Participants in the roundtable, which took place in March, were:
Arve Austestad, head of funding, SpareBank 1, Stavanger
Andreas Denger, senior portfolio manager, covered bond analyst, Munich-ERGO Asset Management (MEAG), Munich
Jonas Erikson, head of group treasury, Swedbank, Stockholm
Philippe Hombert, global head of FIG DCM, Natixis, Paris
Anders Kvist, head of group treasury, SEB
Arnaud-Guilhem Lamy, portfolio manager, covered bonds, BNP Paribas Asset Management (BNPP AM), Paris
Ola Littorin, head of long term funding, Nordea, Stockholm
Laurence Ribot, head of triple-A syndicate, Natixis, Paris
Timo Ruotsalainen, managing director, Aktia Real Estate Mortgage Bank, Helsinki
Per Tunestam, treasurer, SBAB, Stockholm
Philip Moore, moderator, EuroWeek
EUROWEEK: What were the main reasons for the strength and stability of Nordic covered bond markets during the crisis? Per, as SBAB has recently described the Swedish covered bond market as probably the "best functioning bond market in the world", why don’t you start us off?
Per Tunestam, SBAB: In Sweden we have had a very well functioning domestic market for 20 or 30 years, which is well before the launch of the Swedish covered bond market.
That tradition has continued since 2004 with the passage of legislation on covered bonds and the subsequent conversion of outstanding issues into covered bonds. We now have a true domestic covered bond market, and the ultimate proof of how well the market works is that we were able to issue bonds on the day that Lehman filed for bankruptcy.
We issued bonds continually throughout the crisis, and I don’t think banks in many other jurisdictions can make the same claim. So, to my knowledge, probably only Denmark can challenge the statement that you allude to from our investor presentation.
Arve Austestad, SpareBank 1: The main reason for the stability of the market is that economies in the Nordic region are performing so well, which appeals to investors searching for safe havens in the covered bond market.
If you look into the covered bond programmes in the region most are strong in that the cover pools are mainly residential mortgages and the LTV ratios are relatively low. So the Nordic region ticks all the boxes that investors are looking for.
Jonas Erikson, Swedbank: Sweden enjoys a number of relative strengths, both within the European and the Nordic context. One is the stable macroeconomic picture, with very strong fiscal and other balances, whether you look at a current account surplus of 6% or 7%, or at the debt to GDP ratio or the resilient loan-loss track records of the banks. By all those measures, Sweden has stood out both in a Nordic and a European context for a long time. Our Nordic neighbours have some of these features but not all of them, and next to the Swiss franc, the Swedish krona is one of the most sought-after currencies in the world at the moment.
Timo Ruotsalainen, Aktia MB: In the Finnish market, as far as the macroeconomic environment is concerned it is often a case of no news is good news. Finland went through its crisis in the early and mid-1990s, which completely transformed the banking industry.
The result is that there was no change at all in the sector during the recent crisis. Banks remained highly conservative and had very little involvement in the Baltic or Russian market where some of the Swedish banks got a few scratches on their shields.
Finland is also the only country in the world that always paid back all of its debts, in war as well as in peace time. That was maintained in the crisis, when there were no restructuring issues and none of the banks needed to ask for any help from the government or the central bank.
Even though the government has started to increase its borrowing slightly, its finances are still in very good shape and Finland is regarded as one of the model students in the EU.
EUROWEEK: Looking more specifically at the Norwegian market, what are its strengths relative to the region and to other European jurisdictions?
Austestad, SpareBank 1: One of the specific strengths is that the home ownership ratio is high at 80% in Norway, where your home is your castle. People don’t buy homes to let, so there are no speculative drivers of the housing market in Norway.
Also, because of its oil reserves, Norway has no net government debt, and all the other macroeconomic variables are also strong. The government runs a budget surplus, which is extraordinary in today’s economic environment. We also have a low unemployment rate of between 3%-4%, which gives investors confidence that borrowers are able to service their mortgage payments.
EUROWEEK: Finland passed a new covered bond law in August 2010. What are the main features of the new legislation and what impact, if any, has it had?
Ruotsalainen, Aktia MB: Germany probably remains the best benchmark for covered bond issuance in Europe, and the key point about the new Finnish law is that it is pretty much in line with the German legislation. The most notable difference is the LTV level, which is a maximum of 70% in Finland, whereas in Germany it is 60%.
From an investor’s point of view, another important point is that the law is now based on a holistic approach, meaning that the cover pool consists of loans, bonds, supplementary collateral and hedge instruments, and all the bankruptcy procedures are described in the new law. So whatever happens to the issuer, under the new legislation, new pools can be operated separately by administrators appointed by the Finnish FSA to maintain liquidity and stability. This means that investors’ bonds remain secure and makes the new law less risky than the old one.
