency both slightly worsened as the return on equity declined to 6.2% and the cost to income ratio increased to 64.4%. Capitalization is strong and further improved as both capitalization ratios increased by 0.7%-points during the financial year 2016.
Table 1: Key figures for The Savings Banks Group
Source: The Savings Banks Group
Cover pool composition The cover pool consists exclusively of EUR-denominated mortgages. SPMB´s cover pool value was EUR 703.5m at end-2016 and consisted solely of residential assets. According to S&P, WAFF and WALS is respectively 16.7% and 20.2% resulting in a WAFF*WALS of 3.4%. The average LTV of the cover pool is 57.5% and overcollateralization is 31.2%. Thus, the quality of the cover pool is relatively high and is similar to many of the larger issuers in the country.
ALM and risk Like many of the other covered bond issuers in Finland, SPMB´s mortgage loans are primarily floating-rate loans, but the covered bonds are issued as fixed-rate bonds, which results in a mismatch and exposure to interest rate changes if this is not adequately hedged. As the loans are all EUR-denominated, the pool is currently not exposed towards currency risk. However, it has exposure towards refinancing risk due to lending at longer term than the funding. Credit risk is assessed as quite low due to the high quality of the cover pool.
Ratings The covered bonds issued by SPMB have been assigned an AAA rating by S&P with a stable outlook as many of its regional peers. SPMB does not have an issuer rating, but the Savings Banks Group was recently upgraded by S&P. On April 28 2017, S&P raised the long-term credit rating on the central credit institution of the Finnish Savings Bank Group to A- from BBB+. The central credit institution (Sp Central Bank) reflects the wide group´s franchise and creditworthiness and thus S&P´s rating can be viewed as a guideline for the entire Group. In addition, a stable outlook was assigned. The upgrade was primarily due to a gradually improved economic environment in Finland during 2017. Nevertheless, the rating also reflects the Group´s strong capitalization, its low risk lending and high overcollateralization, while it also notes the mutual business model.
NORDEA MARKETS | 48 SP MORTGAGE BANK
Graphs and statistics
Table 2: Cover pool statistics
Source: S&P, SP Mortgage Bank
Table 3: Rating by S&P
Source: S&P
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: SP Mortgage Bank
NORDEA MARKETS | 49 THE MORTGAGE SOCIETY OF FINLAND
The Mortgage Society of Finland
Key points Strengths Weaknesses The covered bonds are rated AAA by S&P. Cover pool loans almost solely consist of float-rate loans (99%) and thus rate hikes in High overcollateralization of 37.85% and the Finland could influence loan performance cover pool consists solely of Finnish residential significantly. assets. Refinancing risk due to lending longer term Part of the Hypo Group, whose operations than funding. are founded on a strong financial position and capitalization with a loyal customer base. Relatively small issuer and low market share.
Company profile Hypo is a mutual company governed by its member customers, which provide its customers with a full range of products within financing home purchases. Among other things, it grants mortgages and consumer loans for all stages of home owning including purchasing and renovating. The covered bonds are issued by the group parent. The Mortgage Society of Finland (hereafter Hypo) grants loans to households and housing companies against housing or residential property situated in Finland. The Mortgage Society of Finland (Hypo) constitutes the core of the Hypo Group, which is the oldest private credit institution in Finland as it was established in 1860. The Hypo Group also includes Suomen AsuntoHypoPankki Oy a deposit bank (founded in 2002) and the housing company Bostadsaktiebolaget Taos, which is 54.6% owned by the Hypo Group. In addition, The Hypo Group is a member of Federation of Finnish Financial Services and a founding member of Nordiska Realkredit Samrådet, the federation of Nordic mortgage banks, while it is also a member of the International Union for Housing Finance and the Mortgage Bankers Association.
Figure 1: Structure of the Hypo Group Figure 2: Market share
Source: Hypo Group, Bloomberg
NORDEA MARKETS | 50 THE MORTGAGE SOCIETY OF FINLAND
Financial performance The Hypo Group reported a rather stable profit after tax for the year as it declined by a modest 0.2% during 2016. This is mainly attributable to a decline in net income from investment properties (- 27.9%), an increase in total administrative expenses (8.4%) and other operating expenses (48.0%). Loan losses also significantly increased to EUR 269t (2015: EUR -6t), but remains rather low compared to total lending. Net interest income improved by 17.8% and net fee income improved by 32.8%, while net income from available for sale financial assets also improved by 46.9%. Both profitability and efficiency slightly worsened as the return on equity declined to 5.8% (-0.4%-points) and the cost to income ratio increased to 57.1% (+1.9%-points). The Group is well capitalized, but capitalization ratios declined throughout 2016 by 0.2%-points.
Table 1: Key Figures for the Hypo Group
Source: The Hypo Group
Cover pool composition At end-2016, the cover pool value stood at approximately EUR 550m. The quality of the cover pool is high as the overcollateralization is 37.9% and it solely consists of Finnish residential assets. There is a geographical bias towards the Metropolitan Area (which is constituted by Helsinki, Espoo, Vantaa and Kauniainen), which compromises 73% of lending. According to S&P, WAFF and WALS is respectively 22.8% and 10.4% resulting in a WAFF*WALS of 2.4%. The average loan to value (indexed) is quite low compared to domestic peers as it stands at 32.6%.
ALM and risk Similarly to other Finnish issuers of covered bonds, Hypo´s mortgage loans primarily consist of floating-rate loans (99%), while the covered bonds are issued as fixed-rate bonds (99%). This results in a mismatch and exposure to interest rate changes if this is not adequately hedged. All the loans are EUR-denominated and thus the pool has no exposure towards currency risk. Hypo has exposure towards refinancing risk due to lending at longer maturities than its funding, but credit risk is low because of the high quality of the cover pool.
Ratings The Covered Bonds issued within the Group are rated AAA by S&P with a stable outlook. The outlook for The Mortgage Society of Finland was revised to stable from negative as of 17 November 2016 due to a gradual improvement in the Finnish economy. S&P believes that this will continue and the housing market will improve, which could lead to further improvements for The Hypo Group. The Short-term rating of The Mortgage Society of Finland was raised to A-2 as of 26 April, 2017. At the same time S&P affirmed the BBB long-term rating and its stable outlook.
NORDEA MARKETS | 51 THE MORTGAGE SOCIETY OF FINLAND
Graphs and statistics
Table 2: Cover pool statistics
Source: Hypo Group, S&P
Table 3: Rating by S&P
Source: S&P
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Hypo Group
NORDEA MARKETS | 52 Issuer profiles Norway
DNB Boligkreditt
Eika Boligkreditt
Møre Boligkreditt
Nordea Eiendomskreditt
SpareBank 1 Boligkreditt
Sparebanken Sør Boligkreditt
Sparebanken Vest Boligkreditt
SR-Boligkredit
NORDEA MARKETS | 53 DNB BOLIGKREDITT
DNB Boligkreditt
Key points Strengths Weaknesses Parent company is the largest provider of Cover pool consists of potentially inflated financial services in Norway. assets in the Norwegian housing market.
High quality cover pool. Mainly Norwegian Parent company, DNB Bank, is exposed to the residential mortgages (97.1%), low average LTV shipping industry, the real estate sector and (54.3%) and high OC at 50.2%. corporates.
DNB is 34% owned by the Norwegian Few limitations on future pool composition – Government. substitution risk.
Company profile DNB Boligkreditt is a wholly-owned subsidiary of the largest bank in Norway, DNB Bank. The DNB Group is the largest provider of financial services in Norway with 2.1m retail customers and 220,000 corporate customers. DNB Boligkreditt has Norway’s most extensive distribution network for mortgage solutions, being one of the largest real estate agencies. This ensures a strong distribution system. DNB Bank was founded in 1822 under the name Christiania Sparebank, but has been formed by several mergers during its lifetime. The Norwegian state holds a 34% share in the bank while a foundation (Sparebankstiftelsen DNB NOR) holds an additional 9%. Due to this ownership structure and DNB’s systemic importance to the Norwegian financial sector, government support is considered highly likely in case of distress. DNB Boligkreditt’s sole purpose is to issue covered bonds backed by mortgage loans. DNB Boligkreditt was the first to issue covered bonds in Norway and has retained a very strong market position with almost 34.6% of all outstanding bonds.
Figure 1: Structure of the DNB Group Figure 2: Market share
Source: DNB Bank ASA, Bloomberg
NORDEA MARKETS | 54 DNB BOLIGKREDITT
Financial performance DNB Boligkreditt reported a worsened profit after tax of NOK 815m, which is equivalent to a decrease of 87.1% since 2015. This is partly driven by a decline in net interest income of -30.9% due to narrowing interest rate spreads. However, the bank also incurred a loss NOK 1,233m on financial instruments at fair value compared to a gain of NOK 4,081m last year. This was primarily driven by losses on FX and derivatives trading and by losses on financial liabilities (long-term borrowing in NOK). Loan losses are low albeit it is worth noting that it further decreased to NOK -14m. In terms of key ratios, DNB Boligkreditt´s profitability worsened as the return on equity declined to 2.1% (2015: 18.4%), which is well below DNB Bank Group´s target of 12% for 2016. Capitalization slightly improved, while efficiency heavily worsened because of a proportionally much larger decline in income than costs.
Table 1: Key figures for DNB Boligkreditt
Source: DNB Boligkreditt Annual Report 2016
Cover pool composition
The cover pool consists exclusively of NOK-denominated mortgages and thus there is no currency risk. These mortgages primarily finance residential properties (97.1%) and a small amount of multifamily assets (2.9%). All loans are granted on Norwegian properties making the pool exposed to the state of the Norwegian economy, in particular the housing market. The residential assets in the pool are characterized by an average LTV of 54.3%, well below the requirements of 75% according to the Norwegian regulations. Similarly, the collateral score excl. systemic risk is low (3.3%) compared to domestic peers reflecting the limited credit risk in the pool. Overcollateralization stands at 50.2% and is higher than most domestic competitors.
ALM and risk
DNB Boligkreditt is subject to interest rate risk given that most loans are floating-rate loans while the outstanding covered bonds are fixed-rate bonds. However, this risk is mitigated through swap agreements. Underlying assets are all NOK-denominated, but bonds are issued in EUR, NOK and USD. The currency risk is eliminated by the use of swap agreements. The pool is subject to refinancing risk as the average weighted lifetime of the loans is shorter than for the outstanding bonds.
Ratings All covered bonds issued by DNB Boligkreditt benefit from Aaa/AAA by Moody’s/S&P. Further, S&P´s outlook is stable, with 1 notch of unused uplift. DNB Boligkreditt does not have a stand-alone issuer rating, but DNB Bank´s long-term rating is A+/Aa2/AA assigned by S&P/Moody´s/DBRS, respectively. Moody´s has a negative outlook, while both S&P and DBRS currently hold a stable outlook for DNB Bank.
NORDEA MARKETS | 55 DNB BOLIGKREDITT
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody’s investor service
Table 3: Rating by Moody´s and S&P
Source: Moody’s investor service, S&P
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Moody’s investor service
NORDEA MARKETS | 56 EIKA BOLIGKREDITT
Eika Boligkreditt
Key points Strengths Weaknesses High-quality cover pool – 73.8% residential Cover pool loans granted on potentially mortgages with a low average LTV on inflated assets in the Norwegian housing residential assets (46.9%). market.
The lowest collateral score excl. systemic Dispersed owner-structure. risk of 2.0% among European countries. Few limitations on future pool composition – Geographically diversified due to substitution risk. nationwide distribution network.
Company profile Eika Boligkreditt (former Terra Boligkreditt) is owned by 71 Norwegian savings banks (Eika banks, excluding Bank2 and Sandnes Sparebank) and the housing cooperative OBOS. The Eika banks and Eika Gruppen AS - a holding company owned by the 73 Eika banks and OBOS - have a collective customer base of approximately one million. OBOS is Norway’s largest housing corporation owned by its 417,000 members. Eika Boligkreditt benefits from a distribution system of about 200 branch offices owned by the various Eika saving banks. Eika Boligkreditt was established in 2003 as a specialized credit institution. Its sole purpose is to offer mortgages on retail properties in Norway distributed through Eika banks’ branches and the real estate agent Aktiv Eiendomsmegling (a merger of Aktiv Eiendomsmegling and Terra Eiendomsmegling in 2013). A guarantee scheme exists between Eika Boligkreditt and the Eika banks to ensure aligned incentives: 1) A loss guarantee implying a first-loss guarantee for the portion of the loan exceeding 50% of LTV plus a minimum guarantee of NOK 25,000 per loan irrespective of LTV and 2) set-off rights implying that Eika Boligkreditt has set-off rights against each bank’s commission for a period of up to three years. Furthermore, an agreement on loans in arrears has been settled, implying that the local Eika bank is notified whenever debt payments are missed. The bank will then be presented with three options to choose from: 1) The bank covers missed payments 2) The bank buys back the mortgage at par plus interest and as a result the mortgage is removed from the cover pool and 3) The bank pays the guaranteed amount. Figure 1: Structure of the Eika Group Figure 2: Market share
Source: Eika Boligkreditt Annual Report 2016, Bloomberg
NORDEA MARKETS | 57 EIKA BOLIGKREDITT
Financial performance Since the Eika banks do not publish a consolidated annual report we do not comment on their financial performance, but instead we comment on Eika Boligkreditt´s financial performance. Eika Boligkreditt´s balance sheet continued its expanding trend as total assets increased by 6.8% throughout 2016, driven by an increase in lending to customers. However, profit after tax severely worsened as it amounted to NOK 39m, down from NOK 263m for 2015. This was partly driven by a decrease in net interest income (-24.1%) and partly driven by a loss on financial instruments of NOK - 82m compared to a gain of NOK 203m for 2015. Net interest income decreased due to lower interest rates on residential mortgages in the cover pool, while losses from financial instruments are due to value adjustments of swaps and other derivatives used for hedging purposes. Profitability heavily worsened as the return on equity declined from 10.7% to 1.4%, while efficiency slightly worsened and capitalization remained quite stable. Eika Boligkreditt is a credit institution, why its key figures are not directly comparable to the reported financial performance of the parent banks or groups of the other Nordic covered bond issuers.
Table 1: Key figures for Eika Boligkreditt AS
Source: Eika Boligkreditt AS Annual Report, 2016
Cover pool composition The value of the cover pool increased substantially and now stands at NOK 83bn consisting mainly of residential mortgages (73.8%), but also 10.6% multi-family houses and 15.7% other assets, mainly cash and cash equivalents. All mortgages are granted on Norwegian property, primarily located in the Oslo region. The average indexed LTV (46.9%) and the collateral score excl. systemic risk (2.0%) are low compared to domestic peers and generally the cover pool is very solid represented by a low collateral score. On May 2017 Moody’s EMEA Covered Bonds monitoring overview for Q4 2016 concluded that covered bonds from Eika Boligkreditt has a top position in regard to having one of the lowest (best) collateral scores.
ALM and risk The cover pool loans are almost solely floating-rate loans (95%) while the outstanding bonds are mainly fixed-rate bonds (62.5%) exposing the issuer to changes in the Norwegian interest rate, if this is not adequately hedged. Furthermore, there is a refinancing risk as the weighted average lifetime of the bonds funding the loans is shorter than the lifetime of the loans (3.9 years and 11.5 years, respectively). All loans are domestic and NOK-denominated but the bonds which Eika Boligkreditt issues are primarily in NOK and EUR. The arising currency-risk is eliminated by the use of derivatives.
Ratings Moody´s upgraded Eika Boligkreditt´s mortgage covered bonds to Aaa from Aa1 as of June 6, 2017. This reflects that the covered bonds are predominantly backed by a pool of Norwegian mortgage loans and are governed by the Norwegian covered bond legislation, while it also reflects Moody´s first issuer rating of Eika Boligkreditt, which resulted in a long-term rating of Baa1. This assessment takes into account, the fact that the Eika Alliance consists of strong banks and the likelihood that member banks would provide support to Eika Boligkreditt in case of need.
NORDEA MARKETS | 58 EIKA BOLIGKREDITT
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody’s investor service
Table 3: Rating by Moody´s
Source: Moody’s investor service
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Moody’s investor service
NORDEA MARKETS | 59 MØRE BOLIGKREDITT
Møre Boligkreditt AS
Key points Strengths Weaknesses Purely domestic bank, benefitting from strong Cover pool consists of potentially inflated Norwegian macro profile. assets in the Norwegian housing market.
Strong parent bank, with high credit strength. Low committed level of over-collateralization.
High quality of cover pool – average LTV in Geographic concentration to Møre and line with domestic peers (62.6%) and low Romsdal regions. collateral score (5.0%).
Company profile Møre Boligkreditt AS is a wholly-owned subsidiary of Sparebanken Møre and owns a license to operate as a mortgage company and issue covered bonds to secure long-term market funding for its parent bank. With a market share of 1.7%, it is the eight largest issuer of covered bonds in Norway. It currently has one cover pool, with a value of NOK 20.5bn containing almost solely residential assets (96.4%). Covered bonds are issued in both NOK and SEK, but also EUR. Møre Boligkreditt’s parent bank, Sparebanken Møre, operations extend geographically to the Møre and Romsdal regions (about 4.79% of Norway’s land area) and currently it has about 380 employees and 30 branches. Sparebanken Møre came into existence in 1985 as the result of a merger of several banks. Since this time it has continued to grow, and the latest merger took place in 2009.
Figure 1: Structure of Sparebanken Møre Group Figure 2: Market share
Source: Sparebanken Møre AS, Bloomberg
NORDEA MARKETS | 60 MØRE BOLIGKREDITT
Financial performance From 2015 to 2016, Sparebanken Møre Group´s profit after tax increased by 14.1%. This is primarily driven by an increase of other income of NOK 76m, which can be attributed to gains from the bond portfolio amounting to NOK 24m compared to NOK -51m in 2015. Loan losses heavily declined by 56% and net interest income declined by 1.5% due to lower interest rates and high competition. While profitability improved as the return on equity increased to 11.6%, the efficiency remained unchanged throughout the year as costs and income proportionally increased by the same. Capitalization ratios marginally improved as both the total capital ratio and the tier 1 capital ratio increased to 17.0% and 14.6% (2015: 16.6% and 14.1%, respectively).
