Swedish house prices have stabilised, but in Norway, where the economy remains stronger, prices are still rising. Regulators have taken steps to limit credit and are considering other measures to slow credit growth.
In any case banks are well capitalised and an expected rise in the capital charge on mortgage portfolios is unlikely to have a big effect on borrowing, which has already begun to slow down.
Regulators have also turned their attention to balance sheet encumbrance. But an overall covered bond issuance cap seems unlikely and provided the proportion of loss-absorbing capital is set at the correct level, encumbrance should matter less.
Funding needs have fallen, but covered bonds are set to remain an integral part of banks’ funding mixes and issuers will continue to invest in marketing to ensure they reach a broadly diversified audience.
While courting investors, Nordic issuers have led the way in transparency, working hard to fulfil the more stringent requirements of the Covered Bond Investor Council.
Nordic spreads are tight and have modest room for performance, but this is justified because investors are assured of finding a good bid.
Investor confidence in Nordic covered bonds appears justified, suggesting the region’s reputation for safety will remain intact.
Participants in this roundtable were:
Ola Littorin, head of long term funding, Nordea
Thor Tellefsen, head of funding, DnB Boligkreditt
Thomas Lay, head of trading, Natixis
Odd-Arne Pedersen, chief financial officer, Terra Boligkreditt
Ralf Burmeister, portfolio manager, covered bonds, Deutsche Asset & Wealth Management
Magnus Karlsmyr, head of funding, Svenska Handelsbanken
John Arne Wang, head of treasury management, SEB
Fredrik Jönsson, head of funding, SBAB
Arnaud-Guilhem Lamy, market head covered bonds, BNP Paribas Asset Management
Housing
The Cover: How have house prices fared in Sweden?
Magnus Karlsmyr, Svenska Handelsbanken: Up until mid-2011 house prices increased. Then we saw a flattening out and declines in some areas, primarily in the bigger cities. From mid-2011 to mid-2012 prices dropped 5%-7%. The market is quite stable and though there is still growth, transaction volume has come down as people are a bit more cautious now.
John Arne Wang, SEB: The underlying phenomenon, however, especially in the major Swedish cities, is a structural lack of supply, so it is unlikely there will be a significant fall from current levels. GDP growth is expected to improve this year and pick up again next year but unemployment is forecast to rise to slightly above 8% next year primarily due to an increase in the labour force. So we don’t expect macro developments will have a negative impact on the housing market.
Arnaud-Guilhem Lamy, BNP Asset Management: We are seeing a soft landing in Swedish house prices and we hope the market continues to stabilise. Household leverage remains, however, a bigger issue.
The Cover: And how about Norway?
Lamy, BNP AM: The situation is a bit different due to the economy, which has been stronger. This explains why Norwegian house prices have risen about 70% compared to where they were in 2000. Every increase we have in Norwegian house prices is a source of concern because it may lead to a decrease in the future. On the other hand it is nothing like the US where there was massive leverage and no recourse back to the borrower.
Odd-Arne Pedersen, Terra Boligkreditt: Norwegian house prices have been rising a lot in nominal terms, but from our perspective it looks sustainable based on high median wage growth, low interest rates and strong population growth — the latter which has been driven by a high birth rate and high net immigration.
The Cover: And in Finland?
Ola Littorin, Nordea: In Finland we have seen a slight recovery recently in prices. On the whole the market is moving sideways.
The Cover: A moderate rise in house prices is surely a good thing as it means the loan to value ratio is going to be lower. So in a way you do want some house price inflation, don’t you?
Ralf Burmeister, Deutsche Asset & Wealth Management: Yes, but the point is having had the recent experience from Ireland or Spain, it’s nice if prices rise by another 10% or 15%, but if prices then start to drop by 30%-40% you have an upward effect on the LTVs. If prices are stable then all things being equal LTVs should drop as loans amortise. You just want to be sure that if everything goes wrong you are in a position to sell the collateral at the given valuation.
The Cover: Do you get a sense that Nordic regulators are concerned about house price inflation?
Burmeister, De AWM: I appreciate the efforts being undertaken by regulators to moderate house prices though, frankly speaking, I do not dare to make a judgement as to whether their precautionary steps will be sufficient. At least they have the historical experience of the banking crisis in the ‘90s and the same people are still in charge. They are taking steps, which wasn’t the case with Ireland and Spain. But time will tell if they have avoided a bubble.