EUROWEEK: What are the strengths of the Swedish mortgage market?
Anders Kvist, SEB: First of all, I would echo what Jonas said about the role played by the very strong Swedish economy in supporting the mortgage market and hence the asset quality of Swedish covered bonds. The economy is flexible, competitive and export-oriented, all of which makes for good long-term growth without excessive leverage and for low unemployment, which is key for residential mortgages.
Another important point to make is that Sweden had a commercial property bust and a financial crisis in the early 1990s. That gave the Swedish banks a very clear lesson that you must not rely too much on asset values when you lend money, either to corporate or private customers. So the residential mortgage lending in Sweden since then has been very cashflow-focused. In other words the repayment-ability of residential mortgage clients is key. So as lenders we don’t get carried away with very high asset prices and collateral values that look very strong but might go down swiftly in a crisis situation.
Tunestam, SBAB: Going back 10 years or so, the common practice in the Swedish market was to provide so-called bottom mortgages, from zero to a maximum LTV of 75%, although you could also access financing above 75% LTV with what we called top-up mortgages. The market was gradually relaxed to the point that it was possible at one point to borrow as much as 95%.
Because of regulatory concerns about house price developments in general, last October the Swedish FSA came out with a recommendation to all lenders in the Swedish mortgage market that they introduce an LTV cap of 85%, which is a recommendation that all lenders have been following since then. There are discussions about whether those measures could be combined with others, such as higher degrees of amortisation requirements.
Erikson, Swedbank: It’s a bit more than a recommendation; it’s a ceiling of 85% on LTVs. Our chief executive was one of the main influences in the market behind the introduction of this ceiling, and he would probably have preferred a lower LTV.
In the Swedish financial market, only 25% of household savings go into deposits. The rest goes into various mutual funds and pension products. That means that you can’t run a broad-based bank in Sweden without being dependent on wholesale funding, even if that wholesale funding still comes largely from domestic sources. That also means that if it is to be reflected on the balance sheet on the asset side, we need to ensure that the stability we’ve enjoyed for the last 15-20 years is maintained.
If this crisis taught us anything, it is that there is a very strong link between the asset and liability side of the balance sheet. So we have been one of the strongest advocates in the market for regulating parts of the asset side to maintain the very strong position that we have developed on the liability side.
Kvist, SEB: Don’t forget that because the loan stock is seasoned, the average LTVs are much lower than the legal limit. In SEB’s case, for example, the weighted average is just 45%, which represents a big additional buffer.
One of the potential weak spots is a lack of amortisation procedures or habits. But that is also being addressed, with banks beginning to tell their customers that while they have always looked at their net worth and savings as a counterbalance to their loans, they now require them to save more in the form of amortisation on those debts.
Tunestam, SBAB: People are moving into the larger cities and other high-growth regions, which means there is a net inflow of people which is not matched by new construction. We also have a regulated rental market in Sweden which puts a cap on permissible rental levels. This has a dampening effect on the ability and willingness of construction companies to start new housing projects, because rental rates are based on utility values rather than location. In other words, rental costs don’t correspond to market forces.
Sweden learned a great deal from its financial and property market crisis of the early 1990s, and there are no reasons to believe a bubble is building up in the Swedish housing market. There has not been enough new construction activity to keep up with demand, so there is a structural undersupply of housing in Sweden underpinning the housing market. Indeed, Sweden has had the lowest rate of investment in housing per person anywhere in Europe for 15 years.
Erikson, Swedbank: The transparency of information in Sweden from entities like the Credit Information Agency is also important. Unlike in the UK, in Sweden, individuals’ financial histories, together with information on salaries and so on, is freely available. All this strengthens the selection process of the credits we originate.
Tunestam, SBAB: I agree that one of the reasons we have such high quality assets in the cover pools is that we have a very rigid and creditor-friendly infrastructure. Information for lenders about the borrowers is extensive and easily accessible, and this is coupled with a very generous welfare system which helps people if they fall into difficulty with their mortgage repayments. There is also a cultural propensity to repay debts, which is applicable to most of the Scandinavian region.
Kvist, SEB: As well as the credit information agency and the strong welfare system, we have under the same headline of socioeconomic factors personal liability for life on the part of the borrower. Even after default and foreclosure procedures you can’t walk away from your house and your mortgage loan.
EUROWEEK: What is the appeal of Nordic markets to investors?
Arnaud-Guilhem Lamy, BNPP AM: What we like about the region is that the legislative framework is good and strong. We also like the fact that the Nordic banks were largely insulated from the crisis. The third point is that the market is much cheaper than German Pfandbriefe.
The one thing we are monitoring in the region is the impact that rising interest rates may have on real estate markets. Most mortgages are in floating rates, so a strong increase in rates might impact borrowers’ ability to pay.