Table 1: Key figures for the Sparebanken Møre Group
Source: Sparebanken Møre Group Annual Report 2016
Cover pool composition
The cover pool value is NOK 20.5bn. It primarily consists of residential assets (96.4%) with a geographical bias towards the Møre and Romsdal regions. A weighted average LTV of 62.6% is in line with domestic peers and below the requirements of 75% for residential mortgage loans. Sparebanken Møre also enjoys a low collateral score incl. systemic risk (5.0%) which illustrates the solid quality of the cover pool. Overcollateralization stands at 14.3%, which is fairly low compared to domestic competitors.
ALM and risk
Loans in the cover pool are exclusively floating-rate loans (100%), while 87.3% of the outstanding covered bonds are mainly floating-rate loans. Therefore, the pool is exposed to some interest rate risk. Regarding currency risk at the end of 2016, the issued bonds are denominated in NOK, SEK and EUR while all pool loans are NOK-denominated, exposing the issuer to currency risk. Both the interest rate risk and the currency risk are eliminated by the use of derivative contracts. Stated in Møre Boligkreditt´s annual report 2016 credit risk represent the most significant area of risk. This risk is however limited by the high quality of the loans (low LTV and low collateral score). As the maturity between outstanding bonds and loans are different, there is refinancing risk.
Ratings All covered bonds issued by Møre Boligkreditt AS benefit from a Aaa rating by Moody’s. Møre Boligkreditt does not have a stand-alone issuer rating while Sparebanken Møre’s long-term credit rating is A2, with a stable outlook by Moody’s. The rating of the cover pool reflects the high credit and asset quality securing the payment obligation of the issuer under the covered bonds, the strength of the Norwegian legal framework and credit strength of the issuer.
NORDEA MARKETS | 61 MØRE BOLIGKREDITT
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody’s investor service
Table 3: Rating by Moody´s
Source: Moody’s investor service
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Moody’s investor service
NORDEA MARKETS | 62 NORDEA EIENDOMSKREDITT
Nordea Eiendomskreditt
Key points Strengths Weaknesses Solid parent company (part of the Nordea Cover pool is exposed to developments in the Group). Norwegian housing market which might be overheated. High quality asset pool consisting only of Norwegian residential mortgages, low Cover pool loans are primarily floating-rate average LTV (52.3%) and OC of 15.5%. loans (97.9%) – rate hikes in Norway could affect loan performance. The Nordea Group as well as Nordea Eiendomskreditt are well capitalized.
Company profile Nordea Eiendomskreditt is a fully-owned subsidiary of the Nordea Group, which is the largest financial institution in Scandinavia and the Baltic region. The history of Nordea Eiendomskreditt goes back to 1927. It was acquired by Nordea in 1996 and changed name to Nordea Eiendomskreditt in 2008. It is a specialist bank with the sole purpose of issuing covered bonds backed by loans originated by Nordea´s operations in Norway (previously Nordea Bank Norge). Nordea Eiendomskreditt enjoys a market share of more than 8% measured by outstanding covered bonds. Nordea Group works throughout the Nordic region and Eastern Europe with operations in Sweden, Denmark, Finland, Norway, the Baltics, and Russia. Nordea is the result of several large mergers in 2000 of Danish, Finnish, Swedish and Norwegian banks. Nordea sets a significant footprint in Nordic banking with 11m private customers, 600,000 corporate customers and approximately 650 branches. Nordea Eiendomskreditt benefits from a strong distribution network via The Nordea Group. Nordea Bank Norge was previously the parent company, but as it merged into Nordea Bank AB (publ) in 2 January 2017, Nordea Eiendomskreditt is now a subsidiary of Nordea bank AB (publ).
Figure 1: Structure of the Nordea Group Figure 2: Market share
Source: Nordea Annual Report 2016, Bloomberg
NORDEA MARKETS | 63 NORDEA EIENDOMSKREDITT
Financial performance Nordea Eiendomskreditt´s profit after tax severely worsened as it declined by 43.7% throughout the financial year 2016, resulting in a return on equity of 6.0% or equivalent to 4.8%-points lower than the previous year. This was primarily driven by a large increase in operating expenses, which is primarily related to management of the lending portfolio and customer contact, a service that is purchased from the parent bank. The increase in operating expenses also resulted in a worsened efficiency as the cost to income ratio increased to 36.1%. In addition, net interest income decreased by 21.4% due to lower lending margins caused by interest rate reductions. Loan losses declined by 97% (provisions declined by approximately 84.5%). Capital ratios excluding the Basel I floor are high as shown in the table and improved further during 2016. Including the Basel I floor, the total capital ratio is 28.3% and the core tier 1 ratio is 25.7%. The massive improvement in capitalization is caused by a combination of a higher amount of capital and a lower credit risk.
Table 1: Key figures for Nordea Eiendomskreditt
Source: Nordea Eiendomskreditt Annual Report 2016
Cover pool composition The cover pool backing the issued covered bonds totals NOK 98.4bn. It solely consists of Norwegian single-family residential mortgages with a geographical bias towards the Oslo and eastern parts of Norway. An LTV value of 52.3% is in line with domestic competitors and much lower than the legislative LTV limit of 75% for single-family mortgages. Nordea Eiendomskreditt also enjoys a low collateral score incluing systemic risk (5.0%), which illustrates the solid quality of the cover pool. Overcollateralization stood at 15.5% at end-2016.
ALM and risk Both the cover pool loans and the outstanding covered bonds are primarily floating-rate, however with a larger share of floating-rate loans in the cover pool than among the outstanding bonds (97.9% and 77.7% respectively). Therefore, there is exposure to interest rate risk. Currency and interest rate risk is hedged by using derivatives. Primarily bonds are issued in NOK, but also in USD and GBP, whereas all loans are NOK-denominated. There is also a refinancing risk due to the mismatch between the WAL of the outstanding bonds and the loans in the cover pool.
Ratings All covered bonds issued by Nordea Eiendomskreditt are rated Aaa by Moody’s. Nordea Eiendomskreditt does not have a stand-alone rating, while Nordea Group’s long-term ratings by Moody’s/S&P/Fitch are Aa3/AA-/AA-. As of 23.05.2017, S&P revised the outlook for Nordea Bank (publ) to stable from negative and at the same time affirmed the AA- long-term rating. This reflects the improving economic environments in Nordea´s core market, while also taking its strong financial performance into account.
NORDEA MARKETS | 64 NORDEA EIENDOMSKREDITT
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody’s investor service
Table 3: Rating by Moody´s
Source: Moody’s investor service
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Moody’s investor service
NORDEA MARKETS | 65 SPAREBANK 1 BOLIGKREDITT
SpareBank 1 Boligkreditt
Key points Strengths Weaknesses Strong group of owners. Few restrictions on future composition of the cover pool could lead to dilution. High-quality cover pool with average LTV of 55.6%. Potentially inflated assets in the Norwegian housing market. Low collateral score excl. systemic risk (2.5%). OC is below domestic competitors (9.10%).
Cover pool consists mostly of Norwegian residential mortgages (86.2%).
Company profile SpareBank 1 Boligkreditt is a wholly-owned subsidiary of the members of the SpareBank 1 Alliance. The members of the alliance are SpareBank 1 Nord-Norge, Sparebanken Hedmark, SpareBank 1 SR- Bank, SpareBank 1 SMN and 11 smaller savings banks. The alliance was founded in 1996 and is the second-largest mortgage lender in the Norwegian market in terms of total assets. It has a strong local presence and an extensive branch network with more than 350 branches covering all of Norway. SpareBank 1 Boligkreditt solely issues Aaa-rated covered bonds backed by loans made by members of the alliance. Sparebank 1 Næringskreditt, a legally separate company, issues Aa1-rated covered bonds and is managed by the same team as Boligkreditt. The ownership structure stands out compared to other Norwegian and Nordic issuers. Each of the banks in the alliance holds a share in the issuer, but the alliance is not a legal entity.
Figure 1: Structure of the SpareBank 1 Alliance Figure 2: Market share
Source: SpareBank 1 Boligkreditt, Bloomberg
NORDEA MARKETS | 66 SPAREBANK 1 BOLIGKREDITT
Financial performance SpareBank 1 Alliance does not publish a consolidated annual report. Therefore, key figures for the four largest members, SR-bank, SMN, SNN, Hedmark (holding 13.9%, 19.1%, 14.6% and 20.3%, respectively) are illustrated below. As evident, the banks are well capitalized with core capital ratios ranging from 14.7-16.9%, which for all of them has increased from 2015 to 2016 except for Sparebank 1 Hedmark as it reported an unchanged core capital ratio. In comparison to domestic peers all four members have a healthy return on equity and are in line with their domestic peers. Efficiency improved for all the four banks except Sparebank 1 Hedmark. Loan losses have severely increased since 2015 for Sparebank 1 SR-bank and Sparebank 1 SMN, while loan losses also slightly increased for Sparebank 1 Nord-Norge and for Sparebank 1 Hedmark.
Table 1: Key ratios for the largest banks of the SpareBank 1 Alliance
Source: Annual reports of the respective companies, 2016
Cover pool composition The value of SpareBank 1 Boligkreditt’s cover pool has remained quite stable within the last year and amounted to NOK 202.2bn at end-2016. The cover pool consists of 86.2% of Norwegian residential mortgages with an average indexed LTV of 55.6%, well below the legal requirement of 75% for residential mortgage loans. Other assets (13.8%) include government treasuries and cash deposits. The weighted average lifetime of the cover pool is 18.9 years and the weighted average lifetime of the outstanding covered bonds is 3.5 years.
ALM and risk Similar to domestic competitors, loans in the pool are mainly floating-rate loans (95.4%), while the outstanding covered bonds are mainly fixed-rate loans (67.7%). Thereby, the pool is exposed to interest rate risk. In terms of credit risk, interest rate hikes in Norway could distress certain borrowers’ ability to repay their loans thus increasing the credit risk of the pool. Considering the solid quality of the cover pool, this risk is furthermore deemed to be minimal. Similar to the other Norwegian covered bond programs, there is no currency risk as both pool loans and outstanding bonds are NOK-denominated. However, there is refinancing risk.
Ratings All covered bonds issued by SpareBank 1 Boligkreditt are assigned Aaa/AAA by Moody’s and Fitch, respectively. The program has not been rated by S&P, and SpareBank 1 Boligkreditt has not been assigned an issuer rating. Regarding the member banks in SpareBank 1’s Alliance, all of them are rated at least A2 by Moody’s. SpareBank 1 SR/SM/Nord-Norge/Hedemark all holds an A1 rating from Moody´s. However, the outlook was recently downgraded to negative from stable for all of the banks, which reflects downward pressure on earnings and increased asset risk in the bank´s corporate book, resulting from the reduction in petroleum investments. This also reflects the proposed legislation by the Ministry of Finance to implement the EU´s bank recovery and resolution directive (BRRD) and the deposit scheme directive.
NORDEA MARKETS | 67 SPAREBANK 1 BOLIGKREDITT
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody’s investor service
Table 3: Rating by Moody´s
Source: Moody’s investor service
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Moody’s investor service
NORDEA MARKETS | 68 SPAREBANKEN SØR BOLIGKREDITT
Sparebanken Sør Boligkreditt AS
Key points Strengths Weaknesses Profitability is supported by efficient Sparebanken Sør has weaker asset quality operations. than domestic peer following a portfolio review.
High quality of the cover pool - residential Geographical concentration: More than 70% mortgages makes up 100% of the cover pool, of all housing collateral is located in Southern with an average LTV of 62.1%. Norway.
Low collateral score incl. systemic risk of Potentially Inflated assets in the Norwegian 4.2%. housing market.
Company profile Sparebanken Sør Boligkreditt AS is a wholly-owned subsidiary of Sparebanken Sør, and the company’s business is operated from Kristiansand. Sparebanken Sør Boligkreditt AS is the result of the merger of Pluss Boligkreditt AS and Sør Boligkreditt AS in 2014 and it issues covered bonds to national and international investors. Its cover pool comprises mortgage home loans that are granted by Sparebanken Sør and later taken over by Sparebanken Sør Boligkreditt. An important requirement is that any outstanding loan balance taken over by the company must not exceed 75% of the mortgaged property’s market value, according to Norwegian law. Sparebanken Sør Bolidkreditt is currently the seventh largest issuer of covered bonds in Norway, with a market share of about 2.8%. It has one cover pool with a value of NOK 28.1bn containing 100% residential assets. Sparebanken Sør, the parent company, is an independent financial institution that engages in banking, securities and real estate brokerage as well as insurance, leasing and mortgaging through its subsidiaries. It mainly operates in Vest-Agder (46.5%), Aust-Agder (26.1%) and Telemark (10.0%) through its 34 branches.
Figure 1: Structure of the Sparebanken Sør Group Figure 2: Market share
Source: Sparebanken Sør Annual Report 2016, Bloomberg
NORDEA MARKETS | 69 SPAREBANK SØR BOLIGKREDITT
Financial performance Sparebanken Sør reported its best result ever in 2016 with a return on equity of 11.6%. This was primarily driven by an increase in income from financial instruments, which increased by NOK 290m caused by a decline in credit spreads yielding positive effects on the profit. In addition, an increase in net returns from shareholdings including gains after the sale of Visa Europe significantly influenced the results in a positive direction. Net interest income increased by 1.4% due to volume growth, while loan losses decreased by 48.5% and operating expenses decreased by 3.7%. Both efficiency and capitalization improved as the cost to income ratio declined by 8.3%-points and capitalization ratios increased by respectively 2.4%-points and 2%-points.
Table 1: Key figures for Sparebanken Sør
Source: Sparebanken Sør Annual Report 2016
Cover pool composition The cover pool backing the issued covered bonds totals NOK 28.1bn. It solely consists of Norwegian single-family residential mortgages with a geographical bias towards the Vest-Agder and Aust- Agder in the southern parts of Norway. An LTV value of 62.1% is in line with domestic competitors and lower than the legislative LTV limit of 75% for single-family mortgages. Sparebanken Sør Boligkreditt also enjoys a low collateral score including systemic risk (5.0%), which illustrates the solid quality of the cover pool. Overcollateralization stands at 14.7%, a little low compared to domestic peers.
ALM and risk Both the cover pool loans and the outstanding covered bonds are primarily floating-rate. 100% of the loans in the cover pool are floating-rate and 78% of the outstanding bonds. Thus, there is some exposure to interest rate risk. This risk is mitigated using financial derivatives. Sparebanken Sør Boligkreditt issues bonds in NOK and EUR, and all assets in the pool are NOK-denominated. Therefore, there is currency risk. Due to the duration mismatch between cover pool loans and outstanding bonds (WAL of 12.3 and 3.4 years respectively), refinancing risk should be taken into account when considering the risk of the pool.
Ratings The covered bonds issued by Sparebanken Sør Boligkreditt are rated Aaa by Moody’s. Sparebanken Sør Boligkreditt does not have a stand-alone rating, while Sparebanken Sør Group’s long-term ratings by Moody’s is A1 and a negatve outlook. Previously it had a stable outlook, which was assigned in late 2016 reflecting the moderate likelihood of support from the Norwegian government in case of need, the bank´s strong asset quality, its improved capitalization, its moderate profitability and its high reliance on market funding, which is a common attribute of Norwegian financial institutions. However, Moody´s recently changed this outlook to negative for five Norwegian banks (including Sparebanken Sør). The negative outlook is triggered by the proposed legislation introduced to the Norwegian parliament on 21 June, 2017 to implement the EU´s bank recovery and resolution directive (BRRD) and the deposit guarantee scheme directive.
NORDEA MARKETS | 70 SPAREBANKEN SØR BOLIGKREDITT
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody’s investor service
Table 3: Rating by Moody´s
Source: Moody’s investor service
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Moody’s investor service
NORDEA MARKETS | 71 SPAREBANK VEST BOLIGKREDITT
Sparebanken Vest Boligkreditt
Key points Strengths Weaknesses Parent is the third largest savings bank in Geographical concentration: 95.2% of all Norway. housing collateral is located in Western Norway (Hordaland, Rogaland, Sogn & Fjordane). High-quality cover pool – residential mortgages makes up 90.8% of the cover pool, Cover pool loans granted on potentially with an average LTV of 56.5%. inflated assets in the Norwegian housing market. Low collateral score incl. systemic risk of 5.0%. Few restrictions on future composition of the cover pool – substitution risk.
Company profile Sparebanken Vest Boligkreditt (SVBK) is a wholly-owned subsidiary of Sparebanken Vest which is Norway’s third largest savings bank with total assets amounting to NOK 163bn by year-end 2016. The bank is especially a large player in Western Norway, the most diversified and wealthiest region of the country. It has a market share of 26.9%/17.1%/5.4% in its core markets Hordaland/Sogn and Fordane/Rogaland. Headquarters are located in Bergen. Sparebanken Vest also has activities in real estate agency via ownership of Eiendomsmegler Vest, which further supports the distribution of mortgage loans. Sparebanken Vest has more than 264,500 retail customers and more than 11,500 corporate customers. SVBK has a strong position in the well-functioning domestic covered bond market which mitigates refinancing risk. SVBK is currently the 5th largest issuer of cover bonds in Norway with a market share of 5.6%. It has one cover pool with a size of NOK 66.2bn mainly containing residential assets.