Pedersen, Terra: From 1989 to 1992, the Norwegian banking regulator gained substantial knowledge about the impact on the banks of a big drop in the house prices, and it is currently monitoring developments closely. The biggest concern is household indebtedness.
Thor Tellefsen, DNB Boligkreditt: The regulator has stated several times they do not fear a correction in house prices will lead to mortgages losses for banks. Their concern is that people will spend relatively more money on servicing their mortgage debts and then might spend less in other areas of the Norwegian economy.
The Cover: Are you concerned?
Tellefsen, DNB: We stress our covered bond mortgage portfolio for a house price decline of up to 30%, and we manage reasonably well. DNB doesn’t think there is a house price bubble in Norway and it’s our view house prices will flatten over the next couple of years. If you look at house prices deflated with disposable income you will see the development has been reasonably flat — it’s people’s ability to service their debt that’s important.
The Cover: What has the Swedish regulator done to curb lending?
Karlsmyr, Svenska: The regulator introduced an LTV cap of 85% in October 2010 to help cool the market, which has clearly worked. As prices have been more or less stable over the last year or so, we don’t believe the regulator has any particular concern.
Jönsson, SBAB: Besides the LTV cap, the Swedish industry itself has imposed an amortisation schedule that takes the LTV down to 75% within a 10-15 year period.
The Cover: What can the Norwegian regulator do to dampen house price growth?
Pedersen, Terra: In 2011 they lowered the maximum loan to value ratio from 90% to 85% and advised banks to stress test borrower liquidity assuming an interest rate hike of 5 percentage points. This is supposed to limit debt growth and ensure that borrowers and banks are more robust against increasing interest rates and lower house prices.
Tellefsen, DNB: The Norwegian regulator is considering increasing the risk weight for mortgages to 35%. The central bank in Norway has been in an interest rate dilemma for a long time. A strong Norwegian economy could have needed a higher interest rate level, but on the other hand this would lead to a currency appreciation.
A higher risk weighting will lead banks to pass on the cost and charge a higher margin on their mortgage loans which, all things being equal, could lead to a decline in the rate of mortgage lending. It is also clear that banks are more focussed on earnings than increasing market share these days, so there is no doubt about the effect on lending rates from a 35% risk weight.
Capital
The Cover: What about the risk weighting in Sweden?
Jönsson, SBAB: A couple of months ago the Swedish FSA released a proposal on risk weight on Swedish retail mortgages. The risk weight according to Basel II is around 7% on average in the industry, mainly due to very low historical losses. That number is low in comparison with other European countries. The floor is likely to be decided in Q1 or Q2 this year. All Swedish banks are well capitalised to meet the new requirement.
Wang, SEB: SEB’s average risk weighting is around 9% on residential mortgages, according to our IRB model. It seems that the Swedish regulator would like to have introduced a pillar one risk weighting, but has not been able to do so for legal reasons.
A change in the risk weight to 15% implemented by the regulator under the Pillar 2 requirement obviously has an effect, but will not appear in the official capital ratios of the banks. The regulator and central bank have both argued for a higher risk weighting, but it is an open question as to whether they want to see it much higher than 15%. For SEB a potential introduction under Pillar I to a minimum of 15% risk weighting on mortgage lending would have a minor effect on the capital ratios.
Lamy, BNP AM: From our perspective it’s very positive to see that the regulators in Sweden and Norway have understood that the advanced IRB approach leads to a very low level of capital being needed. It shows that regulators are fully aware of the issue and recognise that by increasing the risk weight on the mortgage, they can strengthen the balance sheet.
Karlsmyr, Svenska: We are an IRB bank and the average risk weighting in our IRB model is around 5%. However, the Swedish FSA has proposed a floor on risk weights of 15% for mortgages, which will be in the form of an extra capital requirement under Basel III’s Pillar 2 regulation. But since Handelsbanken’s capital buffer is already huge, it’s more a matter of reallocating part of the buffer into the mortgage product, which means the expected rise from 5% to 15% will have no material impact.
Pedersen, Terra: Terra Boligkreditt and the Terra banks use the standardised approach under Basel II and apply a transitional 35% risk weighting to the mortgage portfolio. But, since the authorities have signalled that they are going to apply a permanent 35% risk-weight, there should be no change. I think some banks had expected that the risk weights would have been lower, so they could be disappointed to see that 35% is likely to be a floor and that might affect the willingness to extend mortgage credit.
