The stunning success of Sampo's debut covered bond last September has shown the way for Nordic borrowers to issue covered bonds. Norway is thought by many to have the biggest potential, with DnB Nor likely to be the next jumbo covered bond issuer from the region. But Icelandic borrowers are also joining the fray and most of the Swedish banks — despite access to a large, liquid and flourishing domestic mortgage bond market — are doing the preparatory work. Philip Moore reports.
If anybody was in any doubt about the extent to which international investors would welcome the chance to diversify their covered bond portfolios into the Nordic region, those doubts were conclusively dispelled by last September's debut jumbo deal from Finland's Sampo Housing Loan Bank.
Led by Barclays Capital, DrKW, JP Morgan and Sampo itself, the first jumbo covered bond from the Nordic region was a Eu1bn five year transaction which generated total demand of Eu5.7bn in less than two hours. That allowed for the deal to be priced at the tight end of guidance of mid-swaps plus 1bp to swaps minus 1bp.
"The Sampo deal was a tremendous success," says Richard Kemmish, covered bond product manager at Dresdner Kleinwort Wasserstein in London, "and there will be other benchmarks to come from Finland. But unfortunately it is such a small market that demand will exceed supply."
In addition to Sampo and Aktia Real Estate Mortgage Bank, which kickstarted the market for Finnish euro denominated covered bonds with its Eu250m seven year FRN via ABN Amro in June 2004, Okobank is weighing up the potential for covered bond issuance.
Bankers say that one of the main successes of the Sampo deal is that it has shown other Nordic issuers what is possible. "Sampo's inaugural benchmark has shown many Scandinavian issuers that it might not be necessary to pay a premium compared to the local market," says Ted Lord, global head of covered bonds at Barclays Capital in Frankfurt. Other bankers agree that the success of the Sampo deal will have helped to encourage other would-be issuers in the Nordic region. "Sampo's deal was an eye-opener for borrowers across the region," says Peter Mason, a director in Citigroup's financial institutions fixed income capital markets team in London.
Among other potential Nordic issuers in the covered bond market, the most promising candidate to be the next jumbo issuer is DnB NoR, which is the product of the merger of DnB and Union Bank of Norway, and which, according to Fitch, accounts for about 40% of Norway's total bank assets.
With Norway's finance ministry expected to have clarified any remaining uncertainties associated with the country's covered bond legislation, bankers are expecting DnB NoR's inaugural euro denominated deal to surface in the third quarter of 2006.
"In terms of euro denominated jumbo issuance I think Norway may have the biggest potential among the Nordic markets," says Heiko Langer, senior covered bonds analyst at BNP Paribas in London. "DnB NoR has stated that it plans to issue between Eu3bn and Eu4bn equivalent per year, in a combination of euros and kronor, so the aim is clearly to internationalise its funding base via the covered bond market."
What no Germans?
DnB NoR has appointed ABN Amro and Barclays Capital to arrange its debut transaction, which has surprised a few bankers in Germany. "There is no doubt that ABN and Barcap are good structuring houses, but the German market still represents about 50% of the investor base for covered bonds," says one German banker. "First-time issuers should aim to penetrate the German investor base and to do so they should have a German bank among their leads."
With Norwegian lawmakers putting the finishing touches to the country's covered bond law, banks other than ABN Amro and Barclays Capital may not have long to wait before other opportunities emerge for bookrunning mandates in Norway.
Other possible issuers weighing up the potential of the Norwegian covered bond market, say bankers, include international players with meaningful exposure to the local mortgage market, such as Nordea, Danske and Iceland's Islandsbanki, which has acquired BNbank and has an extensive portfolio of residential mortgage loans.
Another candidate for covered bond issuance in Norway, according to Citigroup's Mason, is the Sparebank 1 Alliance of the country's leading savings banks. The alliance members are testing the possibility of pooling their assets under the umbrella of the alliance's mortgage entity, which would provide them with sufficient collateral to issue covered bonds in jumbo format. "The larger savings banks already have a joint EuroMTN programme and the idea is to contribute enough assets against which the mortgage entity can issue a benchmark-sized transaction," says Mason.
Further to the north, potential for issuance of covered bonds in Iceland has been galvanised in recent years by deregulation of the country's mortgage market and the loss of the near monopoly on housing finance previously enjoyed by Ibudalanasjodur, the Icelandic Housing Financial Fund (HUFF). That has prompted a surge in mortgage lending among Iceland's commercial banks, some of which are now exploring opportunities for refinancing those portfolios.
Foremost among those is Iceland's largest bank, Kaupthing, which in February was assigned a provisional Aaa rating by Moody's on its planned issue of up to Ikr62bn (Eu800m) of covered bonds, which will be Danish-style amortising securities rather than bullet bonds.
According to Moody's, "the programme has been established under general Icelandic law unlike many other European covered bonds which rely on specific legislation. The Icelandic law is regarded as a relatively creditor-friendly legal framework which enables Kaupthing to create a structured bond with similar characteristics to other covered bonds found across Europe."
But bankers do not expect the limited Icelandic market to be a big source of supply in the short to medium term. "The deregulation of the mortgage market comes at a time when pension funds have a lot of cash to invest, so the launch of covered bonds in Iceland is very much an Icelandic króna solution to an Icelandic króna problem," says DrKW's Kemmish. "But I don't see any euro denominated jumbo bonds coming from Iceland in the foreseeable future."