Figure 1: Structure of the Sparebanken Vest Figure 2: Market share
Source: Sparebanken Vest Boligkreditt AS Investor Presentation 2016, Bloomberg
NORDEA MARKETS | 72 SPAREBANK VEST BOLIGKREDITT
Financial performance From 2015 to 2016 profit after taxes increased by 45.3%, which also resulted in an improvement of the profitability throughout the year as the return on equity increased to 13.1%, up from 11.0% from the previous year. The result was positively influenced by a decline in loan losses of 78.9% and by an increase in net interest income of 1.9%. The cost to income ratio declined to 39.7% due to a combination of a higher income level and a lower cost level compared to 2015. Capitalization also improved as the total capital ratio and the core tier 1 capital ratio increased by 1.8%-points and 1.2%- points, respectively.
Table 1: Key figures for Sparebanken Vest
Source: Sparebanken Vest AS Annual Report 2016
Cover pool composition The value of the cover pool is NOK 66.2bn, and the pool mainly consists of residential mortgages (90.8%). All mortgages are granted on Norwegian property with a strong geographical concentration towards Western Norway, especially the region Hordaland (75.7% of all mortgages in the pool). This exposes the pool to developments in the Norwegian housing market, especially to the conditions in Hordaland, while there is also a substantial exposure towards Rogaland and Sogn & Fjordane. Weighted average LTV is 56.5% which is lower than most European peers and in line with other Norwegian mortgage portfolios. Moody’s collateral score incl. systemic risk is 5.0%. Substitution assets are mainly government T-bills and deposits in Sparebanken Vest.
ALM and risk The cover pool consists primarily of floating-rate loans (91.4%) and only 8.6% are fixed-rated, while only 40.7% of the outstanding covered bonds are floating-rate bonds, and the pool is thereby exposed to interest rate changes. The floating-rate loans might expose the pool to credit risk in case of interest rate hikes. Sparebanken issues bonds primarily in EUR and NOK whereas all assets in the pool are NOK-denominated. The use of currency swaps eliminates currency risk. Due to the duration mismatch between cover pool loans and outstanding bonds (WAL of 12.2 and 3.1 years respectively), refinancing risk should be taken into account when considering the risk of the pool.
Ratings Sparebanken Vest Boligkreditt is not independently rated, but Sparebanken Vest’s long-term rating is A1/A- by Moody’s/Fitch. Fitch currently has a stable outlook, which reflects Sparebanken Vest´s strong franchise and regional concentration, its resilient profitability, its reliance on wholesale funding and its strong capitalization. However, Moody´s recently downgraded its outlook from stable to negative due to the proposed legislation introduced to the Norwegian parliament on 21June 2017 to implement the EU´s bank recovery and resolution directive (BRRD) and the deposit guarantee scheme directive. Moody´s believe if the law is enacted, the Norwegian banks will have a lower probability of support from the government. Its covered bond programme is rated Aaa by Moody´s.
NORDEA MARKETS | 73 SPAREBANK VEST BOLIGKREDITT
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody’s investor service
Table 3: Rating by Moody´s
Source: Moody’s investor service
Figure 3: Indexed LTV distribution, Q1 2017 Figure 4: Loan seasoning, Q1 2017
Source: Moody’s investor service
NORDEA MARKETS | 74 SR-BOLIGKREDITT
SR-Boligkreditt A/S
Key points Strengths Weaknesses Solid parent company (SR-Boligkreditt A/S, Exposure to developments in the Norwegian wholly owned subsidiary of Sparebank 1-SR housing market which might be overheated. Bank). Few limitations on future pool composition – Good quality in asset pool with an OC score of substitution risk. 13.1% and with 94.7% in residential assets. Cover pool loans are only float-rate loans Low collateral score excl. systemic risk (4.2%). (100%) – rate hikes in Norway could affect loan performance.
Company profile Sparebank 1 SR-Bank’s roots go back to 1839 and today it is Norway’s largest regional bank and the second largest Norwegian-owned bank. Sparebank 1 SR-Bank is, with approximately 312,000 retail customers, one of the leaders in the retail market in the Southern and Western parts of Norway. In addition to the retail market Sparebank 1 SR-Bank also serves around 14,500 corporate customers, which is divided into the energy and maritime industry as well as the public sector. The group’s primary activities are selling and procuring a wide range of financial products and services such as investment services, accounting services and leasing and estate agency. As of the end of 2016 the group had 1,172 employees. SR-Boligkreditt A/S was established in the second quarter of 2015, and is a wholly owned subsidiary of Sparebank 1 SR-Bank. Its function is to purchase home mortgages from Sparebank 1 SR-Bank and fund these by issuing covered bonds. SR-Boligkreditt enables SpareBank 1 SR-Bank to diversify and optimise its funding. SR-Boligkreditt is a small issuer of covered bonds in Norway with a market share of 3.1%. However, despite its recent establishment it is already viewed as a high quality issuer and has increased its market share in recent years. As of 11 June, 2015 Moody´s assigned all covered bonds issued by SR- Boligkreditt an Aaa rating.
Figure 1: Structure of Sparebank 1 SR-Bank Figure 2: Market share
Source: Sparebank 1 SR-Bank, Bloomberg
NORDEA MARKETS | 75 SR-BOLIGKREDITT
Financial performance From 2015 to 2016, SpareBank 1 SR-Bank Group´s profit after taxes slightly increased by 0.5%, but the return on equity decreased by 0.8%-points as equity proportionally increased faster than profits. Net interest income continued its improving trend as it increased by 10.7% throughout the year, which is driven by improved risk pricing for large parts of the corporate market portfolio, as well as better deposit margins. Net income stemming from financial investments increased by NOK 350m or 115%. However, the impressive increase in net interest income and net income from financial investment was almost completely offset by an increase in operating expenses (9.1%) and loan losses (85.2%). The large increase in loan losses was especially driven by a large increase in impairments regarding the service sector, but it is worth noting that loan losses remains at a fairly low level. Efficiency improved during the year as the cost to income ratio declined by 1.2%-points, while capitalization also improved as the total capital ratio and the core capital ratio increased to respectively 17.5% and 14.7%.
Table 1: Key figures for Sparebank 1 SR-Bank
Source: Sparebank 1 SR-Bank Annual Report 2016
Cover pool composition The cover pool value amounted to 32.1bn as of end March 2017, which is significantly larger than a year ago (approximately 100%). The weighted average LTV (indexed) in the pool is 64.5%, which is slightly above domestic peers. SR-Boligkreditt experiences a low collateral score incl. systemic risk of 5% which is in line with their peers and also indicates the high quality of the cover pool. Additionally, the collateral composition exists mainly of residential assets (94.7%) and other assets (5.3%). In addition, it has a moderate overcollateralization score of 13.1% which is in line with domestic peers.
ALM and risk Sparebank 1 SR-Bank is subject to interest rate risk given that all of their loans are floating rate loans (100%) while their outstanding bonds primarily are fixed rate (64.5%). Primarily bonds are issued in NOK; however, bonds are also being issued in EUR. Interest risk and currency risk is hedged via swap agreements. There is also the risk of refinancing, which stems from the mismatch between the WAL of the bonds and the cover pool (respectively 5.6 years and 17.3 years).
Ratings Sparebank 1 SR-Bank is rated A1/A- for the long-term rating and P-1/F2 for the short term rating by Moody’s and Fitch respectively, which reflects the strong macro profile and the Group´s adequate capitalization. The outlook for Sparebank 1 SR-Bank is negative due to Norway’s high exposure towards the oil industry and its pressured profitability and its reliance on market funding. The covered bonds issued by SR-Boligkreditt are all rated Aaa, which reflects the high quality of the cover pool and the strong issuer profile.
NORDEA MARKETS | 76 SR-BOLIGKREDITT
Graphs and statistics
Table 2: Cover pool statistics
Source: Sparebank 1 SR-Bank, Moody´s investor service
Table 3: Rating by Moody´s
Source: Moody´s investor service
Figure 3: Indexed LTV distribution, Q1 2017 Figure 4: Loan seasoning, Q1 2017
Source: Moody´s investor service
NORDEA MARKETS | 77 Issuer profiles Sweden
Danske Hypotek
Landshypotek
Länsförsäkringar Hypotek
Nordea Hypotek
SCBC
SEB AB
Stadshypotek
Swedbank Mortgage
NORDEA MARKETS | 78 DANSKE HYPOTEK
Danske Hypotek
Key points Strengths Weaknesses Danske Hypotek is part of the Danske Bank No commitment regarding available Group, which is one of the largest financial overcollateralization above the legislative groups in the Nordic region. minimum of 2%.
The (provisional) cover pool is of high quality A high amount of the mortgage loans in the as the average LTV is low (49.6%) and OC is pool are interest only loans (62%). high (50.1%). Liquidity risk (180 days) is currently not Strong Swedish covered bond legislation. covered.
Exposure towards a potentially inflated housing market.
Company profile Danske Hypotek AB is domiciled in Sweden and is a newly established entity. The issuer´s business is to acquire Swedish mortgages from Danske Bank´s Swedish branch funded by the issuance of covered bonds. The covered bonds are governed by Swedish law and the operations from the issuer are supervised by the Swedish FSA (SFSA). On June 26 2017, it was granted a license to conduct financing business as a credit market company to issue covered bonds under the covered bond act. Danske Hypotek issued its first covered bonds as of August 29 2017. The cover pool solely consists of loans from Sweden. However, it will have a SEK covered bond programme as well as an EMTCN (EUR) covered bond programme. Danske Hypotek is a wholly owned subsidiary of the Danske Bank Group. Danske Bank is a result of several large banking mergers, most recently in 2007 when the Finnish Sampo Bank was acquired. Today, Danske Bank operates in all Nordic countries plus Ireland, Northern Ireland, Luxembourg, Poland and the Baltics. The group has over 5m private customers, 322 branches and more than 19,000 employees.
Figure 1: Structure of the Danske Bank Group Figure 2: Market share
Source: Danske Bank, Bloomberg
NORDEA MARKETS | 79 DANSKE HYPOTEK
Financial performance At the time of writing there was no financial information available regarding Danske Hypotek because it is a newly established entity. However, from 2015 to 2016 the Danske Bank Group experienced an increase in net profit of 51.3%, but noting that the increase is a more modest 12% if excluding goodwill impairment charges. Despite low growth and negative interest rates in Denmark, the underlying business remained robust and benefited from the Group´s diversified business model. The improved results were driven by improvements in net interest income (+2.9%), net trading income (+25.7%) and very low impairment charges (-105.3%). However, the cost level also improved partly due to decreases in operating expenses, depreciation and partly due to lower net contribution to the Danish Resolution Fund and the Guarantee Fund, which resulted in a decrease in the cost to income ratio to 47.2%. As a result of the improved net profit, the return on equity increased to 13.1% compared to 11.6% for the previous year. Danske Bank has a long term goal of a return on equity larger than 12.5% and thus exceeded their long term goal at end-2016. The Group is well capitalized.
Table 1: Key figures for the Danske Bank Group
Source: Danske Bank Group Annual Report 2016
Cover pool composition According to S&P, the provisional cover pool comprises Swedish residential mortgage loans originated from the Swedish branch of Danske Bank. As of June 30 2017, the provisional cover pool has a value of SEK 30.1bn (40.2% are loans backed by tenant-owner rights). The cover pool has a low LTV of 49.6% compared to the legislative maximum of 75%. OC is currently high as it stands at 50.1%. A high amount of the loans are concentrated in Stockholm (50.6%) and a high amount of the loans are interest only loans (62%). WAFF and WALS are respectively 14.7% and 60.8%.
ALM and risk As all loans are SEK denominated, but Danske Hypotek intends to issue SEK as well as EUR denominated bonds, which could result in exposure towards currency risk going forward. Danske Hypotek has exposure towards interest rate risk due to the mismatch between the WAM of assets and bonds (35.6 and 4.0 years respectively). However, Danske Hypotek has entered into a swap agreement with Danske Bank in order to mitigate its interest risk. Credit risk is currently assessed as limited due to the high quality cover pool.
Ratings Danske Hypotek´s mortgage covered bond program was assigned a preliminary AAA rating by S&P on 25 August in 2017. The rating takes the jurisdictional support and a relatively low level of required credit enhancement (CE) into account. Danske Bank´s issuer credit rating is A/A1/A (Fitch, Moody´s, S&P). The issuer rating was recently upgraded from A2 to A1 by Moody´s, reflecting the continuing strengthening of its asset quality, capitalization and profitability, while it also takes into account the Group´s balanced and well-diversified lending portfolio.
NORDEA MARKETS | 80 DANSKE HYPOTEK
Graphs and statistics
Table 2: Cover pool statistics
Source: S&P
Table 3: Rating by S&P
Source: S&P
Figure 3: Indexed LTV distribution, Q2 2017 Figure 4: Loan seasoning Q2 2017
Source: S&P
NORDEA MARKETS | 81 LANDSHYPOTEK BANK
Landshypotek Bank
Key points Strengths Weaknesses
High-quality cover pool consisting of 99% High exposure towards the agricultural agricultural loans with average LTV of 41.83%. sector.
High over-collateralization of 29.3%. Low liquidity compared to other Nordic covered bond issuers. Borrower-owned credit institution, loyal customer base. Duration mismatch between cover pool loans and outstanding bonds – refinancing Historically low loan losses compared to risk. peers. Dynamic cover pool.
Company profile Landshypotek Bank (formerly Landshypotek) is a specialist mortgage bank. With respect to owner structure, Landshypotek Bank differs from most of the other Nordic issuers, as it is borrower-owned via its parent association, Landshypotek Ekonomisk Förening. Operations began in 1836, and today the parent association has some 41,000 members who are all land and/or forest owners. Landshypotek Bank is a market leader in lending for agricultural and forestry properties in Sweden. The company has 19 sales offices throughout the country with approximately some 160 employees undertaking loan processing and servicing customers locally. At year-end 2016, the Bank had loans outstanding of SEK 61.9bn, a market share of approximately 2.4% of the Swedish mortgage market. With 26% of lending for agricultural and forestry properties in Sweden, it is the market leader in this area. Landshypotek Bank has a wholly-owned subsidiary, Landshypotek Jordbrukskredit, which also provides credit to farm and forest owners.
Figure 1: Structure of the Landshypotek Group Figure 2: Market share
Source: Landshypotek Bank Annual Report 2016, Bloomberg
NORDEA MARKETS | 82 LANDSHYPOTEK BANK
Financial performance Landshypotek Bank reported historically strong earnings and has a growing presence in the lending and savings markets. From 2015 to 2016 total lending to Swedish farmers and foresters rose by 3.1% to SEK 66.5bn. Demand for credit from Swedish farmers and foresters remain high, although growth has eased off in recent years. Net interest income decreased by 2.2% due to higher costs for a new subordinated loan and lower market interest rates. Loan losses have been extremely low and decreasing in recent years because lending is secured by property collateral. This trend continued throughout the financial year 2016 as loan losses declined by 67.4% to SEK 15m, which is equal to 0.02% of lending. This is much lower than its regional peers. Profit after taxes increased by 7.4%, while the return on equity marginally increased by 0.1%-point and the cost to income ratio increased by 1%-point. Capitalization is strong and both the total capital ratio and the core tier 1 ratio improved during the year and amounted to respectively 39.9% and 29.4%.
Table 1: Key figures for the Landshypotek Group
Source: Landshypotek Bank Annual Report 2016
Cover pool composition The value of the cover pool amounted to SEK 61.9bn at end-2016 and mainly includes mortgage loans to Swedish agricultural and forest owners (99%). The quality of the asset pool is solid; the average LTV is low (41.83%) compared to domestic peers, and the over-collateralization is high (29.3%). The pool consists of 102,180 loans with an average loan size of SEK 605,823. The top 10 largest borrowers, accounts for 2.56% of the total loan volume and thus there is high loan diversification. Within the past year, the amount of loans has decreased, but this has been more than offset by an increase in the average size of the loans. There is no major concentration to any particular branch of the agriculture/forestry sector or geographic area.
ALM and risk As the interest rate on the loan (fixed or floating) does not always match the interest rate on the issued bond, the issuer is exposed to interest rate risk. Furthermore, the issued covered bonds are denominated in SEK, NOK and CHF, while the underlying loans are SEK-denominated, exposing the issuer to exchange risk. Both FX risk and interest rate risk is however managed by the use of derivative contracts. The issuer’s lending is on average on longer terms than the funding, exposing the issuer to refinancing risk. In addition, there is credit risk which is, however, assessed as being limited because of the high quality of the pool and the high level of over-collateralization.
Ratings The covered bond programme of Landshypotek Bank benefits from an AAA-rating by S&P. Landshypotek Bank as a company has a long-term rating of A- from S&P, and a long-term rating of A from Fitch. Fitch currently holds a stable outlook on Landshypotek Bank, while S&P recently downgraded its outlook from stable to negative. Landshypotek Bank was downgraded two notches from A3 to Baa2 by Moody’s in May 2012. Shortly after the downgrading, in July 2012, Landshypotek terminated its agreement with Moody’s.
NORDEA MARKETS | 83 LANDSHYPOTEK BANK
Graphs and statistics
Table 2: Cover pool statistics
Source: Landshypotek cover pool report Q4 2016, S&P
Table 3: Rating by S&P
Source: S&P
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning Q4 2016
Source: Landshypotek Bank 2016
NORDEA MARKETS | 84 LÄNSFÖRSÄKRINGAR HYPOTEK
Länsförsäkringar Hypotek
Key points Strengths Weaknesses Parent bank is the fifth largest retail bank in High share of IO loans in the pool (78.6%). Sweden. Refinancing risk due to a longer term lending High credit quality of the cover pool – than funding. collateral score excl. systemic risk of 3.1%. Dynamic pool – substitution risk Current over-collateralization of 38.3% and committed level of 10%. Exposure towards a potentially inflated housing market.
Company profile Länsförsäkringar Hypotek (LF Hypotek) is a wholly-owned subsidiary of Länsförsäkringar Bank (LF Bank), which in turn is fully-owned by the insurance group Länsförsäkringar AB, formed by 23 regional independent mutual insurance companies. The alliance has a customer base of 3.7 million. LF’s market position has continuously strengthened and has resulted in a higher market share in recent years. It is the fifth-largest Swedish retail bank, with a strong presence in especially rural areas. Loans are distributed through bank branches and internet operations.