Tellefsen, DNB: DNB presents capital ratios both with and without transitional rules. DNB’s long term capital target is to have core tier one (Basel III) of 12%-12.5% by the end of 2015. When we announced this target last autumn we assumed a risk weighting for mortgages of around 12.5 %. If the risk weightings for mortgages are changed to 35%, it might take us somewhat longer to reach our Basel III capital target.
Burmeister, De AWM: If banks are required to hold more capital against the residential mortgage portfolio that’s OK, because that’s really a very effective brake on lending. If you increase the risk rate, thereby implicitly increasing the funding costs, that’s fine because the banks will be more solid as they become better capitalised. I admit it might result in a lower supply of covered bonds, but that’s a price I’m willing to take if the offered amount becomes better in quality.
Encumbrance
The Cover: Does the regulator have any concerns about encumbrance?
Wang, SEB: The primary focus of the regulator is that the banks become more transparent in showing encumbrance figures, but the Swedish regulator is nowhere near setting hard limits for covered bond issuance, or discussing specific encumbrance ratios. The Swedish regulator has been far more focussed on liquidity and capital to ensure that the banks’ balance sheets are both extremely sound and are well funded. SEB is on the very low end of the scale of encumbrance.
Lamy, BNP AM: From a covered bond investor’s perspective, encumbrance is not so much of an issue. However, it’s a huge topic when we look at senior unsecured bonds, impacting the loss-given default expectations. It is not so easy to find the information especially since encumbered assets do not only include covered bonds but every type of encumbered assets through to collateral for swaps or bonds repoed with the ECB.
Pedersen, Terra: The Terra group banks have transferred 23% of their mortgage portfolio to the covered bond programme so there’s still potential to increase the transfer rate. Plus we have strict control over which loans we accept into the cover pool and the speed we build the pool.
The Norwegian regulator looks on covered bonds as a positive element of the bank’s funding structure, but at the same time they are considering what should be the prudent limit for asset encumbrance and I believe they are thinking about introducing some general restrictions. They may impose a soft limitation for the individual bank as part of the Pillar 2 process by requiring higher capital ratios.
Burmeister, De AWM: It would be hard to impose a strict limit on encumbrance because there will always be a question of where the trigger points are and whether they are justified. But having seen the statements from the Nordic regulator that show a concern over asset encumbrance, LTVs and so on, it is clear they are on to it. So I think this has already had an effect on the business models of banks and their behaviour in the origination of new loans.
All the experience we have had since 2009 is that regulations generally come at a later stage and end up being softer than was originally stated, as was the case with the liquidity coverage ratio.
Jönsson, SBAB: It is important to look at the credit quality of assets on the balance sheet. At SBAB we have predominately mortgages, which are low-risk quality assets so I would say it’s natural to be more encumbered compared with a universal bank that has a lot of other types of lending.
I think it’s likely that we will see different approaches from different jurisdictions.
The Swedish Central Bank has urged the larger banks to provide more transparency around encumbrance. Today they have five different outstanding recommendations and one is about asset encumbrance and providing transparency — but the Swedish regulator has not discussed a general encumbrance level.
Karlsmyr, Svenska: Handelsbanken has taken a big step forward when it comes to disclosure. We recently published our balance sheet showing the quality and amount of all our unencumbered assets, which we think is what really matters for senior bondholders. We think this is a very relevant way of looking at the balance sheet from an encumbrance perspective, rather than talking about an encumbrance ratio, which will vary depending on the bank’s business model.
Lamy, BNP AM: That’s an interesting way of dealing with encumbrance, but we would need to have a full understanding of encumbered assets with their link to each bond or swap. Clearly transparency would help, but for sure the spread between senior and covered bonds should widen the more encumbered an issuer’s balance sheet is and I don’t believe the market has priced for this — due to the lack of transparency.
On another side, for the moment, senior unsecured debt holders are pari-passu with the depositors. However, a change in this rule would lead the encumbered asset topic to be even more important. Assuming depositors are senior to unsecured bondholders, it would not change the default probability, but would largely increase the loss-given default expectations.