Of all the countries in the Nordic region, however, it is the Swedish market that excites the most interest among bankers looking to the longer term potential of covered bonds in Scandinavia.
Much of the groundwork for the development of a liquid market in Sweden has already been done. A covered bond law was enacted in 2003, while in 2004 the Swedish Financial Services Authority (SFSA) released a number of additional regulations providing for the issuance of Säkerställda Obligationer.
The snag, which bankers say that a number of commentators from beyond the region appear to be ignoring or deliberately overlooking, is that Sweden — like Denmark — already has a large, liquid and flourishing mortgage bond market that provides an ultra-cheap funding source for the country's leading mortgage lenders. That was one reason why the central bank was hesitant about the benefits of introducing covered bond legislation in the first place.
As Lars Nyberg, deputy governor of the Riksbank, said in speech soon after the passage of the law, "the potential effects of introducing particular legislation for secured bonds are... possibly less in Sweden than in other countries, and it is difficult to see that the legislation regarding secured bonds would entail any dramatic change in the activities of Swedish mortgage institutions."
Paradoxically, the enactment of Sweden's covered bond law may have made the issuance of internationally targeted benchmarks by the five banks that command 99% of the mortgage lending market even less likely. This is because the continuing conversion of old mortgage backed bonds into new covered bonds has already improved the creditworthiness of the domestic market.
"Despite already having a dominant position in the Swedish market, [mortgage bonds'] collateral assets do not benefit from special protection, which means investors receive no preferential treatment in the case of insolvency," explains a recent DrKW research bulletin. "Such standards will, however, apply to the new covered bonds. The market has already discounted these improved conditions for some time. This is evident in spreads, but also in an increase in holdings of international investors in this market, which is essentially dominated by domestic demand."
All this perhaps leaves only one compelling reason explaining why Swedish banks are likely to look favourably at the issuance of euro denominated jumbo covered bond markets — the opportunity it would give them to diversify their investor bases. The simple trade-off that Swedish mortgage lenders are therefore now analysing is the cost of swapping covered bond proceeds into kronor versus the much less quantifiable benefit of building a bigger investor base beyond the Nordic region.
"Once their existing mortgage bonds are converted into covered bonds, the big question is whether the Swedish banks will choose to keep their issuance in Swedish kronor or to start issuing in euros," says Citi's Mason. Bankers say that that particular pendulum was swinging towards the euro option until Sweden's rejection of the single European currency in the country's referendum in September 2003. That decisive result reduced the immediate need for Swedish borrowers to cultivate broader relations with euro-based investors.
Swapping proceeds into euros need not be a prohibitively cumbersome or expensive task. "The currency rate is relatively stable, so there wouldn't be much of a volatility premium priced into the swap," says Christian Haller, head of sales, Germany, at DrKW in Frankfurt.
Nevertheless, some bankers remain sceptical about the outlook for issuance from Sweden. "I think that some of the London banks have deliberately created a lot of hype about Swedish jumbo covered bonds because that is what they would like to see," says one Nordic banker. "What I think is much more likely is that some of the banks will issue smaller and more targeted euro denominated bonds on a more opportunistic basis."
In London itself, many share the view that with such formidable domestic competition Sweden is unlikely to provide a bonanza of new issuance. "Banks in Sweden have always said that the domestic market is so brutally cheap, flexible and efficient that they would need a very good reason to diversity internationally," says Tim Skeet, managing director of financial institutions origination at ABN Amro in London. "But they also recognise the benefits associated with being part of the wider European covered bond market. So we will see issuance, but it won't be a case of watching benchmark after benchmark."
At BNP Paribas, Langer is also doubtful about the potential for an explosion in Swedish jumbo issuance. "Swedish borrowers aren't accustomed to issuing in single-tranche deals of amounts as large as Eu1bn," he says. "Their preference is to tap existing bonds and gradually bring them up to benchmark size, which is very different to standard practice in the European jumbo covered bond market."
Maybe so. But a number of Sweden's mortgage lenders are clearly taking the new opportunities open to them very seriously. Statshypotek has applied for an issuance licence and is in the process of converting some of its outstanding mortgage issues into covered bonds.
SBAB, meanwhile, announced in October that it had appointed Citigroup as its advisor in "the preparatory work for the transition to secured bonds". Of the three remaining large mortgage lenders, Nordea and SEB are understood to have filed applications for covered bond issuance with the Swedish FSA, leaving Spintab as the only lender still hesitating.
Citi's Mason says that the mandate from SBAB is three-pronged. "The mandate is to look at exchanging SBAB's existing domestic mortgage bonds into covered format as well as to assess its current and future swap arrangements, and finally, but most importantly, to advise on the structuring of a covered bond programme," he explains. "So it is a wholesale recalibration of SBAB's financing strategy."
|Market potential of Swedish covered bonds|
|Issuer's unsecured rating issue||First covered bonds expected in||Expected new volume in 2006 (Eu equivalent)|
|Stadshypotek AB (Svenska Handelsbanken)||H1 2006||Eu1bn-Eu2bn|
|Nordea Hypotek (Nordea)||H1 2006||Eu1bn-Eu2bn|
|AB Spintab (Swedbank)||2007 likely||-|
|SEB Bolan (SEB)||2007 likely||-|
|Total new issuance 2006||Eu4bn-Eu6bn|