Figure 1: Structure of the Länsförsäkringar Group Figure 2: Market share
Source: Länsförsäkringar Hypotek Annual Report 2016, Bloomberg
NORDEA MARKETS | 85 LÄNSFÖRSÄKRINGAR HYPOTEK
Financial performance Länsförsäkringar Hypotek’s profit after tax for 2016 increased by 25.7% compared to 2015. This is primarily due to an increase in the net interest income, which increased by 24.2% as a result of increased volumes and lower refinancing costs. Loan losses decreased by 50% to NOK 5m and are very low compared to domestic peers. Both profitability and efficiency improved as the return on equity increased by 0.7%-points and the cost to income ratio declined by 3%-points. Capitalization is strong and further improved throughout 2016 with a total capital ratio of 49.7% and a core capital ratio of 44.1%.
Table 1: Key figures for Länsförsäkringar Hypotek
Source: Länsförsäkringar Hypotek Annual Report 2016
Cover pool composition The number of loans increased by 9%, while the number of borrowers increased by roughly 8% during the financial year 2016. The value of the cover pool backing LF Hypotek’s covered bonds is SEK 168.1bn, and the collateral compromise only private homes, compromising primarily single- family homes (71.7%) and tenant-owned apartments (23.2%). LF Hypotek benefits from the lowest collateral score among domestic peers (5%) and a low collateral score excl. systemic risk (3.1%). The average LTV is 57.5%, while the over-collateralization is fairly high (38.3%). Investors also benefit from a commitment to maintain an overcollateralization of minimum 10%. A large share of residential loans (78.6%) are IO loans.
ALM and risk More than half of the cover pool loans are floating rate loans (63.1%), while almost all outstanding bonds (95.4%) are fixed-rate bonds. Due to this mismatch, the issuer is exposed to interest rate risk. As the outstanding bonds are denominated in SEK, EUR and CHF, while pool loans are solely SEK- denominated, there is exposure to currency risk as well if not adequately hedged. There is refinancing risk due to mismatch between the lifetime of the cover pool loans and the outstanding bonds (lending on longer term than funding), and there is credit risk as well, which is, however, limited because of the high quality of the pool loans and the high level of over-collateralization.
Ratings Covered bonds issued by LF Hypotek are rated Aaa/AAA by Moody’s/S&P. LF Hypotek does not have an issuer rating from any rating agency, but LF Bank holds a long-term rating by Moody’s/S&P of A1/A. Both Moody´s and S&P have a stable outlook for LF Bank. In addition, S&P holds a stable outlook on the covered bonds. The high ratings and stable outlooks reflect the high quality of the cover pool.
NORDEA MARKETS | 86 LÄNSFÖRSÄKRINGAR HYPOTEK
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody’s investor service
Table 3: Rating by Moody´s and S&P
Source: Moody’s investor service and S&P
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Moody’s investor service
NORDEA MARKETS | 87 NORDEA HYPOTEK
Nordea Hypotek
Key points Strengths Weaknesses Strong parent bank – provides support and Refinancing risk, mismatch in duration access to widespread distribution network. between pool loans and outstanding bonds.
High-quality cover pool – average LTV in line Low committed level of over-collateralization. with peers (59.3%) and high over- collateralization (57.2%). Cover pool is dynamic – substitution risk.
Strong Swedish covered bond legislation. Exposure towards a potentially inflated housing market.
Company profile Nordea Hypotek is a specialist credit company issuing covered bonds backed by Swedish mortgages. It is currently the fourth largest issuer of covered bonds in Sweden, with a market share of 14.2%. Nordea Hypotek is a fully-owned subsidiary of Nordea Bank AB and a part of the Nordea Group, which is active throughout Scandinavia with operations in Sweden, Denmark, Finland, Norway, the Baltics, and Russia. Nordea is the result of several large mergers of Danish, Finnish, Swedish and Norwegian banks. Nordea sets a significant footprint in Nordic banking with 11m private customers, 600,000 corporate customers and approximately 650 branches. Nordea Hypotek benefits from the strong position and widespread distribution network of its parent company, Nordea Bank AB. It functions as a funding vehicle for Nordea Bank and all mortgage loans are originated through Nordea’s Swedish branches.
Figure 1: Structure of the Nordea Group Figure 2: Market share
Source: Nordea Annual Report 2016, Bloomberg
NORDEA MARKETS | 88 NORDEA HYPOTEK
Financial performance Nordea Hypotek’s profit after tax continued its improving trend as it increased by 18.8% throughout 2016, which was primarily attributable to an increase in net interest income of 17.1% due to a combination of higher lending volumes and lower funding costs. Impairment on loans solely stems from household lending and decreased significantly by 59.1%, but was already fairly low. Despite an improvement in the profits, Nordea Hypotek´s profitability weakened as the return on equity declined to 24.9% (-1.3%-points) due to a proportionally larger increase in equity than in profits. Efficiency improved as the cost to income ratio declined to 7% caused by a larger increase in income than costs. Capitalization has been under pressure due to a proportionally larger increase in RWA than the capital base in recent years, which has resulted in a downward trend in capitalization from 2012-2015. Nonetheless, capitalization ratios improved in 2016 as the total capital ratio and the core capital ratio amounted to 9.6% and 8.5% respectively, which is mainly due to an increase in the capital base of 20%. This was because of an increase in equity (and thus tier 1 capital) due to a high amount of the earnings being retained in the year.
Table 1: Key figures for Nordea Hypotek
Source: Nordea Hypotek Annual Report 2016
Cover pool composition The cover pool backing the issued covered bonds totals SEK 512.3bn. It is mainly comprised by Swedish residential mortgages (81.6%) together with a smaller amount of multi-family loans (12.6%) and to an even lesser extent commercial loans (3.1%) and public sector loans (2.7%). The pool is of high quality with a collateral score incl. systemic risk of 5.6%. The average LTV is fairly low (59.3%) and in line with domestic peers. In addition, overcollateralization is very high as it stood at 57.2% at the end of Q4 2016. The committed overcollateralization stands at 2.0% as of 2016, which is low compared to other domestic issuers.
ALM and risk The issuer is exposed to interest rate risk, as only 17.8% of the cover pool loans are fixed-rate loans, while most of the outstanding bonds issued are fixed-rate bonds (97.2%). Regarding currency risk at end of Q4 2016, the issued bonds are denominated in SEK, EUR, CHF while all pool loans are SEK- denominated, exposing the issuer to currency risk. Both the interest rate risk and the currency risk are eliminated by the use of derivative contracts. The lending provided by the issuer is typically on longer terms than the funding, thus resulting in refinancing risk. There is credit risk as well, which is however limited due to the high quality of the loans (low LTV and low collateral score) and the high level of over-collateralization.
Ratings All covered bonds issued by Nordea Hypotek are assigned Aaa/AAA ratings by Moody’s/S&P. Nordea Hypotek does not have a stand-alone rating, but Nordea Group’s long-term ratings by Moody’s/S&P/Fitch are Aa3/AA-/AA-. As of 23.05.2017 S&P revised the outlook to stable from negative. This reflects the improving economic environments in Nordea´s core market, while also taking its strong financial performance into account.
NORDEA MARKETS | 89 NORDEA HYPOTEK
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody’s investor service
Table 3: Ratings by Moody´s and S&P
Source: Moody’s investor service, S&P
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Moody’s investor service, Nordea Hypotek.
NORDEA MARKETS | 90 SCBC
Swedish Covered Bond Corporation
Key points Strengths Weaknesses Strong parent bank fully-owned by the A sale of the parent bank is considered by the Kingdom of Sweden. Swedish government.
High-quality cover pool – low average LTV Low committed level of over-collateralization. (53.7%) and high over-collateralization (40.4%). Cover pool is dynamic – substitution risk. Strong Swedish covered bond legislation. Exposure towards a potentially inflated housing market.
Company profile The Swedish Covered Bond Corporation (SCBC) is a wholly-owned subsidiary of SBAB Bank (Statens Bostadsfinansieringsaktiebolag). SCBC’s operations started in 2006 after it received a license from the Swedish Financial Supervisory Authority. In the same year SCBC became the first issuer of Swedish covered bonds. SCBC does not engage in new lending itself but acquires loans from SBAB. SBAB Bank was established in 1985 with the objective to finance government mortgages. The bank is still fully-owned by the Kingdom of Sweden. However, in June 2007 the Swedish parliament approved the government’s proposal to reduce ownership in SBAB. Currently, a sale is not being considered due to non-attractive market conditions. SBAB has in recent years expanded its product line to include savings accounts for personal banking customers (2007) and deposits for the corporate market and tenant-owner associations (2009). In December 2009, SBAB submitted an application to the Swedish FSA to obtain permission to conduct banking operations and thereby broaden its product line and become more than a mortgage bank.
Figure 1: Structure of the SBAB Group Figure 2: Market share
Source: SBAB Group, Bloomberg
NORDEA MARKETS | 91 SCBC
Financial performance SCBC reported a profit after tax of SEK 1,221m for 2016 compared to SEK 1,203m for 2015, which is equivalent to an increase of 1.5% throughout the year. SCBC´s funding costs declined, which resulted in an increase in net interest income by 9.8%, albeit a resolution fee of SEK 65m was reported as net interest income rather than net commission, which it has been in previous years. Net expenses from financial transactions increased to SEK 179m (2015: SEK 16m) due to compensation for the transfer of credits to Swedbank and buyback expenses linked to the discontinuation of financing, but this was partly offset by a decrease in net commission expenses. Total expenses rose by roughly 13% and loan losses has consistently remained low compared to the total loan portfolio in recent years. Overall, this resulted in a 0.7%-points decline in the return on equity and a 2%-points increase in the cost to income ratio. SCBC´s capital ratios without the transitional rules amounted to 82.4% at end- 2016 compared to 86.1% at end-2015. With transitional rules, the total capital ratio amounted to 11.4% in 2016 compared to 12.1% in 2015.
Table 1: Key figures for SCBC
Source: SCBC Annual Report 2016
Cover pool composition SCBC has a cover pool value of SEK 240.1bn with a collateral score incl. systemic risk of 5.0%, which is in line with the average collateral score of the domestic peers. The cover pool consists mostly of Swedish residential mortgages (73.9%) with 36% being loans to tenants of tenant-owned housing cooperatives. The over-collateralization is 40.4%, which is relatively high compared to many Swedish competitors. There is a substantial amount of IO loans in the pool corresponding to 51.2% of all loans. Regional distribution exhibits a bias for the Stockholm area (57%) and to a lesser extent Gothenburg (8.4%) and Malmoe (8.2%), while the rest are widely spread throughout Sweden.
ALM and risk Similar to the other Swedish covered bond issuers, SCBC’s outstanding bonds are SEK, CHF, EUR- denominated, while the pool loans are SEK-denominated exposing the issuer to currency risk if not adequately hedged. Furthermore, there is a mismatch between loans and funding with respect to interest rates, as 38.1% of the loans are fixed-rate loans, while 13.5% of the bonds are floating-rate bonds exposing the issuer to interest rate risk. There is refinancing risk due to the mismatch in lifetime between loans and funding as well as credit risk. The latter is, however, limited due to the high quality and high over-collateralization of the cover pool.
Ratings All covered bonds issued by SCBC are subject to an Aaa rating from Moody’s. S&P no longer rates the covered bonds issued by SCBC upon request from SCBC, but rated it AAA/Stable in 2014. SCBC is not independently rated but the parent group SBAB Bank is rated A2/A by Moody’s/S&P. Moody´s holds a positive outlook on SCBC (May, 2017) reflecting their expectations of a stabilization of earnings and an improved funding profile. S&P holds a negative outlook on SCBC (January, 2017) due to high concentration towards the Swedish property market and the economic imbalances in Sweden.
NORDEA MARKETS | 92 SCBC
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody’s investor service
Table 3: Rating by Moody´s
Source: Moody’s investor service
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: SCBC
NORDEA MARKETS | 93 SEB AB
Skandinaviska Enskilda Banken AB
Key points Strengths Weaknesses Leading financial group in the Nordic region Duration mismatch between cover pool loans and third-largest bank in Sweden. and outstanding bonds – refinancing risk.
High-quality cover pool – 83.1% Swedish Dynamic cover pool – substitution risk. residential mortgages, average LTV of 51.1%, and a TPI leeway of 5. 62.9% of pool loans are IO loans.
High level of over-collateralization (62.6%). Exposure towards a potentially inflated housing market.
Company profile Skandinaviska Enskilda Bank (SEB) is one of the Nordic region’s leading financial groups, and the third-largest bank in Sweden. SEB was founded in 1856 by André Oscar Wallenberg under the name Stockholms Enskilda Bank. It currently operates in the Nordic region, Germany, Poland, Russia and the Baltics and is present in around 20 countries worldwide. SEB serves 4m private costumers, 400,000 SME customers, 2,300 large corporations and 700 financial institutions, and has around 15,300 employees. It functions as a universal bank in Sweden and the Baltics and as a corporate bank in Denmark, Norway, and Germany. The company has a stronger commercial profile than its Scandinavian peers, with corporate lending compromising a larger share than retail lending in absolute terms. The group is moreover a leading asset manager. It has 219 branches in Sweden and the Baltic countries, but loans are mostly distributed via telephone and internet.
Figure 1: Structure of the SEB Group Figure 2: Market share
Source: SEB Annual Report 2016, Bloomberg
NORDEA MARKETS | 94 SEB AB
Financial performance The SEB Group reported a worsened profit after tax as it declined by 36%, but this was mainly due to an increase in depreciation/amortization of SEK 5,300m due to impairment of goodwill in connection with restructuring of activities in the Baltics and Germany. Excluding items which affects comparability, SEB´s net profit after taxes declined by 9% rather than 36%. Assets increased by 5%, loan losses increased by 28.8% and net interest income declined by 1.1% throughout 2016. Return on equity declined to 7.8% (excluding items affecting comparability: 11.3% compared to 12.9% for 2015). SEB maintains an ambitious long-term goal of 15% which is higher than most peers in the Nordics, which aims for a return on equity somewhere between 10-15%. Overall, capitalization ratios marginally improved as the total capital ratio increased by 1%-point and the tier 1 ratio declined by 0.1%-points and the Group thus continues to be well capitalized.
Table 1: Key figures for the SEB Group
Source: SEB Annual Report 2016
Cover pool composition SEB has a cover pool valued at SEK 510.4bn while liabilities are valued at SEK 313.9bn, resulting in a high over-collateralization of 62.6%. SEB has a collateral score incl. systemic risk of 5.0%, which is in line with most domestic competitors. The cover pool is comprised of 83.1% Swedish residential mortgage loans (among them 26.5% are to tenants of tenant-owned housing cooperatives), 15.2% multi-family loans, and 1.7% agricultural assets. The weighted average LTV on residential assets (51.1%) is competitive compared to its domestic peers. A relatively large share (62.9%) of the residential loans is interest only (IO) loans.
ALM and risk For the cover pool, 74.3% of the loans are floating-rate loans while most of the issued covered bonds (96.8%) are fixed. Because of the mismatch, the investor is exposed to interest rate risk, although the mismatch is modest compared to other Nordic cover pools backing covered bonds. The outstanding covered bonds are primarily SEK-denominated, but also EUR- and USD- and to a lesser extent CHF- and NOK-denominated. As all cover pool loans are SEK-denominated, the issuer is exposed to currency risk. Interest-rate risk and currency risk are eliminated by the use of derivatives instruments. There is credit risk and refinancing risk. Credit risk is, however, deemed low due to the high over- collateralization in the pool (62.6%).
Ratings SEB AB’s covered bond program is Aaa-rated by Moody’s, while SEB AB’s long-term rating by Moody’s/S&P/Fitch is Aa3/A+/AA-. All three rating agencies have rated SEB’s outlook stable. The stable outlook (and not positive) is primarily due to the fact that there might be an increasing economic risk in Sweden, which could weaken SEB’s creditworthiness. Nevertheless, the strong ratings also reflect the strong underlying operations in the Group.
NORDEA MARKETS | 95 SEB AB
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody’s investor service
Table 3: Rating by Moody´s
Source: Moody’s investor service
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Moody’s investor service, SEB Factbook Q4 2016.
NORDEA MARKETS | 96 STADSHYPOTEK
Stadshypotek
Key points Strengths Weaknesses Part of one of the strongest financial groups High collateral concentration in Stockholm in the Nordic region. area for the Swedish cover pool.
High-quality cover pools with LTVs of 50%, Relatively low over-collateralization and a 53.6% and 48.7% and collateral scores of 5.2%, low Committed OC. 6.8% and 5.2%. Dynamic cover pool – substitution risk. Strong operations (efficiency) and profitability. Exposure towards a potentially inflated housing market.
Company profile Stadshypotek is a wholly-owned subsidiary of Svenska Handelsbanken, which is among the largest financial institutions in the Nordic region. Handelsbanken offers a full palette of banking services to personal and corporate customers. The bank considers all four Scandinavian countries and Great Britain as domestic markets. The bank has 832 branches in 24 different countries and close to 12,000 employees. The bank is also expanding in the UK and Netherlands which is self-funded by productivity enhancements in other home markets. The Group has six home markets: Sweden, Norway, the UK, Denmark, Finland and Netherlands. Since the early 1970s, Handelsbanken’s organization has been strongly decentralized. This implies that all business decisions are taken closer to the costumer in question. Stadshypotek is a specialist bank, which primarily originates loans secured by mortgages to Swedish residential housing, agriculture/forestry properties and corporate clients. The company dates back to 1865. Stadshypotek has been a subsidiary of Handelsbanken since 1997. It issues covered bonds with collateral in Swedish and a small portion of Norwegian mortgages issued via Handelsbanken’s extensive branch network. Stadshypotek has quite recently (2015) established a separate Finnish covered bonds pool, which contains mortgages from Finland issued via Stadshypotek AB´s activities.