Tellefsen, DNB: From DNB’s perspective it is important to note we haven’t moved any mortgages from the bank to the covered bond entity for many years. Less than 25% of the mortgages in the covered bond entity have been moved from the bank and new mortgages are directly established in the covered bond entity. The question is therefore whether the regulator wants to put a limit on how much we can grow DNB Boligkreditt.
The regulator is concerned that we might not have enough collateral at a time when other funding markets are challenging. Having a hard encumbrance limit would not solve that problem. If a bank has already utilised its hard limit there will be nothing left in reserves. Norwegian banks may instead be obliged to maintain an unutilised reserve of collateral in order to maintain covered bond issuance capacity.
Littorin, Nordea: The Finnish regulator is focused on the role covered bonds play in the creation of asset encumbrance. However, as the volume of Finnish covered bonds outstanding is not as large as in the other Nordic countries, the aim is more to manage a controlled growth. In 2012, the Finnish FSA presented new requirements for each issuer to impose individual limitations related to covered bonds which shall be communicated to the FSA. The new regulation signals that the FSA is pro-actively monitoring the situation as well as an awareness that there is no one size fits all.
Marketing
The Cover: What efforts have you made to broaden your investor base?
Karlsmyr, Svenska: We are putting more resources into marketing today compared to three years ago. At that time we had one person dedicated to debt investor relations, but since summer 2010 we have built a team of four people. We are constantly in touch with investors, including those in new markets like Asia and Australia — where we issued our first covered bond last year. We are also striving to keep our existing domestic, European and US investors constantly updated with developments.
Tellefsen, DNB: We have a very active approach to meeting investors and we are constantly on the road. We were one of the frontrunners in the US market and we were the first Nordic issuer in Australia. We have been roadshowing a lot in Asia and hope these markets will develop further going forward. But our biggest investor base is still within Europe and especially in Germany, where we also have issued large amounts of registered covered bonds.
Wang, SEB: We have gradually expanded the investor work to more systematically cover US investors in addition to our European investor base, which has been and continues to be our highest priority. Although covering most of the European jurisdictions, Germany, France and UK are the main focus areas away from the Nordics.
Since initiating a 144A programme, in which we can issue both covered and senior, our approach towards US dollar investors has become a lot more active, not only in the US, but also increasingly towards Asian investors with dollar interest. The demand seen from Asian investors is very significant and constantly increasing, and it is thus likely that our efforts towards Asia will grow in the near term. Due to limited funding needs, however, we have chosen to mainly concentrate our efforts on Europe and the US.
Littorin, Nordea: We are continuously doing investor work to provide the best conditions for our secondary curves as well as for new issuance. This includes investor work in Europe, Asia and US. It also includes investor work in the Nordics, where we have the bulk of our issuance.
Pedersen, Terra: We go on the road about twice a year to see European and Nordic investors in order to present the business model of Terra Boligkreditt, but usually this has been connected to deals. We also attend a lot of conferences and have met a lot of investors. In future we may consider doing non-deal related roadshows and will probably target individual geographic areas.
Jönsson, SBAB: Since we were set up in 1985 we have been active in foreign markets, and have always had an ambition to have a diversified funding portfolio. That said, the Swedish domestic market functioned well back in 2008 when most markets were shut.
We haven’t yet entered the US as our funding needs are smaller and our projected funding volume is expected to go down. Outside the Swedish market, the European market is our second largest market. Updating our investor base is an ongoing process. We are also trying to expand our investor base.
Currencies and formats
The Cover: How has the distribution of your deals changed?
Karlsmyr, Svenska: In some of the recent trades we have had up to a 30% Asian allocation, which is certainly a new phenomenon. In the Australian covered bond last year we had a very significant Asian participation. None of this would have been possible without very frequent visits out there.
It’s all about building long term relationships with investors and getting to know them. We aim to make our name so familiar with investors that we don’t necessarily need to do deal-related roadshows.
The Cover: Have you considered 3(A)(2) documentation for your US dollar programme?
Karlsmyr, Svenska: We have a 3(A)(2) for our senior bonds, so obviously we have been looking into this but right now we’ve made no decision. We are not too frequent in the US market but we will keep up the dialogue as we could become more frequent.
Wang, SEB: We have the possibility to implement 3(A)(2) via our New York branch. But due to uncertainty as to how this could be treated in future by the US regulator we feel that 144A is probably a better way to go, at least for now.
Tellefsen, DNB: We have looked at 3(A)(2), but for the time being we’ve decided not to pursue it any further.
Littorin, Nordea: We are not exploring 3(A)2 for the time being.
The Cover: You’ve issued in US dollars, Swedish kroner, Australian dollars, euros, sterling, Swiss francs — what am I missing?
Karlsmyr, Svenska: We have a substantial amount of mortgage lending in Norway and issue from a Norwegian programme into the local Norwegian kroner market, where we launched four deals last year. The deals are mainly invested in by Norwegian investors, but we’ve also seen Danish, Swedish and Finnish demand for these bonds as well.
Pedersen, Terra: Though we issued a Swiss franc deal in the autumn of 2007, our strategy has been to build a liquid euro curve, so we have had to concentrate our resources, in terms of time and collateral, with this end in mind. This has ruled out issuance in other currencies and formats such as floating rate notes and private placements.
Littorin, Nordea: We have issuance in Denmark in Danish kroner, in Norway in Norwegian kroner, in Sweden in Swedish kronor and in Finland in euro. So our four platforms naturally provide a wide range in issuance currencies in benchmark format. They also provide a natural diversification in different geographic markets. To complement this, we also issue in other currencies on a private placement basis. We continuously monitor different markets for issuance possibilities to see if any added value can be gained in other currency markets.
Burmeister, De AWM: We are a euro-based investor but we tend to have global mandates which are, by definition, multi-currency, so if the risk profile fits we will take Swedish paper, dollars, Norwegian bonds or sterling. But these investments are not a major driver — the investment decision is generally opportunistic.
I see it as a sign of quality that the Nordic issuers are able to access non-euro markets, as it means they are not too dependent on only one market or one currency. Banks that are more diverse in terms of their funding strategy are more stable, so this is surely a positive argument for investing in Nordic bank bonds.
Funding
The Cover: What’s your covered bond issuance strategy this year?
Karlsmyr, Svenska: We want to have a well diversified funding base, when it comes to investors, currencies and geography, and aim to be a regular issuer in the markets we are active in. So that means issuing into Sweden and Norway as well as at least one deal each in euros, US dollars and Australian dollars.
Pedersen, Terra: We issued €1bn in a 10 year bond in January 2013 and as we said at that time, our annual funding need is between €2bn and €2.5bn to refinance redemptions and finance net mortgage growth. The funding mix will be about 30/70 between Norwegian kroner and euros. For 2013 we have about €1bn-€1.5bn in additional funding to do which leaves the possibility to launch another €1bn deal, one or two €500m deals, along with some domestic transactions.
Wang, SEB: We have a covered bond funding need of about Skr50bn-Skr60bn ($7.9bn-$9.4bn) of which 75%-80% will be issued in the domestic Swedish krona market with the remainder raised in euros and possibly dollars. Though we look at all currencies, we are less likely to initiate new programmes in other currencies as our 2013/14 funding needs are not that great.
Littorin, Nordea: We will continue to actively use our four covered bond issuing platforms. This means to continue issuance in the local Scandinavian markets complemented by international issuance including registered covered bonds. We will be active across the whole curve.
Jönsson, SBAB: We have an annual funding need of around Skr50bn, or about €6bn. That compares to around Skr90bn a few years ago. The lower funding need reflects a reduction in mortgage lending growth and an increase in retail deposits, which were up by Skr20bn last year. Around €3bn is expected to come from covered issuance.
Tellefsen, DNB: We are probably going to issue less this year than we did last year. This comes as a result of slower lending growth, higher deposit growth and also the fact that we already have made a large adjustment towards the net stable funding ratio. We have done a euro transaction and we will look at the dollar market, but we will definitely be less present in the euro market this year than we were last year.
The Cover: What about senior unsecured issuance — do you target any sort of ratio between senior and covered issuance?
Karlsmyr, Svenska: We do not target a set ratio but aim to have a good balance between senior and secured funding. In the past, we have tended to issue a little more senior benchmark funding in foreign currencies, because the domestic market is tremendously liquid and important for us when it comes to covered bonds. I think that will be the case going forward too.
Pedersen, Terra: We issue senior unsecured bonds in Norwegian krone which we use to boost over-collaterisation to 105%.