Figure 1: Structure of Svenska Handelsbanken Figure 2: Market share
Source: Svenska Handelsbanken AB, Bloomberg
NORDEA MARKETS | 97 STADSHYPOTEK
Financial performance Profit after tax improved by 6.4% throughout 2016, while the return on equity remained stable at 24.2%. This was mainly caused by an increase in net interest income in Sweden, which was the result of higher lending volumes to the private market. However, the profit at the Danish branch also increased by 27% due to higher lending volumes to the private market, but the profit in Finland and Norway both declined as a result of declining margins. Net interest income and total assets increased by respectively 5.2% and 6.4%. Expenses decreased by 1.7% due to a lower level of compensation paid to Handelsbanken for the services performed by its branch operations on behalf of Stadshypotek, which resulted in an improvement of the efficiency. Capitalization worsened during the year, but is very strong. Credit risk remains low due to Stadshypoteket´s conservative risk lending, which is also reflected by the low amount of loan losses.
Table 1: Key figures for Stadshypotek
Source: Stadshypotek Annual Report 2016
Cover pool composition The Swedish cover pool is considerably larger than the Norwegian and Finnish cover pools with a value of SEK 631.5bn whereas the Norwegian and Finnish are valued at NOK 29.7bn and EUR 0.5bn respectively. The cover pools have collateral scores of 5.2%, 6.8% and 5.2% respectively, which are in line with other domestic competitors and low compared to international measures. All three pools are primarily comprised of residential mortgages all being above 80%. The pools have low LTV levels (residential assets) compared to both domestic and international peers, the LTVs are 50% for the Swedish pool, 53.6% for the Norwegian pool and 48.7% for the Finnish pool. A fairly large share (60.9%) of the Swedish pool are IO loans. Over-collateralization for the Swedish pool remains low compared to other Swedish issuers and lies at 11.4%. Overcollateralization stands at 9.8% for the Norwegian pool and 8.4% for the Finnish pool.
ALM and risk For the Norwegian pool, there is no currency risk as both loans and outstanding bonds are NOK- denominated. This is not the case for the Swedish pool where all loans are SEK-denominated, but outstanding bonds are primarily SEK-, EUR-, and USD- but also AUD-, GBP-, CHF-denominated implying currency risk if not adequately hedged. For the Finnish pool all cover pool assets and covered bonds are euro-denominated resulting in no currency risk. For all three pools there is refinancing risk as well as credit risk.
Ratings Stadshypotek’s three covered bond programmes are all ranked Aaa by Moody’s. Stadshypotek does not have an independent issuer rating, but the parent company Handelsbanken’s long-term rating by Moody’s/S&P/Fitch is Aa2/AA-/AA. The high ratings reflect Handelsbankens strong financial and strategic position in its home markets, but the rating agencies are also worried about the heightened economic risks in Sweden due to rising private sector debt and house price appreciation.
NORDEA MARKETS | 98 STADSHYPOTEK
Graphs and statistics Table 2: Cover pool statistics
Source: Stadshypotek and Moody’s investor service
Table 3: Rating by Moody´s
Source: Moody’s investor service
Figure 3: Indexed LTV, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Moody’s investor service, Handelsbanken cover pool data 2016
NORDEA MARKETS | 99 SWEDBANK MORTGAGE
Swedbank Mortgage
Key points Strengths Weaknesses Parent bank is the largest in Sweden with Refinancing risk, mismatch in duration respect to customer base and possess a huge between pool loans and outstanding bonds. distribution network. Cover pool is dynamic – substitution risk. High-quality cover pool – low average LTV (56%) and really high over-collateralization A large share (78.0%) of the residential loans (67.4%). is IO loans.
Strong Swedish covered bond legislation. Exposure towards a potentially inflated housing market.
Company profile
Swedbank Mortgage is a Swedish mortgage institution with a leading position in Sweden, where it has over 1m customers and finances more than one-third of all houses. Swedbank Mortgage is a fully-owned subsidiary of Swedbank, which is the largest bank in Sweden in terms of customers with over 4m private customers and 266,000 corporate and organizational customers. Other home markets include Estonia, Latvia, and Lithuania (around 3.3m private customers and 300,000 corporate customers in these three markets). The group reported total assets of SEK 2,154bn in 2016 and have some 13,500 people employed, while Swedbank Mortgage reported assets of SEK 1,007bn. In February 2014, Swedbank acquired Sparbanken Öresund in order to form the largest savings bank in Sweden (Sparbanken Skåne AB) and strengthen the Group’s presence in the growth region of Southern Sweden.
Swedbank dates back to 1820 where the first Swedish savings bank was founded in Gothenburg. Today, Swedbank has a strong distribution network with 389 branches in Sweden, Estonia, Latvia, and Lithuania. Swedbank Mortgage benefits from this as its products are mainly sold through the branch network of Swedbank and the savings banks.
Figure 1: Structure of the Swedbank Group Figure 2: Market share
Source: Swedbank AB, Bloomberg
NORDEA MARKETS | 100 SWEDBANK MORTGAGE
Financial performance Swedbank mortgage reported satisfactory results for the financial year 2016 as its profit after tax increased by 21.6%, which resulted in an increase in the return on equity of 2.5%-points. Increased lending volumes and growing lending margins contributed to an increase in net interest income of 12.5% during the year. Lending volumes was positively influenced by Swedbank´s takeover in October (2016) of mortgages from SBAB as a final step in the acquisition of Sparbanken Öresund. Operating expenses increased, but efficiency improved as income increased proportionally more than costs, while loan losses declined by 33.3% and net gains on financial items also increased, which was one of the main drivers behind the improved result. In terms of capitalization, Swedbank Mortgage has an extremely strong capitalization with a total capital ratio and core capital ratio of 77.5% and 70.7% respectively.
Table 1: Key figures for Swedbank Mortgage
Source: Swedbank Mortgage Annual Report 2016
Cover pool composition The total value of Swedbank’s cover pool is SEK 878.4bn and is of high quality with a low average LTV on residential assets (56%) and high overcollateralization compared to domestic peers at 67.4%. Swedbank holds a collateral score incl. systemic risk of 5.1%, which is in line with the average of the main domestic issuers. The cover pool mainly consists of Swedish residential mortgages (77.3%), while the rest primarily consists of multifamily assets (14.6%) and other assets (6.8%). Currently, no loans are in arrears. This is a reflection of the Swedish practice of moving non-performing loans to the balance sheet of parent companies. A large share (78.0%) of the residential loans are IO-loans.
ALM and risk The issuer is exposed to interest rate risk as 26.7% of the cover pool loans are fixed-rate loans, while almost all outstanding bonds (91.3%) are fixed-rate bonds. There is also some currency risk as the issued bonds are mainly denominated in SEK, EUR, USD and to a lesser extent in CHF, NOK, RUB, JPY, while all pool loans are SEK-denominated. Both of these risks are reduced by the use of derivative contracts. The lending provided by the issuer is typically on longer terms than the funding thus creating refinancing risk. There is credit risk as well, which is however limited due to the high quality of the loans and the high level of over-collateralization (67.4%).
Ratings The ratings of Swedbank Mortgage´s covered bonds are Aaa/AAA by Moody’s/S&P. Swedbank Mortgage’s issuer rating by Moody’s and S&P is respectively Aa3 and AA-, which is to a high extent driven by the parent company, Swedbank, which is rated Aa3/AA-/AA- by Moody’s/S&P/Fitch. The current outlook from Moody´s and Fitch is stable. S&P continue to hold their negative outlook on Swedbank which is mostly due to the fact that there is a heightened economic risk linked with the growing economic imbalance in Sweden. Nonetheless, the outlook could move to stable if the trend for the economic risk stabilizes.
NORDEA MARKETS | 101 SWEDBANK MORTGAGE
Graphs and statistics
Table 2: Cover pool statistics
Source: Moody’s investor service
Table 3: Rating by Moody´s and S&P
Source: Moody’s investor service, S&P
Figure 3: Indexed LTV distribution, Q4 2016 Figure 4: Loan seasoning, Q4 2016
Source: Moody’s investor service
NORDEA MARKETS | 102 LEGAL FRAMEWORK - DENMARK
Legal framework Denmark
Legislation Danish mortgage legislation can trace its roots back as far as Denmark 1797, but the most recent and important change came into force on July 1, 2007 with the implementation of CRD into Danish law. This law enabled a breakaway from the traditional Danish mortgage model based on the principle of matching loans and bonds. With the introduction of the new covered bonds, Danish mortgage banks may today choose from three types of bonds to fund their loans: the traditional mortgage bond (RO), the covered mortgage bond (SDRO) and the covered bond (SDO). The Danish market is a mature market in the sense that it is large and has played an important role for society for centuries. Incorporation of new legislation, changing risk perceptions, has also resulted in a vibrant market where market characteristics are constantly changing in order to adapt, and at the same time fulfilling the needs of both investors and borrowers alike.
Cover pool assets Cover assets should be registered in the Danish land register, and may, depending on the mortgage type, be made up of different asset types. Særligt Dækkede Realkreditobligationer (SDROs) and Realkreditobligationer (ROs) may solely comprise mortgages (residential, commercial or agricultural) or public sector loans, and Særligt Dækkede Obligationer (SDOs) may on top of this also come in the form of ship mortgages, although ships are not allowed in mortgage banks cover pools. Exposures to credit institutions are capped at 15%, and derivatives are allowed for hedging purposes only. Commercial banks will further maintain a register making it possible to segregate cover assets from its balance sheet. Danish mortgage banks are to a wide extent pass-through vehicles. This means that there exists a direct link between the bonds issued and the loans (bond loan) borrowers receive. As such, if a borrower wishes to redeem a loan, the mortgage institution will accordingly buy back the equivalent bond in the market. This implies that cover pools of Danish mortgage banks are only semi-dynamic, whereas commercial banks cover pools are dynamic in the traditional European sense, e.g. that cover assets may be added or removed at the will of the issuing commercial bank.
LTV limits and valuation LTV levels are in line with the levels set out in CRDIV/CRR. LTVs on residential assets cannot exceed 80%. LTV on commercial, agricultural and holiday assets are generally capped at 60%. Vacation homes cannot exceed 70%. LTVs may be above the legal minimum, but mortgage banks will have to add collateral to the cover pool accordingly. For commercial banks, only the part of the loan within the legal maximum will be deemed as eligible, and thus in compliance with the legislation. Property valuation is based on market values.
ALM Danish financial institutions are subject to strict guidelines concerning risk. These include interest rate, currency, option, liquidity and prepayment risks. For each risk type a stringent set of rules describes the exact levels of risk which is allowable. The legal ALM setup is split into two categories; the specific balance principle and the general balance principle, and the financial institution has to choose which it will adhere to. Under the general balance principle there are differences between what mortgage and commercial banks need to comply with. This is not the case for the specific balance principle where the rules are the same for both mortgage and commercial banks. If the issuer provides voluntary overcollateralization this will legally become part of the cover pool, and will therefore be bankruptcy remote.
NORDEA MARKETS | 103 LEGAL FRAMEWORK - DENMARK
Segregation and bankruptcy remoteness Danish covered bond holders have a preferential claim on the cover pool together with derivative counterparties. The assets in the cover pool will remain with the estate in case of bankruptcy. Insolvency or bankruptcy will not trigger acceleration. As long as the cover pool provides full cover to the claims of covered bond holders and derivative counterparties, an administrator is obliged to make timely payment. Danish covered bonds in the form of SDROs, SDOs and grandfathered ROs (issued before January 1, 2008) fully comply with UCITS and CRDIV/CRR qualifying for a 10% risk weight.
NORDEA MARKETS | 104 LEGAL FRAMEWORK - FINLAND
Legal framework Finland
Legislation The latest round of legal changes in Finland came into force on August 1, 2010 (Act on Mortgage Credit Bank Operations). The main aspects were the abolishment of the specialist banking rule, revising LTV levels and giving derivatives privileged status on par with covered bonds. With the changes the Finnish legal framework now to a higher degree resembles other common traits in the Nordic area. In Finland issuers can be credit institutions or banks authorised to engage in mortgage credit bank operations.
Cover pool assets Finnish issuers have generally limited themselves to only include Finnish residential assets in their cover pools, but the legal framework allows for cover assets originating within the European Economic Area (EEA). As for actual asset types, these can comprise of residential assets, shares in Finnish real estate corporations (housing companies), public sector assets and substitute assets. In order to ensure liquidity within the cover pool, substitute assets are allowed up to a maximum amount of 20%. Commercial assets are also allowed, but these can only make up 10% of the cover pool if included. Derivatives are allowed, but for hedging purposes only.
LTV limits and valuation One of the most notable legal changes implemented in 2010, was the increase of LTVs on residential assets which are now 70%. The LTV limit on commercial assets is 60%. Assets in the cover pool may have a LTV above the legal maximum, but only the part of the loan within the legal maximum will be deemed as eligible, and thus in compliance with legislation. Property valuation is based on market values.
ALM With the 2010 legal revision, there was introduced mandatory overcollateralization levels based on a NPV of 2%. Besides the mandatory NPV overcollateralization demand, there co-exists a nominal demand as well. Further tightening was implemented with the 12 month liquidity requirement. Under this rule, the sum of all interest received on cover assets, in any 12 month period, must exceed the interest paid on outstanding covered bonds. Further, assets must be in the same currency as covered bonds unless fully hedged. Non-performing assets (90 days past due) are excluded from cover tests. The covered bond law prohibits set-off against any mortgage-backed or public sector cover pool assets over which covered bondholders have priority rights and also effectively removes claw-back risk.
Segregation and bankruptcy remoteness All cover assets are registered in a cover register which is managed by the bank in question, and the register is supervised by the Finnish FSA. By maintaining the cover register, cover assets will be individually identifiable in case of insolvency, and the assets in question will be ring-fenced, and will not become part of the insolvency estate. Covered bonds and derivatives will in case of insolvency not necessarily be accelerated. If the claims of covered bond and derivatives counterparties are not fulfilled by the cover assets, then a claim can be made on the assets of the bank on an equal footing with other creditors. Covered
NORDEA MARKETS | 105 LEGAL FRAMEWORK - FINLAND
bond holders thus have dual recourse with a preferential claim on cover assets, and a secondary claim on the bank’s assets. Following issuer default, a cover pool supervisor is appointed to supervise the interest of covered bondholders. The cover pool supervisor has wide powers to direct the issuer’s general administrator and, in particular, will supervise cover pool cash flows and payments to covered bondholders. Finnish covered bonds fully comply with UCITS and CRDIV/CRR qualifying for a 10% risk weight.
NORDEA MARKETS | 106 LEGAL FRAMEWORK - NORWAY
Legal framework Norway
Legislation The legal framework in Norway came into force on June 1, 2007. In the Nordic area, Norway distinguishes itself as the only jurisdiction where only specialised institutions are allowed to issue covered bonds. The nascent Norwegian covered bond market was challenged by the financial crisis, but liquidity was ensured by a swap scheme with the Norwegian central bank, Norges Bank, where covered bonds were swapped for treasury bills. The swap scheme has now been phased out. However, this has since propelled the Norwegian covered bond market and a large number of banks have established subsidiaries in order to be able to issue covered bonds.
Cover pool assets Norwegian issuers have generally limited themselves to only including Norwegian residential assets in their cover pools, with only one issuer of public sector covered bonds. The legal framework allows for cover assets originating within the European Economic Area (EEA) or OECD. As for actual asset types, the main asset types allowed comprise residential assets, commercial assets and public sector assets. Other than these, derivative contracts, substitute asset and loans secured on other “registered assets” are permitted in the cover pool. In order to ensure liquidity within the cover pool, substitute assets are allowed up to a maximum amount of 20%. This might however be increased to 30% temporarily.
LTV limits and valuation LTV levels are in line with and just below the levels set out in CRDIV/CRR. LTV on residential assets is 75%, and LTV on commercial assets is 60%. Assets in the cover pool may have a LTV above the legal maximum, but only the part of the loan within the legal maximum will be deem as eligible, and thus in compliance with the legislation. Property valuation is based on market values.
ALM The legal framework stipulates that the value of cover assets at all times shall exceed the outstanding covered bonds based on market values. To ensure cover pool diversification there is a cap on any single borrower of 5%. A maximum of 15% of the exposure in the form of substitute assets may be exposures to banks. The issuer’s swap counterparties must provide pool collateral (or provide other security) if their credit quality reduces. A minimum legal OC-level of 2% has been introduced. Issuers may agree to hold a larger amount of OC, and to date have always provided full nominal asset coverage of their bond issuance. If the issuer provides voluntary overcollateralization this will legally become part of the cover pool, and will therefore be bankruptcy remote. The credit institution shall ensure that cash flows from the cover pool are enough to cover cash out flows, in addition with strict guidelines on liquidity, interest rate and currency risk. Non-performing assets are excluded from the cover pool tests. However, they may remain in the cover pool and be included in OC calculations. Assets typically become non-performing at 90 days past due. The issuer’s administrator has the right to re-set on floating-rate mortgage loans with a limited notice period, reducing the length of time the cover pool is exposed to refinancing risk following issuer default. Currently, almost all loans are floating rate. If the proportion of fixed-rate loans in a cover pool increases, the benefit of the right to re-set rates would diminish.
NORDEA MARKETS | 107 LEGAL FRAMEWORK - NORWAY
Segregation and bankruptcy remoteness Because issuers are specialist credit institutions, the default of the parent or group supporting them would not necessarily trigger the immediate default or insolvency of the issuer. This may enable an issuer to continue solvent operations for a period and possibly gain access to alternative liquidity sources, such as repurchasing (repo) facilities. Norwegian covered bond holders have a preferential claim on the cover pool. The assets in the cover pool will remain with the estate in case of bankruptcy. Insolvency or bankruptcy will not by itself trigger acceleration. As long as the cover pool provides full cover to the claims of covered bond holders and derivative counterparties, then an administrator is obliged to make timely payment. Norwegian covered bonds fully comply with UCITS and CRDIV/CRR qualifying for a 10% risk weight.