Wang, SEB: Last year we issued between 60%-70% of our long term funding needs in covered bonds, and the balance sheet needs we have medium term do not differ significantly from that number. SEB has ample over-collateralisation and could therefore increase the share of covered bonds of total funding. Although there is no specific senior-covered funding ratio, one key element is to be a sufficiently frequent senior issuer in order to maintain and further develop the investor base. Another factor is the relative spread, meaning that if senior versus covered spreads continue to contract, we could increase our senior financing and temporarily decrease covered. At this point, however, covered bonds are still by far the most economical and thus I don’t see any reason to change the funding plan.
Tellefsen, DNB: We don’t necessarily have a fixed idea in mind. The most important thing is to make sure we have enough collateral available and for the time being we have plenty available, which means you can expect to see a higher amount of covered bond funding from DNB versus senior.
Lamy, BNP AM: For the moment it’s clear that banks are trying to issue as much senior unsecured as possible while they have the opportunity. And they should because they know that the market could shut very quickly. With covered bonds the market has been open much more often, and even when it was shut a few years ago, the ECB was there to re-open it again with its purchase programme. Nordic borrowers don’t have to issue covered bonds, even though the market is open for them, they can easily issue senior.
We prefer to focus on covered bonds because we think the spread to senior is not wide enough, even though Nordic covered bond spreads are quite expensive compared to the other countries. When bail-in regulations come into effect, I expect a much wider spread between covered bonds and senior unsecured even if some Nordic countries may not be impacted by this regulation. Secured funding is explicitly out of the scope of bail-in so that clearly changes the probability of default between the two instruments. This should become more important as we move towards the 2018 implementation of bail-in, or maybe now it is going to be 2015.
Jönsson, SBAB: We typically have a 60-40 mix of covered bonds to senior unsecured. Senior issuance helps fund over-collateralisation in our cover pool, our liquidity portfolio and assets that are not encumbered.
Even though it is less expensive to issue covered bonds we try to keep spare issuance capacity as we view covered bonds as a kind of liquidity reserve that also increase our overall funding flexibility.
Littorin, Nordea: We issue in both senior and covered. The split varies a little depending on market situation, pricing and funding need. Roughly half or our wholesale funding outstanding is made up of covered bonds. The balance is relatively stable and we monitor this continuously.
The Cover: Do you target a spread level when you look at covered bonds versus senior?
Karlsmyr, Svenska: The spread is not important, we want to be a regular issuer and show we have access in good and bad times.
Littorin, Nordea: There is not a magic number. We fund in both senior and covered and we are more focused on execution of our deals in the market than the spread relationship between the two. The choice of issuance format is made primarily with reference to market parameters. We shall essentially issue the right product at the right spread in the right market at the right time. Then we serve both ourselves and our investors’ best interest.
Liquidity
The Cover: Which market is more liquid do you think — domestic or international?
Karlsmyr, Svenska: The answer is two-fold. Throughout the financial crisis the domestic market has been open each and every day and the euro covered bond market was shut for almost a year from 2009. On the other hand, when the euro and dollar markets are shining brightly you can find more liquidity on specific days.
Wang, SEB: Swedish benchmarks are many times the size you see for a typical euro benchmark. Moreover, Swedish covered bonds have to some extent replaced Swedish sovereign issuance as their supply has declined in contrast to covered bond issuance. Being a typical rates instrument also has its disadvantages as in times of continuous rising rates, the activity level in Swedish covered bonds will be dampened. The euro market therefore represents a perfect diversification match to the domestic covered bond market.
The Cover: The euro market is back again and it seems anybody can do any size they choose at the moment. In the good times do you think the euro market is more liquid than the Swedish krona market.
Tellefsen, DNB: The Norwegian covered bond market is growing constantly, but for Norwegian issuers like us the euro market is still more important.
Jönsson, SBAB: In a euro covered bond deal we normally have 80-100 investors from various different countries when we do a public deal. In the Swedish covered bond market there are five to 10 really large investors and that means Sweden is a much more concentrated, but very well functioning market. Liquidity is supported by market maker agreements with the dealers. Liquidity in the euro secondary market often goes down as time progresses. The fact that Swedish supply in euros over the two last years has been very scarce of course also affects liquidity.
Thomas Lay, Natixis: Finland and Norway offer similar liquidity. But Swedish issuers haven’t really issued for a while in euros, which means offers tend to be more protected. Liquidity is reasonably steady as you have domestic euro sellers switching into the domestic market, or into dollars or pounds. But these bonds have been picked up pretty quickly by German accounts, which see Scandinavian covered bonds as a good alternative to the tighter German ones. This has been a trend for almost 12 months now and it still continues.
Lamy, BNP AM: The problem currently with Nordic covered bonds relates to the lack of offers. But that’s less of a problem than having a lack of bids. So from my perspective the solution to improving Nordic liquidity would be for the issuers to issue more. However, not all Nordic bonds are equal in terms of liquidity, with non-AAA bonds being far less liquid.
Lay, Natixis: Over the last 12 months bid offer spreads have moved tighter in core and non-core bonds, and for Nordic bonds they are around 2bp-3bp for our customers in up to €25m. But in certain bonds you hardly see many offers. If there are no bonds you simply can’t offer them. But on the more liquid bonds, bid offer spreads have come in quite decently and I think, vis-à-vis our customers, they are now at levels which are quite acceptable.
Littorin, Nordea: Liquidity in our bonds in the domestic market has historically been better than the international markets. We’re pleased to see that the turnover and liquidity in our name in euro has increased over the last year. We trade with low spread volatility as investors take comfort in our name and our access to the strong domestic markets.
The Cover:What about the cost of the cross-currency swap?
Jönsson, SBAB: For Swedish banks like us the cost differential between a euro issue swapped into Swedish kronor or issuing directly into Swedish kronor has fallen to about 10bp, which is much better than it used to be. But it is also noteworthy that demand in the Swedish domestic market is typically for short to medium tenors, while in the euro market there is also good demand for duration, which means euros can complement Swedish krona covered bond funding.
Transparency
The Cover: Do you think that, by improving transparency, investors are more likely to bid for your bonds when conditions get tough?
Karlsmyr, Svenska: Definitely, yes. We’ve been extending transparency throughout the crisis by updating and adding cover pool information as well as regularly visiting investors, which we think is also really important.
Burmeister, De AWM: As an asset manager we should have an informed opinion so the more relevant information you have on the cover pool and issuer’s business model, the more you can come up with a holistic picture and be less dependent on rating agencies. But the Nordic markets these days are rather liquid so even if markets turn sour, it generally doesn’t affect Nordic covered bonds, which are a defensive instrument.
Wang, SEB: We have worked hard on improving transparency. For example, Swedish issuers have put in a lot of effort to make sure all cover pool data calculations are similar and therefore easier to compare. For example, loan to value ratios are now comparable across all Swedish issuers. We also try to be as open and transparent as possible both in terms of the way we present our annual accounts, our investor handbook, and so forth.
Lamy, BNP AM: Transparency makes a difference and is very important, but unfortunately it seems that the market does not always penalise issuers that are less transparent.
Tellefsen, DNB: Everything else being equal, improving transparency is of course good. We have nothing to hide and we are showing a lot of information. DNB is known to be a very transparent bank giving out a lot of information not just on the cover pool but about the whole the group on a quarterly basis. We also provide cover pool data in Excel format so it’s much easier for analysts to copy and paste that data into their own spreadsheets.
Littorin, Nordea: By improving transparency we enable a more informed decision process for the investor and the market as a whole. The ECBC label is a step in promoting transparency for the market as a whole which we support fully.
The Cover: What have you done in the last year or two that we weren’t doing before?
Pedersen, Terra: For us this has been a key issue since the start of the company because we realised that if we want to attract international investors they would need to have confidence in the Terra story. So long before the ECBC’s label initiative and Covered Bond Investor Council’s transparency initiatives got underway, we were already publishing covered pool data on a quarterly basis.
But we now have a national transparency template where we have agreed with the all the Norwegians in the Norwegian Covered Bond Council how we should present information. Following this initiative we adjusted our template to fit the suggestions. We are also closely monitoring the ECBC label and we think it is absolutely right to have a sort of qualitative checkpoint.
Lamy, BNP AM: The label is useful as it helps to provide information on issuers that have the least transparency. However, it is really only setting the minimum in terms of information. It’s still not enough but at least it is a start and that’s really important, especially for some issuers where it was really difficult to get the data from. There are still some improvements to come I hope, but that’s a very interesting start and that is important for us as investors.
Loan level information would be great but I do not expect we’ll get that. It would be good to see more detailed pool stratification, especially on the higher risk loans and on substitution assets.
Jönsson, SBAB: We signed up for the European Covered Bond Council’s labelling initiative but also the Association of Swedish Covered Bond Issuers has developed a national transparency template that was released at the end of last year.