NORDEA MARKETS | 108 LEGAL FRAMEWORK - SWEDEN
Legal framework Sweden
Legislation The Swedish legal framework dates back to July 1, 2004 where it came into force. It has since then been amended in order to become CRD compliant. In Sweden, issuers can be either universal or specialized banking institutions. In practice, with the exception of SEB, all Swedish issuers are specialized banks, fully owned by their parent banks from which they enjoy a strong support. The Swedish market is a large and mature market, which takes advantage from a strong domestic investor base. This also means that issuers are able to take advantage of the different funding opportunities which are available to them concerning currency, maturity and other.
Cover pool assets Swedish issuers have generally limited themselves to only include Swedish residential assets in their cover pools. The legal framework, however, allows for cover assets originating within the European Economic Area (EEA). As for actual asset types the main asset types comprise residential assets, commercial assets, agricultural assets and public sector assets. On top of these come site-leasehold rights and pledges against tenant-owner rights. According to Swedish law, cover pools can be mixed, but there is a cap on commercial assets of 10%. In order to ensure liquidity within the cover pool, substitute assets are allowed up to a maximum amount of 20%, though the Swedish FSA can temporarily increase this to 30% under special circumstances. Derivatives are allowed, but restricted to hedging purposes only. Loans more than 60 days past due are not eligible for inclusion in cover tests. Loan parts that materially exceed the LTV thresholds must be removed from the cover pool. Further, cover pools must be stress tested against falls of up to 30% in mortgaged property values. Issuers must report the outcome of the tests to the Financial Supervisory Authority and state how the issuer will improve cover pool matching if price falls are experienced.
LTV limits and valuation LTV levels are in line with and just below the levels set out in CRDIV/CRR. LTVs on residential assets are 75%, 70% on agricultural assets and 60% on commercial assets. Assets in the cover pool may have a LTV above the legal maximum, but only the part of the loan within the legal maximum will be deemed as eligible, and thus in compliance with the legislation. Property valuation is based on market values.
ALM The legal framework stipulates that the nominal value of cover assets at all times shall exceed the nominal value on outstanding covered bonds. In addition, there also exists a NPV requirement. This demands that the value of the cover assets shall at all times exceed the value of the outstanding covered bonds on a NPV basis, inclusive of a stress test. This includes chocking the swap curve by +/- 100bp and a twist of the curve. Currency stress testing involves a 10% change. A minimum legal OC- level of 2% has been introduced. Further, it is common for issuers to have the right to re-set interest rates on residential mortgage loans on a quarterly basis. This reduces the length of time the cover pool is exposed to refinancing risk following issuer default.
Segregation and bankruptcy remoteness The bankruptcy of the parent or group entity supporting a specialist issuer would not necessarily trigger the immediate default or insolvency of the issuer. This may enable a specialist issuer to continue solvent operations for a period and possibly gain access to alternative liquidity sources,
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such as repo facilities. In case of bankruptcy of the issuer, it will maintain a register available to the Swedish FSA. Registration secures the preferential claim bond holders and derivatives counterparties have on the cover assets in the event of insolvency or bankruptcy. Insolvency or bankruptcy will not by itself trigger acceleration. If the claims of covered bond and derivatives counterparties are not fulfilled, by the cover assets, then a claim can be made on the assets of the bank on an equal footing with ordinary creditors. Swedish covered bonds fully comply with UCITS and CRDIV/CRR qualifying for a 10% risk weight.
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The covered bond market Denmark
Historical perspective Covered bonds have a long history in Denmark going back to 1797 where the first mortgage bank Kreditkassen for Husejere i Kjøbenhavn was established to help rebuild Copenhagen after the devastating fire of 1795. The first legal framework was enshrined in The Danish Mortgage Credit Act in 1851. Since 1989 several amendments have been introduced to make the Danish covered bond system compatible with the European regulatory framework. The latest amendment dates back to 2007 when a new law was introduced to allow universal banks to issue covered bonds - a right which has so far only been utilized by one bank (Danske Bank).
Types of covered bonds and market volume Danish bonds The total outstanding volume of Danish covered bonds issued by mortgage credit institutions and backed by property amounted to DKK 2,993bn by June 2017, according to Statistics Denmark. There was a smaller amount of outstanding covered bonds backed by ship loans (DKK 39bn) and loans to municipalities (DKK 40bn). Denmark has the largest market for covered bonds in the Nordic region and is the second largest in Europe for year-end 2016 just slightly below Germany according to ECBC. The centrality of covered bonds in Denmark is illustrated below. As evident from the table, the value of outstanding covered bonds is close to four times the value of outstanding government bonds.
Table 1: Outstanding bonds in the Danish market by June 2017
Source: Statistics Denmark, table DNVPDKBR
From June 2016 to June 2017 the value of covered bonds – mortgage credit issues increased by 1.5%, up to DKK 2,993bn from DKK 2,947bn. Danish covered bonds are primarily issued in DKK, and a few series are EUR-denominated. The issuance of SDOs from universal banks amounts to DKK 25bn. Currently this category only consists of SDOs issued by Danske Bank, which as the only Danish universal bank has used its obligation to issue covered bonds. Types of covered bonds As opposed to other Nordic covered bond markets there are several categories of covered bonds in Denmark: Særligt dækkede obligationer (SDOs), Særligt dækkede realkreditobligationer (SDROs), and Realkreditobligationer (ROs). The main difference between SDOs/SDROs and ROs is that ROs are not CRDIV/CRR compliant if issued after 1 January 2008 since ROs do not fulfil the continuous LTV requirements. ROs issued prior to January 1 2008 have been grandfathered. SDROs satisfy the requirements of the old system, but are also compatible with the European CRDIV/CRR-framework. The types of eligible cover assets also differ among the three types as specified below. Mortgage institutions are allowed to issue all three types of bonds while universal banks are only licensed to issue SDOs.
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As illustrated in the figure below, the Danish market is moving away from traditional ROs towards SDROs and SDOs. The non-compliance of CDR will most likely lead to a further decrease in the market for ROs going forward.
Figure 1: Outstanding amounts of SDOs, SDROs and ROs
Source: Nordea Markets
Loan types The Danish mortgage market is dominated by three different types of bonds: fixed-rate callables, fixed rate bullets and floaters. The characteristics of these are illustrated in the table below.
Table 2: Types of bonds
Source: Nordea Markets The short maturity fixed bullet bonds have previously become increasingly popular, but their share of the market seems to have peaked. Fixed bullet bonds are issued to finance adjustable rate mortgages (ARMs), which are loans where the interest rate is reset according to a specified agreement at 1, 3, 5 or 10 years intervals. This system requires issuance of short-dated securities, which run until the next resetting of the interest rate on the loan. Given that ARM loans turn long- term mortgages into a series of shorter maturity loans they are especially attractive during times with steep yield curves.
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Figure 2: Outstanding amounts of different covered bond types
Source: Nordea Markets
Regarding repayment, the Danish borrowers have the opportunity to choose an interest only (IO) profile. Denmark’s National bank has several times pointed to the importance of gradually phasing out the large amount of IO loans. In response to this, the Danish mortgage banks have changed their fee structure in order to give the borrower a greater incentive to move into longer dated bonds.
ALM and risk Specific and general balance principle Compared to other European markets the Danish system stands out in a number of ways, most importantly by the use of a strict balancing principle implying a close link between the covered bonds issued and the loans in the cover pool. For many years, all Danish issuers employed a true pass-through system, i.e. the underlying loans perfectly corresponded to the issued covered bond. However, the amendments to the Mortgage Act in 2007 introduced a more European approach, where universal banks along with mortgage banks had the obligation to adhere to either the specific balance principle (a true pass-through system) or the general balance principle in accordance with the Executive Order on bond issuance. For the specific balance principle, there is no mismatch between the payments from borrowers and the payments to the holders of the issued bonds implying that there is very limited refinancing risk, interest rate risk or currency risk for the issuer. The only risk faced by the issuer is the default risk, i.e. the risk that the borrower does not meet his obligation. Regarding the general balance principle, there is no requirement for true pass-through, but the mismatch between loan and bond is, however, limited. All Danish mortgage banks (including Danmark´s Skibskredit) have chosen to apply the specific balance principle and hence use a true pass-through system. Only Danske Bank (a universal bank) uses the general balance principle.
ARMs and refinancing risk Loans granted by Danish mortgage banks (following the specific balance principle) are funded exclusively through the issuance of mortgage bonds. Thus, proceeds from the issuance must be available on the day the loan is disbursed, which is ensured via tap issuance on a daily basis. Each loan is thus linked to a certain amount of bonds in one or several specific ISIN codes. The daily tap issuance results in no clear distinction between the primary and secondary market. In recent years, the refinancing of ARMs has been spread out over the year to mitigate the refinancing risk. Nykredit Realkredit in particular has been successful in spread out the auctions, which now are held 4 times a year. The interest rate that is the result of the auction is passed directly onto the borrower, implying that the interest rate risk associated herewith does not impact the issuer.
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However, a steep rise in the interest rate after an auction could result in the default of the borrower, and thereby a higher interest rate can have an impact on the issuer. Moody’s, among others, has recently been critical of the refinancing risk associated with ARM loans. This led to several downgrades of Danish covered bond issuers and banks during 2011 by Moody’s. Shortly afterwards, three of the four largest Danish covered bond issuers, Realkredit Danmark, BRFkredit and Nykredit Realkredit, terminated their collaboration with Moody’s due to disagreements with the rating methods used by Moody’s. Today, all Danish mortgage credit institutions are rated by S&P, and only Nordea Kredit and Danmark’s Skibskredit are rated by Moody’s. The ratings of the issuers are reported under the individual issuer profiles.
Issuers and market shares Denmark has six specialist issuers (Nykredit Realkredit, Realkredit Danmark, Nordea Kredit, BRFkredit, DLR kredit and Danmarks Skibskredit) and one universal issuer (Danske Bank). Nykredit is the largest issuer with 38.6% of the Danish market followed by Realkredit Danmark and Nordea with 26.1% and 13.0%, respectively.
Figure 3: Market shares of outstanding amounts by July 2017
Source: Nordea Markets
Investors Market share by investor group Danish covered bonds benefit from a very solid domestic investor base as about 75% of all covered bonds are held by domestic investors. Especially financial institutions are important investors with 48.6% of the market. The distribution of investors in the Danish covered bond market is illustrated below.
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Figure 4: Investor distribution by June 2017
Source: The Danish Central Bank, table DNVPDKR Over the past decade financial institutions has been the dominant investor holding the largest amount of Danish bonds. Their share of the Danish covered bond market significantly increased from 24% in January 2000 to 54% in 2013, but this has so far been the peak. The market share as of June 2017 is 48.6%. Insurance companies and pension funds are another relatively large investor whose market share has remained stable since the previous year as it stands at approximately 22%, but it has previously been declining (market share of 36% in 2000). Foreign investors have over time increased their share of the Danish covered bond market and now have a market share of 23%. Public administration’s market share remained unchanged from 2016 to 2017 and landed at 2%.
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The covered bond market Finland
Historical perspective The first legal framework for covered bond issuance was adopted in 1999. Several amendments have been made since then, most recently in 2010. With the new Finnish Mortgage Act in 2010, the special banking principle was abolished allowing universal banks to issue covered bonds along with specialized mortgage banks. The new legislation also, among other changes, allowed for mixed pools. The first covered bond series was issued in 2004 by Aktia Real Estate Bank, and in the following years three additional issuers, Sampo Bank (today Danske Bank plc), OP Mortgage Bank and Nordea Mortgage Bank (previously known as Nordea Bank Finland), entered the market. There are currently seven issuers of Finnish covered bonds including the newest issuer SP Mortgage Bank. Three of the Finnish covered bonds programmes are legacy programmes meaning that they are no longer used for public issuance. Since its entrance in 2010, Nordea Mortgage Bank (Nordea Bank Finland) has become the market’s largest issuer accounting for about 45% of the outstanding covered bonds.
Types of covered bonds and market volume The Finnish market is relatively small compared to other European markets; with an outstanding amount of covered bonds of EUR 34bn at year-end 2015. The outstanding amount of Finnish covered bonds increased from EUR 32bn to EUR 34bn at year-end 2015, which makes the Finnish covered bond market the 12 largest in Europe (in 2015). Within the Finnish bond markets, government bonds dominate the market accounting for 47% of all outstanding bonds, while non-financial corporations bonds account for 12% and monetary financial institutions bonds for 35% of the outstanding. The share of bonds issued by financial corporations other than MFIs has increased significantly in recent years and now amounts to roughly EUR 11bn (5%).
Table 1: Outstanding Finnish bonds by June 2017
Source: Bank of Finland
Since the first issuance in 2004, the Finnish covered bond market has shown substantial growth, especially from 2010 to 2011 with a remarkable growth rate of 85%. Almost all outstanding bonds are fixed rate bonds and EUR-denominated. However, between 2012 and 2013 Finland followed the global trend, as total covered bond issuance in EUR fell. Between these years issuance decreased by about 6bn and stood at EUR 3.7bn at year-end 2013. The decrease was almost closed at end-2015 due to issuance of EUR 7.5bn during the year (15% more than in 2014).
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Figure 1: Finnish covered bonds outstanding Figure 2: Finnish covered bonds issuance
Source: ECBC and Bank of Finland
Loan types The cover pool loans are primarily collateralized by Finnish residential mortgages with a high concentration of property in Southern Finland due to the higher population density in this area. Almost all cover pool loans are floating rate loans, where the funding primarily is fixed rate bonds. All cover pool loans are EUR-denominated, except from Bank of Åland’s Cover Pool’s SWE, which are SEK-denominated.
ALM and risk The consistency in currency between bonds and loans implies that the issuer is not exposed to currency risk, while the mismatch in interest rates implies that there is exposure to interest rate changes. This risk is being hedged. The Finnish covered bond market is characterized by high quality cover pools with low collateral scores assigned by Moody’s, and a high degree of transparency due to all the cover pools consisting mainly of residential mortgages with low default rates.
Issuers and market shares The Finnish market is characterized by few smaller issuers compared to the other Nordic markets which is due to the fact that the market is relatively small in terms of outstanding bonds and relatively young. There are currently seven issuers of Finnish covered bonds. Nordea Mortgage Bank entered the market in 2010 and holds the major market share of 44.6%. The second largest issuer is OP mortgage bank (31.4%) followed by Danske Bank PLC (13.2%) and Akita Hypoteksbank (5%). Bank of Åland (Ålandsbanken) and The Mortgage Society of Finland has a market share of 2.4% and 1.8% respectively. SP Mortgage Bank is a new issuer as of 2016 with a market share of 1.7%.
Figure 3: Market shares of outstanding amounts by July 2017
Source: Bloomberg
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Investors In 2016 a weighted average of the issuance of EUR covered bonds in Finland shows that banks and central banks and government organizations dominate the investor base accounting for 29.9% and 37.4%, respectively. The third and fourth largest investors in these recent issuances are asset managers and funds (19.1%) as well as insurance and pension companies (11.1%). In terms of the country distribution, the Nordics and Germany constitutes most of the investor base (42.1% and 41.8%, respectively).
Figure 4: Investor distribution based on weighted average EUR issuance in Finland in 2016
Source: Nordea Markets
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The covered bond market Norway
Historical perspective The Norwegian covered bond market came into effect in June 2007 with the introduction of a specific legal framework for the Norwegian version of covered bonds: “obligasjoner med fortrinnrett”. The legislation was drafted in close cooperation with relevant parties to ensure a modern legislation in compliance with European rules. The first Norwegian covered bonds were issued in the second half of 2007. Hence, the market was still in its infancy when the financial crisis erupted. In order to support the covered bond market, the Norwegian central bank opted to swap treasury bills with covered bonds in October 2008. This led to several banks establishing new subsidiaries to benefit from the liquidity scheme. A total of NOK 230bn (EUR 30bn) was swapped. The swap arrangements show the indirect support to the covered bond market by the Norwegian authorities. Today, the market is no longer depending on the swap agreements, but has since facilitated the emergence of several new issues. According to ECBC, the outstanding amount of covered bonds in the Norwegian market amounted to EUR 109.4bn by year-end 2015. This is an increase of about 4.7% from year-end 2014. The Norwegian market has exhibited strong growth since 2007, as illustrated in the figure below, and it is reasonable to believe that this trend will continue as the covered bond market is increasingly becoming an important funding channel for financial institutions.
Figure 1: Outstanding Norwegian covered bonds by currency, year-end 2015
Source: Finans Norge
Types of covered bonds and market volume Norwegian covered bond issuers issue bonds denominated in various currencies; NOK, EUR, USD, CHF, AUD, SEK, GBP and JPY, with the NOK- and EUR-issuances denominating. The NOK- denominated covered bond issues are listed on both Oslo’s Børs and the Nordic Alternative Bond Market (ABM). Below is shown the value of all outstanding Norwegian bonds on both stock exchanges by issuer. As evident from the table, covered bonds represent a large share of the Norwegian bond market, 34% on Oslo’s Børs and 15% on the Nordic ABM. Bank & Insurance issued bonds make up a large share of the market at the Nordic ABM (67%), but a smaller amount on Oslo´s Børs (8%). On the other hand, Government Bonds and Industry bonds compromise 32% and 19% on Olso´s Børs respectively.