The template allows investors to get homogenous information about all Swedish covered bond issuers. We have been providing the market with monthly updates of our cover pool since we started issuing covered bonds in 2006.
Burmeister, De AWM: I’m quite relaxed about the level of transparency offered by the Nordic issuers. There might be room for improvement on an individual level, but overall transparency is not the foremost problem in the Nordic regions.
Littorin, Nordea: For all the Nordic markets we have developed national templates in accordance with the ECBC label initiative. These standards are very close to the level of disclosure we had before this ECBC label initiative and we are today, as an issuer for all our covered platforms, reporting in accordance with the international template.
Karlsmyr, Svenska: In co-operation with the Association of Swedish Covered Bond Issuers, we have come up with a uniform document that shows different information on the same data template. We feel that this is good for the investors to easily compare the Swedish issuers. On top of that we meet with investors to provide the additional information they ask for. The whole process has been a steep learning curve.
Burmeister, De AWM: I would love to see a little bit more transparency on the banks in general than on the covered pools. For example, I would like to see more information on the derivative concentration risks. I wonder, for example, whether the whole Swedish banking sector is swapping against each other. I’m not sure whether this is the case.
Spread outlook
The Cover: Spreads now are so tight some rates investors will prefer to choose agency paper and clearly there’s not much scope for core covered bonds to perform from here. Does that concern you?
Karlsmyr, Svenska: I don’t really see that as a big problem because I think there will still be liquidity for really highly rated Swedish cover bond issuers where you also see proof of stability in the portfolio.
Added to that we see more investors from the credit world who do much more credit research around the issuer as well as the cover pool.
I think their inclusion could lead to greater spread differentiation between issuers — and even those within the same jurisdiction.
Wang, SEB: I don’t expect covered bonds spreads to widen, but I think that the potential for further spread tightening is getting very limited. I still think there is some room for potential spread tightening, but more on senior and subordinate debt than on covered bonds. The euro crisis is not yet over, event risk is high and will continue to be so for the foreseeable future.
Lay, Natixis: It is no surprise that Nordic bonds trade on the tight side, knowing that we are still facing high redemptions overall, and that most banks need less funding, hence new issue supply decreases. If liquidity in the market generally starts to dry up and holders need to raise liquidity, Scandinavian bonds are among the easier to sell, as there will always be a good bid. When it comes to liquidity on the bid side, I think investors get excellent execution, because the competition among the top five players is incredibly high.
Tellefsen, DNB: Norwegian covered bonds are still trading with a premium versus German Pfandbrief and I believe there is still scope for a smaller difference here. But this is not just about spread, it’s also about the yield level. I think investors are actually facing a big challenge when the coupon gets to as low as 1%.
Burmeister, De AWM: If you look at spreads there’s not much of a risk premium or much upside but as I said, Nordic covered bonds are a defensive instrument. That’s OK as long they stay that way. But if your investment turns into being a more medium quality instrument and things start to unwind then bang, you have a problem. In terms of profitability and in terms of expected performance, Nordic bonds are very limited, but that’s the price you have to pay for the quality.
Jönsson, SBAB: Compared with other safe triple-A assets like govvies or agency paper, there is limited room for further performance. But it is important to recognise that Swedish covered bonds provide investors with something very safe and of good quality. Moreover, Swedish issuers have access to several markets including our own well functioning domestic market. Therefore I don’t expect a lot of supply in any individual market. I expect the supply factor will continue to support Swedish covered bonds.
Lamy, BNP AM: There’s not a lot of room for further spread tightening, but with supply being scarce and demand for triple-A paper still high, the Nordic covered bonds should remain stable. But the LTRO can be a spread mover as higher redemptions would suggest greater supply, which should put pressure on spreads. On the other hand, the bail-in directive should push investors towards covered bonds, as credit investors increase their share of covered bonds versus senior unsecured.
Littorin, Nordea: Nordic spreads in particular are a reflection of the strong underlying credit quality in the covered pools, which is supported by a very strong banking sector and triple-A sovereigns.
Pedersen, Terra: You see the floors that are established on the OATs and Bunds that limit how tight Norwegian covered bonds can trade. But, if you look at the cover pool quality then I think spreads have the potential to trade flat to swaps and even below swaps assuming the financial markets remain stable.