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Table 1: Outstanding Norwegian bonds by year-end 2016
Source: Oslo Børs and Nordic ABM
Of the outstanding amount of covered bonds by year-end 2015 (EUR 109.4bn), 46.7% were NOK- denominate and 40.2% were EUR-denominated and the remaining in other currencies (13.1%). The share of EUR-denominated bonds is significantly less important than a few years ago; it dropped from 70% in 2007 to 46% of the total outstanding amount by year-end 2015. However, the volume of EUR-denominated bonds has increased gradually since 2009 whereas the volume of NOK- denominated bonds has slowly contracted. In terms of interest rate, the bonds are issued with a floating or a fixed rate. The fixed rate bonds accounted for 63.5% of the market by year-end 2015, and their dominance in the market has increased in recent years after a drop from 2007 to 2009.
Figure 2: Currency denomination by year-end 2015 Figure 3: Interest rate type by year-end 2015
Source: Finans Norge
Loan types All covered bonds are backed by a cover pool of loans. The cover pool may consist of exposures to public sector entities, mortgage loans, group originated Senior MBS, and Senior MBS issued by third parties. Furthermore, the pool may include substitute assets (only certain highly liquid and secure assets) and derivative contracts to hedge the interest rate and currency risk of the issuer. The cover pool is dynamic meaning that the issuer has the obligation to substitute assets in the pool. However, there are some limitations as substitute assets may not exceed 20% of the cover pool, and total exposures to banks (through substitute assets and derivative contracts) may not exceed 15%.
ALM and risk Due to the fact that there is no direct link between bond and loan, there is currency and interest rate risk associated with the bond issues which is, however, handled by the use of derivative contracts.
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Norwegian law furthermore sets requirements for limits to interest rate risk, currency risk and liquidity risks. The legal framework furthermore contains a 5% maximum exposure limit to reduce concentration risk. Overcollateralization is not required by law, but many issuers agree to voluntary overcollateralization. Norwegian covered bond are predominantly issued as soft-bullets, meaning that the issuer has the option to extend the maturity of the bond with an extra year if the issuer is having financial difficulties.
Issuers and market shares The covered bond market is dominated by DNB Boligkreditt that accounts for 35% of the outstanding bonds. The second and third largest issuers are Sparebank 1 Boligkreditt and Eika Boligkreditt who accounts for respectively 20% and 9.5%. In general, the Norwegian covered bond market is characterized by a large amount of smaller issuers (others).
Figure 4: Market shares of outstanding amounts by July 2017
Source: Bloomberg
Investors A weighted average of the issuance of EUR covered bonds in Norway during 2016 shows (in the figure below) that banks mainly dominate the investor base, accounting for 47.1%, while asset managers & funds accounts for 25.5%. Central banks & government organizations accounts for 16.5%. The investors primarily stem from Germany & Austria, which currently accounts for 55.3% of the investor base. Another significant part of the investor base is the Nordics (12.7%) and Benelux (12.1%).
Figure 5: Investor distribution based on weighted average EUR issuance in Norway in 2016
Source: Nordea Markets
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The covered bond market Sweden
Historical perspective The Swedish mortgage bond market dates back to 1861 when the first mortgage bank was established. The mortgage bond market further developed in the 1980s with several acts of financial deregulation. The formal standards of market-making and issuance formats were established in this period. All mortgage bonds (bostadsobligationer) were continuously converted to covered bonds (Säkerställda Obligationer) after the Swedish Covered Bond Issuance Act (CBIA) was enacted in 2004. Today, all mortgage bonds have been converted to covered bonds. The Swedish covered bond market has shown robustness and longevity during times of crisis including the break with ERM in the early 1990s, the LTCM crisis and the recent financial crisis in 2008. Swedish covered bonds are UCITS and CRR compliant.
Types of covered bonds and market volume Sweden has increased its new issuances and is now the second largest issuer of covered bonds with EUR 60.7bn of new issuances in 2015 according to ECBC. The total amount of outstanding Swedish covered bonds experienced a slight increase of 0.2% from 2015 to 2016 and stood at EUR 222.4bn. Sweden is thus the fifth-largest market for covered bonds in Europe and the second largest in the Nordic region. In the Swedish bond market covered bonds dominate. There is a relatively large amount of issued debt form Swedish banks and the Swedish government as well.
Table 1: Outstanding bonds in the Swedish market by June 2017
Source: Statistics Sweden (Statistikdatabasen)
The Swedish covered bonds are issued with both floating and fixed coupons. Fixed coupon covered bonds are dominant in the market (90.39% of outstanding covered bonds). However, the share of floating rate bonds has increased over time from almost no market share in 2006 to 10.7% in 2014, but has gradually declined again since then.
Figure 1: Outstanding amounts of different bond types
Source: Association of Swedish Covered Bond issuers
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Outstanding covered bonds are backed in their entirety by the cover pool. Hence, there is no direct legal link between the individual cover assets and particular covered bond series. Typically, the share of floating rate loans in the pool is larger than the share of floating rate bonds. The Swedish system does allow for prepayments, but the borrower has to compensate the investor for the interest rate differential.
Loan types Eligible cover assets are mortgage loans, public sector assets and substitution assets. There is no separation and a given cover pool can contain both mortgage loans and public sector assets. Substitution assets may comprise 20% and only include cash and government bonds with zero risk- weighting. The limit can be raised to 30% if approved by the authorities. Neither asset-backed nor mortgage-backed securities may be included as collateral. This being said, mortgage loans will typically comprise the majority of the collateral assets. Besides from the cover pool assets, the issuer can engage in derivatives contracts for hedging and matching purposes. Regarding the composition of the pool, one should be aware that this is dynamic, and non-performing loans are removed from the balance sheet and often transferred to parent banks.
ALM and risk A key feature of the Swedish covered bond market is the tap issuance system. It allows issuers to tap the market in small and medium sizes. This frequent tapping is conducted via market makers supported by regulations regarding terms of trade, bid-offer spreads, repo functionality of outstanding benchmarks, communication to the market and remuneration to the dealers. This system ensures a minimum of mismatch between assets and liabilities. The market makers have an obligation to quote two-way pricing when an issue reaches SEK 3bn in outstanding volume, which ensures liquidity in the market. The bonds are sold into primary markets via banks acting as agents for the issuer. In the secondary market, these banks also act as market makers. Thus, most mortgage banks are subsidiaries of universal banking groups with large distribution networks facilitating this system.
Issuers and market shares There are seven major issuers in Sweden. Swedbank Mortgage, Stadshypotek, SEB, and Nordea Hypotek are the four largest measured by outstanding covered bonds as illustrated below. All four major issuers are part of strong financial groups and benefit from a wide distribution network.
Figure 2: Market shares of outstanding amounts by July 2017
Source: Bloomberg
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Investors A weighted average of the issuance of EUR covered bonds in Sweden during 2016 showed the investor distribution displayed in figure 5 below. Like the other Nordic countries, banks dominate the investor base as it holds 51.3% of the Swedish covered bonds. Asset managers and funds holds 22.9%, while central banks and government organizations holds 18.4%. Germany and Austria is by far the countries holding the largest amounts of EUR Swedish covered bonds (54.4%), followed by the Nordics (13.9%) and Benelux (10.9%).
Figure 5: Investor distribution based on weighted average EUR issuance in Sweden in 2016
Source: Nordea Markets
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Macroeconomic conditions Denmark
Key points
Full-blown recovery For the first time in more than ten years, we see a full-blown recovery of the Danish economy. Employment is rising, consumer spending is increasing, companies benefit from growing international trade and the pick-up in housing prices has spread to all parts of the country. The challenge is to maintain the recovery and make sure it is not followed by a renewed steep downturn.
In light of the past quarters’ high activity level in the Danish economy we have revised up our growth forecast for 2017 to 2.2% – if we are correct, it will be a post-2006 high. We look for sustained growth in the following years, although growing labour shortages and rising interest rates will slow the pace a bit. The prospects of a multi-year period of robust growth place new and heavier demands on eco-nomic policymakers. The labour supply must be expanded and at the same time the conditions for businesses must be improved to boost investments aimed at lifting productivity. The government has recently presented its proposal for a new tax reform; it will increase the structural labour supply by 7.600 persons in order to strengthen the current upswing. The reform, which is fully financed, aims to cut taxes and tariffs by a total of DKK 23bn towards 2023, equivalent to more than 1% of GDP. Spending spree – not financed through loans Rising household consumption is the key driver of the upswing. This year consumption looks set to rise by more than 2.5% – the biggest upturn in more than ten years and driven mainly by increased car sales and rising demand for services. Despite spending more freely, households continue to reduce their debt relative to their income. The value of households’ financial assets has reached a record high and their home equity is rising sharply in step with the housing market improvement. It is highly uncertain how much of this wealth will be channelled into actual consumption in the years ahead. Also the new tax reform may boost con-sumption more than we currently envisage. Higher production and investment activity In H1 2017 Danish manufacturing companies recorded historically high production levels especially in the pharmaceutical, metal and food industries. Confidence indicators suggest that this positive trend will continue in the period ahead. This view is also supported by the recent pick-up in business investment and the increase in corporate lending demand. Exports on rising path Danish exporters of goods and services currently benefit from the growing global trade and relatively strong Danish competitiveness. Against this backdrop we look for an increase in total exports of over 4%, which would make 2017 the best year for exporters since 2011. So although imports have risen as well, foreign trade is providing a solid boost to the economy. This also means that we only expect a moderate decline in Denmark’s very large current account surplus. However, the recent strengthening of the trade-weighted DKK rate as well as the expected slowdown in the global economy towards the end of the forecast period could slightly dampen future export growth. Labour market approaching a critical point Over the past four years the number of persons in private sector employment has increased by over 150,000. With this solid increase, available resources in the labour market have gradually diminished
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and the number of companies now reporting labour shortages is at a 10-year high. The labour shortages have emerged despite a significant influx of foreign labour since the start of the recovery. Now over 8% of all people working in Denmark are foreign citizens. The influx of foreign labour and the wish to preserve Danish competitiveness contribute to keeping wage growth at a lower level than warranted by the actual level of joblessness, see chart. Housing market buoyed by optimism Historically low financing costs and rising incomes have boosted activity in the housing market. Over the past year prices of single-family houses have increased by some 4%, while prices of owner- occupied flats have gone up by more than 7%. Like ripples in a pond the pick-up in prices has spread from the big cities to all regions of the country. One factor that may have contributed to levelling out previous price differences could be mortgage lenders’ greater caution when mortgaging homes in Copenhagen and Aarhus. We expect this uptrend to continue, although at a slower pace towards the end of the forecast horizon due to rising interest rates. The housing market optimism has boosted investment activity in the property market and lifted demand for housing market related goods and services. Consequently, the housing market is once again a key catalyst of growth in the Danish economy.
A/ Rising growth and employment B/ Increased consumption and lower household debt
C/ Low wage growth despite declining unemployment D/ Regional house prices
Source: Nordea Markets, Economic Outlook, September 2017 and Macrobond
2015 2016 2017E 2018E 2019E Denmark: Macroeconomic indicators Real GDP, % y/y 1.6 1.7 2.2 2.0 1.9
Consumer prices, % y/y 0.5 0.3 1.1 1.5 1.8
Unemployment rate, % 4.6 4.2 4.2 4.0 3.7 Jan Størup Nielsen Current account balance, % of GDP 9.2 7.8 9.1 8.6 8.0 Chief Analyst General gov. budget balance, % of GDP -1.8 -0.6 -1.2 -0.8 -0.1 [email protected] +45 5547 1540 General gov. gross debt, % of GDP 39.5 37.7 36.2 35.4 34.5 @JanStorup Monetary policy rate, deposit (end of period) -0.75 -0.65 -0.65 -0.65 -0.30
USD/DKK (end of period) 6.87 7.05 7.09 5.91 5.91
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Macroeconomic conditions Finland Key points
Finally The boom cycle has finally reached Finland, where economic growth is now driven by both exports and domestic demand. Investment in construction, machinery and equipment is growing strongly. Consumer confidence is high, and consumption expands faster than incomes. Employment will
improve, and consumer prices rise moderately.
It is now confirmed. After long years of waiting, the boom cycle has finally arrived in Finland. Exports have performed strongly since the start of the year, and the demand outlook in key export regions is more promising. Domestic demand has also remained excellent. Investment and consumption growth has beaten expectations and should continue unabated. For the first time in years, the Finnish economy is in the fortunate position of having two growth engines: foreign trade and domestic demand. We made an exceptionally large upward revision to our growth forecast for Finland back in June, adjusting it to 3% for 2017 and 2% for 2018. We are not making any changes to this forecast for the time being. As for 2019, we are raising our growth forecast to 1.5% (from 1.0%). After that, growth will most likely slow down for structural reasons, and given that the United States’ growth period will soon become the longest in the country’s history, and will thus end sooner rather than later. There are many reasons for the huge change in growth expectations this year. The outlook for the global economy and global trade has improved again; Finland has finally joined the growth club, and many uncertainties have subsided. It is also crucial that statistics describing the Finnish economy have been revised sharply upwards in a fairly short period. Higher demand driving growth in exports The pick-up in exports comes on the back of a broad-based increase in goods exports. The export of production supplies, intermediate goods and investment goods has begun to recover, and we expect this trend to continue to strengthen. A total of 85% of Finland’s exports go to OECD countries, whose economies are now all growing at the same time for the first time in a decade. The demand indicator, which we have calculated using the imports of Finland’s 31 most important export partners, indicates that demand has risen sharply. Moreover, we have two bonus cards that will boost exports. The Russian economy is back on a growth track, and the Finnish automobile industry will post some staggering (albeit temporary) growth figures this year. A pick-up in global manufacturing and new investments will sustain growth in exports well into 2018. Investments on the rise Investments in construction, machinery and equipment grew by 10% year-on-year in 2016, well exceeding expectations. Data have little-by-little been revised upwards, which means the figures for 2017 will inevitably be strong, too. Growth in already-hot housing construction will continue, although we expect it to flatten somewhat next year. Other building construction has been stronger than estimated, its peak likely postponed until 2018. The sharp rise in machinery and equipment investments raises the possibility of a ketchup bottle effect – i.e. pent-up investment needs bursting out all at once followed by a quick cool-down. We believe the upward trend to be more permanently fed, by the boom in the export industry. Machinery and equipment acquisitions will increase much more than 10% this year. Low interest rates encourage consumption According to preliminary data, private consumption grew in the first months of this year at the fastest rate in five years. Nevertheless, we expect consumption growth to slow down in the forecast
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period, despite improving employment. Consumer prices will rise less than previously expected, by around 1%, which will most likely curb wage pressure in the collective bargaining negotiations this autumn. Private consumption has primarily followed the rapid improvement in household confidence over the more modest increase in purchasing power. Growth in consumer spending has outpaced that of disposable income for three years in a row, which means households are saving less. We expect saving to decline further during the forecast period. Should we be worried about a lower savings rate? At the very least we can say that households are behaving exactly as expected. The ultimate purpose of the ECB’s low interest rates is to stimulate economic activity, as well as consumption. Moreover, the fact that consumption is outgrowing income does not necessarily mean that households are taking on more debt. It could also be a case of pensioner households spending the savings they have accumulated during their professional careers to finance their extra consumption which, from the point of view of balancing spending throughout one’s lifetime, is completely sensible.
A/ Export demand has rapidly improved B/ Improved confidence boosts consumption
C/ Household saving on the decline D/ Public sector debt to GDP will not increase further
Source: Nordea Markets, Economic Outlook, September 2017 and Macrobond
2015 2016 2017E 2018E 2019E Finland: Macroeconomic indicators Real GDP, % y/y 0.0 1.9 3.0 2.0 1.5 Pasi Sorjonen Consumer prices, % y/y -0.2 0.4 0.9 1.0 1.3 Chief Analyst Unemployment rate, % 9.3 8.9 8.6 8.3 8.0 [email protected] Current account balance, % of GDP 1.4 1.2 0.2 1.1 1.4 +358 9 5300 5182 @PasiSSorjonen General gov. budget balance, % of GDP -2.7 -1.8 -1.1 -0.8 -0.5 Public sector debt, % of GDP 63.6 63.1 62.8 62.6 62.2 ECB deposit rate (end of period) -0.30 -0.40 -0.40 -0.40 -0.05
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Macroeconomic conditions Norway Key points
Finally Growth in the Norwegian economy has gained momentum, and the outlook is good. With rising housing and business investment and solid export and consumption growth, economic expansion in 2018 looks set to be strong enough for the economy to reach full capacity that year. However, despite robust growth and lower unemployment we look for relatively low price and wage inflation in coming years and do not expect Norges Bank to tighten policy until central banks abroad start hiking their rates in 2019.
Strong growth in mainland economy Growth in mainland Norway was relatively strong in H1 2017. The downturn in oil-intensive industries has come to a halt, while the rest of the economy continues to grow at a healthy clip. We look for a mild recovery of the oil-intensive industries in the years ahead. Oil investment is close to bottoming out, and Norwegian oil-related industries may gain market share at home and abroad partly due to the relatively weak NOK. Meanwhile, growth in the rest of the business sector should remain solid, supporting strong growth in the mainland economy in coming years and especially in 2018. Weak NOK and higher investment activity For a while yet, the weak NOK will continue to underpin sectors exposed to competition and thus support sound mainland export growth. But we expect the NOK to strengthen fairly sharply in 2018, so the benign currency effects should fade in 2019. Demand for capital goods from businesses is rising on the back of the low interest rates and improved outlook for the economy. We look for good growth in business investment in both 2018 and 2019 from the current low level. Housing market a key factor Housing investment has increased much faster than business investment and is now relatively buoyant. The trend in applications for building permits could suggest that construction activity will remain high going forward, but probably peak in 2018 and then decline slightly. Housing prices are a key factor for residential construction activity going forward. We expect a further downward correction of prices in the Oslo area. The stock of unsold homes has increased sharply, and the market in Oslo is especially hard hit by new regulations introduced at the beginning of the year. In 2016 the proportion of residential property acquired for investment purposes increased; but now the new regulations have probably scared away many of these investors, and with prospects of declining prices many will probably also want to unload their investments. Moreover, in the Oslo area housing costs as measured by the costs of servicing a mortgage loan are historically high. With no boost from investors, housing prices in the rest of the country have shown a different trend, and the pick-up in prices has not been as strong as in the Oslo area following the decline in interest rates and increase in income. The effect on prices of previous rate cuts is probably now fading; still, the declining unemployment and rising purchasing power suggest that housing prices in most of the country will edge higher in coming years. With prospects of slightly higher housing prices across the country, we do not expect housing market trends to dampen private consumption growth significantly, despite a potential sharp price decline in and around Oslo. Rising employment, declining unemployment and modest real wage growth point to robust consumption growth in the years ahead. And when the temporary stimulus effects on exports and investment of the low interest rates and NOK weakness start to fade, private consumption will become the key growth engine. Good growth, but low price and wage inflation We expect the Norwegian economy to approach ‘normal’ full capacity in 2018. In 2019 we reckon slightly lower growth, although high enough to prompt labour market tightening. But inflation will
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remain low in coming years. A wish to maintain competitiveness will keep a lid on wage growth, which, coupled with some NOK strengthening and low inflation internationally, will hold back inflation. Stronger NOK The NOK has appreciated slightly lately, but has generally been weaker than expected, given the clear recovery of the economy, Norges Bank’s shift to a neutral stance and the stabilisation of oil prices. The NOK remains historically weak, but should strengthen in step with the normalisation of the economy. Rate hike in 2019 With normal capacity utilisation and benign growth prospects for 2018, one could argue for a first rate hike sometime soon. However, inflation remains far below target, and we expect the 2018 pay deals to result in sustained moderate wage growth. This, coupled with sharp NOK strengthening next year towards 8.50 versus the EUR, will likely keep inflation at low levels. We do not expect Norges Bank to act until the ECB hike its policy rate in 2019. By then, a rate hike should not prompt further NOK strengthening.
A/ Mainland GDP and employment growth is picking up B/ Construction is a growth engine
C/ Outside of Oslo house prices are not unreasonable D/ NOK remains weak compared to historical standards
Source: Nordea Markets, Economic Outlook, September 2017 and Macrobond
2015 2016 2017E 2018E 2019E Norway: Macroeconomic indicators Real GDP (Mainland), % y/y 1.4 1.0 1.9 2.6 2.0
Core cnsumer prices, % y/y 2.7 3.1 1.5 1.2 1.2
Unemployment rate, % 4.4 4.7 4.3 4.0 3.8 Erik Bruce Current account balance, % of GDP 8.9 4.6 6.9 6.3 7.0 Chief Analyst [email protected] General gov. budget balance, % of GDP 6.0 3.0 3.6 3.6 3.5 +47 2248 7789 Private consumption 2.6 1.5 2.5 2.4 2.7 @erikjbruce Monetary policy rate, (end of period) 0.75 0.50 0.50 0.50 0.75
USD/NOK (end of period) 9.61 9.08 9.00 8.50 8.50
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Macroeconomic conditions Sweden Key points
Higher pressure The Swedish economy is in a unique situation. Activity is higher than it has been for a long time while economic policy is very expansionary. Domestic and external stimulus effects will not start to fade until late 2018, which will then slow growth. Inflation will edge lower and stabilise below the 2% target. Wage growth will rise, although it will not approach the historical average until 2019
Full speed ahead Economic growth has picked up from an already strong level. Resource utilisation is high, and bottlenecks probably dampen growth. Domestic economic policy is highly expansionary. Interest rates are low and the SEK rate weak. Asset prices have gone up, the population is expanding and income in the economy is rising on the back of stronger demand and growing employment. In this environment it is hardly surprising that household consumption continues to rise and remains a key growth engine. Investment activity is also rising. Residential construction is growing fast, and the energy sector is expanding capacity. Investment in other parts of the business sector is also increasing, albeit at a much slower pace. Public consumption has declined this year, mainly due to the falling number of asylum seekers and the resultant reduction in central government spending. Also growth in the municipal sector has lost momentum, but due to large-scale initiatives and rising income growth, local government consumption and investment look set to pick up in the years ahead. More to come next year In election year 2018 fiscal policy measures to the tune of SEK 40bn, or almost 1% of GDP, are expected to contribute to growth. But due to the strong economy, the state coffers are filled quickly enough to keep financial savings in positive territory despite the increased expenditure. The stimulus provided by the low interest rates is substantial. For example, next year’s fiscal policy stimuli correspond to only two months’ increase in household debt. The effects of policy stimulus will gradually fade, though. Rising interest rates towards the later part of the forecast period will dampen household consumption and slow growth in house prices and residential construction. Growing exports We see similar trends among Sweden’s key trade partners. The US Federal Reserve continues to hike rates, and the ECB will ease up on the accelerator. This will contribute to slowing global economic activity especially in 2019. This year and the next, global demand will remain high, though, driving a more broadly-based and faster rise in exports than seen in several years. Rising, but still modest wage growth The number of people in employment will this year rise by over 100,000 or some 2%. The employment rate is the highest since the early 1990s and among the highest in the world. But due to the sharp increase in the labour supply from immigration, unemployment is declining only slowly. With the tight labour market, wage drift (pay rises beyond those collectively agreed) will accelerate going forward. So far, wage drift has been moderate, though. Note also that this spring’s historically modest pay deals cover a period extending beyond our forecast period. We expect total wage growth to be relatively low in coming years despite accelerating wage drift.
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Inflation to edge lower again This summer’s high inflation numbers above 2% are partly due to temporary factors. One example is the new methodology for measuring travel prices. It has resulted in a sharp increase in travel prices which should reverse as early as this autumn. Moreover, import prices now jack up inflation. However, this year’s appreciation of the SEK, which will likely continue, will start to dampen inflation as from the turn of the year. Domestic inflation has risen over the past years, but should not accelerate further as domestic cost pressures are relatively stable. Overall, we expect inflation to edge lower next year. Rate hikes still some way off The challenge facing the Riksbank is therefore to maintain credibility in its inflation target. Owing to the strong economy, further stimulus measures seem unlikely. Meanwhile, rate hikes are some way off as they could strengthen the SEK further and thus dampen inflation even more. We expect the Riksbank to hike the repo rate in H2 2018 and to raise it further in 2019 when the ECB starts to slowly tighten monetary policy. The Riksbank’s easing up on the accelerator faster than the ECB will support the SEK, which should gradually strengthen over the forecast period.
A/ GDP growth to decline from high levels B/ Employment at long-term high
C/ Accelerating wage drift D/ Inflation edging lower
Source: Nordea Markets, Economic Outlook, September 2016 and Macrobond
2015 2016 2017E 2018E 2019E Sweden: Macroeconomic indicators Real GDP (calendar adjusted), % y/y 3.8 2.9 3.3 2.6 2.1
Underlying prices (CPIF), % y/y 0.9 1.4 1.9 1.6 1.6 Torbjörn Isaksson Unemployment rate, % 7.4 6.9 6.7 6.5 6.4 Chief Analyst Current account balance, % of GDP 4.7 5.1 4.8 5.0 5.3 [email protected] +46 8 407 91 01 General gov. budget balance, % of GDP 0.3 0.9 1.4 0.5 0.4 @TorbjrnIsaksson General gov. gross debt. % of GDP 43.9 41.6 38.6 36.9 35.9 Monetary policy rate, (end of period) -0.35 -0.50 -0.50 -0.25 0.25 EUR/SEK (end of period) 9.16 9.59 9.40 9.15 9.00
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Rating - Approaches and Methodology
Introduction European covered bonds have traditionally benefitted from Aaa/AAA ratings due to the extensive investor protection inherent in the covered bond structure. However, ratings have been under review in recent years. Rating methodologies have convened towards more focus on the creditworthiness of the issuer, though substantial differences still exist between the three major rating agencies Moody’s Investor Service, Fitch Ratings and Standard & Poor’s. For all three rating agencies, there is a lower bound for the covered bond rating based on the rating of the issuer. However, their approaches to how a given covered bond programme may receive uplifts differ as discussed below. The individual ratings of the covered bond programs of all four markets are reported and described in the chapter of issuer profiles.
Moody’s Investor Service Moody’s ratings are based on the “joint default analysis” where the credit quality of the issuer as well as that of the cover pool is taken into account. The dual structure is a reflection of the dual recourse protection of investors of covered bonds implying a claim on both the issuer and a cover pool of high-quality collateral. Hence, as long as the issuer is performing there should be no loss to covered bondholders. The probability of issuer default was based on the senior unsecured rating of the issuer. In March 2014, Moody’s updated their rating methodology however in August 2015 there was an update this update does however not have any impact on the content on the methodology itself. Moody’s now starts from rating levels that are between 0 or 2 notches above the senior unsecured ratings of the issuer. The exact level of notches depends on the level of cushion (5% or 10%) of bail- in able debt of a bank. Moody’s rating approach for covered bond is based on a two-step analysis:
• Step 1: An application of a quantitative model that produces a maximum potential rating based on (1) the probability that the issuer will cease making payments under the covered bonds (i.e. a CB anchor event) and (2) the estimated losses that will accrue to the cover pool after the CB anchor event. This is referred to as the Expected Loss Covered Bond Model (EL Model).
• Step 2: The maximum potential rating that the EL Model produces is then refined to account for certain risks, particular refinancing risk, arising on the occurrence of a CB anchor event. This is done by applying the timely payment indicator (TPI) framework. This framework limits the rating uplift that covered bonds may achieve over the CB anchor and may constrain the final covered bond rating to a lower level than the maximum potential rating under the EL Model.
These two steps are more thoroughly explained below. 1. The EL Model a. The EL model determines the value of the cover pool, and key features include the cover pool collateral’s credit quality, refinancing risk if funds need to be raised against the cover pool to make payments on the covered bonds and any interest-rate or currency mismatches between the cover pool assets and the covered pool liabilities.
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2. The Timely Payment Indicator Framework a. The TPI reflects the probability that payments on the covered bond will be made in a timely fashion following a CB anchor event and follows a scale that ranges from “Very High” to “Very Improbable”. An important annotation in this context is that as the issuer credit quality declines, there is a greater risk that (1) the issuer will default, leading to refinancing risk for the covered bonds and/or (2) the issuer may exercise its discretion to make decisions that are credit negative for the value of the cover pool. b. Additionally, Moody’s is assessing the potential for systemic or political support in stressful situations. This dimension is based on how mature and systemically important the covered bond markets are in a given nation, since the chances of timely payments will increase if government support is likely in case of issuer default. The relationship between the issuer’s rating and the TPI indicator is illustrated below. Under the TPI framework, the maximum covered bond rating is capped depending on the issuer rating and the TPI factor. For instance, if the TPI factor is “High”, the issuer should be rated at least Baa1 in order to achieve a covered bond rating of Aaa.
Table 1: Moody’s rating methodology - the joint default analysis
Source: Moody’s Investor Service
Standard and Poor’s In September 2014 S&P rating changes came into force. Most importantly was the clarification of the country ceiling and the possible maximum uplift above the country-rating. S&P has a covered bond rating framework that organizes the general principles of credit rating into four key steps:
• Step 1: Performing an initial analysis of covered bond issuer-specific factors, mainly assessing whether a rating on the covered bond may be higher than the rating on the issuer.
• Step 2: Assessing the starting point for the analysis, based on the applicable resolution regimes, to determine the reference rating level (RRL). The RRL assess the likelihood that the issuer would continue servicing its covered bonds without accessing the cover pool or receiving jurisdictional support.
• Step 3: Determining the maximum achievable covered bond rating based on cover pool specific factors.
• Step 4: Combining the results from the stages above to assign the final covered bond rating by incorporating any additional factors.
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Each step is then divided into sub-parts, as described below. 1. The initial analysis mainly assesses whether the rating on the covered bond may be higher than the rating on the issuer and is divided into two parts. a. An assessment of legal and regulatory risks which focuses on the degree to which a covered bond programme isolates the cover pool assets from the bankruptcy or insolvency risk of the covered bond issuer. If S&P’s asset isolation analysis concludes that covered bonds are not likely to be affected by the bankruptcy or insolvency of the issuer, then the covered bond programme may be assigned a higher rating than the rating of the issuer. b. An analysis of operational and administrative risks which assesses whether key transaction parties are capable of managing a covered bond programme for as long as any bonds issued remain outstanding. The key transaction party is typically the issuer which originates, underwrites and services the cover pool. 2. The second stage of stage of S&P covered bond rating framework determines the reference rating level (RRL), i.e. the likelihood that the issuer would continue servicing its covered bonds without accessing the cover pool or receiving jurisdictional support. In general the RRL is at least equal to the issuer’s credit rating. a. Consider if it is possible that an issuer may continue to service protected liabilities, such as covered bonds, even though it may default on other types of liabilities.
b. This takes into account the features of the applicable resolution regime (measures taken by supervisory authorities in case of a bank’s failure).
c. Under the analysis of jurisdictional support, the jurisdiction-supported rating level (JRL) is determined. This is the assessment of the creditworthiness of a covered bond program once the level of jurisdictional support has been considered.
3. The third stage determines the maximum achievable covered bond rating, i.e. the rating level consistent with the available credit support to achieve repayment on the covered bonds including any ALMM risk. a. The likelihood for the provision of jurisdictional support is considered when the cost of a failed covered bond program to and financial system would be considered greater than the cost of providing support. This is assessed by analysing the strength of the legal framework, the systemic importance of the covered bonds in their jurisdiction and the credit capacity of the sovereign to support the covered bonds. b. A pool-specific analysis is also carried out. This looks into the asset credit quality of residential mortgage loans, commercial mortgage loans, public-sector assets and mixed cover pools. It also looks into payment structure and cash flow mechanics. 4. The aim of the fourth and final step of the covered bond rating framework is to determine whether considerations not directly related to the covered bond issuer and covered bond programme would limit the maximum achievable covered bond rating (based on the previous three steps). This is where the final covered bond rating is assigned. This stage is divided into two sections as well. a. An analysis of the counterpart risk. This is important since a counterpart’s failure to perform on its obligations may lead to payment default on the bond. The analysis is focused on obligations arising from third parties that either hold assets or make financial payments that may affect the creditworthiness of the covered bonds. b. An analysis of the country which may further constrain the final covered bond rating.
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Figure 1: S&P’s rating methodology
Source: S&P Covered Bond Ratings Framework Overview
Fitch Fitch’s covered bond rating mainly address the bond’s probability of default (PD), but also include recovery on the bond given default. The rating excludes event risk, such as a change in legislation for a covered bond framework or the merger of an issuer. The rating of covered bonds includes three steps. Step 1 sets the floor for the covered bond rating, by looking at the issuer default rating. Step 2 determines the maximum achievable covered bonds rating by setting discontinuity caps. Finally, step 3 stress-tests the OC. The key rating drivers used in these steps are summarized below: • Issuer risk: Covered bond ratings are linked to the credit risk of the issuing financial institution – as measured by its Long-Term Issuer Default Rating (IDR). Assets and liabilities are dynamic and ratings can be affected by an issuer’s decisions regarding cover pool composition, asset/liability mismatches and maintenance of overcollateralization.
• Bail-in exemption: In bank resolution frameworks where covered bonds are favourably treated, Fitch’s analysis starts with an uplift over the IDR, based on: relative ease and motivation for resolution methods other than liquidation; the importance of covered bonds to the jurisdiction’s financial markets; and the extent of any buffer provided by senior unsecured debt.
• Discontinuity risk: Most covered bonds are designed to survive issuer insolvency. The potential risk that a covered bond could default under such an event is captured via Fitch’s Discontinuity Caps (D-Caps), which determine the maximum uplift from the IDR (adjusted by any IDR uplift) to the covered bond rating on a PD basis. It reflects the highest risk assessment of asset segregation, liquidity gap and systemic risk, alternative management
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and privileged derivatives, ranging from ‘0’ for full discontinuity to ‘8’ for minimal discontinuity. • Systemic risk: Covered bonds can be vulnerable to systemic crises, which may impact issuer and counterparty credit risk, asset performance and asset liquidity. In countries rated above A+, Fitch assumes an issuer default will stem from idiosyncratic factors, while the financial sector as a whole remains stable. This means cover pool liquidation assumptions are determined on a stressed, rather than a distressed basis which would be associated with systemic crisis. Programmes issued out of lower rated countries are assigned more conservative D-Caps.
• OC protection: OC between cover assets and covered bonds is the main source of enhancement. Fitch determines the level of OC it views as sustainable and tests it against assets and cash flow stresses to determine the covered bond rating which can be supported on a PD basis, as well as the recovery uplift for the covered bond rating itself. Cover pools are analysed in line with asset-specific covered bond or relevant structured finance (SF) criteria.
• Cash flow testing: Fitch’s cash flow model determines the breakeven OC for a given rating. The result is broken down between the cash flow valuation, credit loss and asset disposal loss components. The cash flow model is built on a stressed net present value calculation. Lower stressed refinancing spreads are applied in the discontinuing of the cover assets when modelling recoveries given default than those used to test timely payment.
• Lack of historical precedent: Covered bonds have never defaulted, given support for issuers. Hence, there is a lack of historical precedent to test the mechanics of a covered bond’s survival under stress. Reasoned opinion, rather than historical precedent, backs Fitch’s assumptions. Taking the Issuer Default Rating (IDR) as a starting point, Fitch’s rating methodology for covered bonds is summarized in the figure below:
Figure 2: Fitch Covered Bond Rating Steps
Source: Fitch Covered Bonds Rating Criteria
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Country comparison Covered bond legislation
Table 1: Country comparison of covered bond legislation
Source: Nordea Markets
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Country comparison Advantages and disadvantages
Table 1: Advantages and disadvantages across Nordic covered bonds
Source: Nordea Markets
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Contact persons Sales, analysts and debt capital markets
Table 1: Contact persons sales and analysts
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NORDEA BANK AB (publ) 2017 Nordic Covered Bonds 2017 – 2018
Nordic Covered Bonds 2017 – 2018
NORDEA BANK AB (publ) 2017 Marketing Material 09/2017