EUROWEEK: What are the characteristics of the Swedish covered bond market compared with other European markets?
Tunestam, SBAB: In the domestic market, we have a system that works slightly differently from the international covered bond market. For example, we don’t have to issue the whole amount of a bond in one go. We can successively issue every week and even every day in small amounts, as we see fit and in accordance with our funding needs and with investors’ preferences. So we cater to changes in demand through tap issues throughout the life of a bond.
We also have a dedicated market maker system, with the issuers providing repos for the market makers, which is another reason why the domestic market functions so well.
Ola Littorin, Nordea: We agree that the tap system is a fundamental reason for the underlying performance and functionality of the Nordic markets and in particular of the Swedish and Danish markets, but also increasingly in the Norwegian market.
Taps allow for issuance of bonds via designated dealer panels in predetermined benchmark maturities, thereby reducing execution risk. Continuous taps also ensure liquidity.
This is probably the most important characteristic distinguishing the Nordic markets from any other. Issuers may be active on both sides of the market, for instance when there is an overhang of paper in the market, and are particularly active when a benchmark is approaching maturity.
Rather than waiting and facing a potentially large volume maturing on the same day, issuers engage in successive buybacks, lifting short term paper from the market and replacing it with longer term bonds. We thereby reduce our liquidity exposure at the time of maturity and allow investors to make more effective use of their limits.
EUROWEEK: How does the Norwegian market compare with others in Europe from a legal and structural perspective?
Austestad, SpareBank 1: It took about four years to draw up the Norwegian law, which allowed it to take best practice from all other legislations, such as the German, Swedish and Danish laws. Having been put in place in 2007, it is a relatively modern law.
In Norway you need a special licence to issue covered bonds. A bank has to move the assets from its balance sheet into a separate company to issue, which ensures the segregation of those assets from the rest of the bank. This means that in an insolvency there would be a separate administrator from the bank that would handle the cover pool, which also gives covered bondholders some comfort.
Covered bond issuers are supervised by the FSA and subject to ordinary banking regulation when it comes to capital and liquidity requirements.
EUROWEEK: How do over-collateralisation levels compare across the region?
Tunestam, SBAB: Required o/c levels for all Swedish issuers are similar. From the outset in 2006 we committed ourselves to maintaining a minimum o/c level of 2%, and then as the crisis evolved the rating agencies’ requirements increased dramatically for all issuers around the globe, including for Swedish issuers. So now we have a more dynamic approach where we are committed to maintaining the o/c levels that are set out by, in our case, Moody’s and S&P, to maintain our triple-A status.
Erikson, Swedbank: We have bonds outstanding of about Skr430bn, compared with a cover pool of Skr630bn, which gives you an indication of our o/c levels.
Kvist, SEB: More generally, Sweden’s banks probably have two-thirds of their pools covered by issued bonds, so we all start off with a very healthy o/c level, with the remainder funded through deposits and other diversified sources.
Austestad, SpareBank 1: There is no minimum requirement when it comes to over-collateralisation in the Norwegian market other than that the o/c level should be positive. When it comes to asset-liability management, matching principles are required to be in place, with incoming cashflows always required to be higher than their net present value. The ratings agencies certainly see the law as a strong one, although we don’t have the 200 year track record that Germany has.
Ruotsalainen, Aktia MB: There has been a change in the o/c requirement since the passage of the new Finnish law. The statutory o/c requirement is now 2%. We have been required by Moody’s to maintain higher o/c levels than this and even to increase them, which is a bit strange as the new legislation is more conservative and transparent.
EUROWEEK: Could the borrowers describe the composition of their cover pools?
Littorin, Nordea: Being a pan-Nordic bank we have four different covered bond issuance platforms in the region with cover pools largely consisting of residential properties, although there are some small differences from country to country. In Denmark, in addition to the large residential holding, we have a small commercial real estate component. In Sweden we have a public sector component of approximately 11% and a small commercial component. Our Norwegian and Finnish pools are 100% and 97% residential respectively.
Tunestam, SBAB: The composition of our cover pool is dominated by residential mortgages. These are recognised as high quality assets with a proven track record going back many years, with low arrears and loan losses. Swedish cover pools are strong compared to many other jurisdictions, which also include public sector bonds and other types of assets, which we don’t find in Nordic cover pools.
Legislation allows for a maximum of 10% in commercial mortgages but I believe that in the case of most Nordic issuers cover pools are 100% residential mortgages. From time to time it’s possible to replace these mortgages with highly rated securities such as government bonds or EU covered bonds, but that is purely for liquidity reasons.
EUROWEEK: Are cover pools of Nordic issuers purely domestic?
Tunestam, SBAB: Yes. Our cover pool consists of 100% Swedish residential mortgages. SBAB has no exposure at all to the Baltic region.
Erikson, Swedbank: Our cover pool is purely domestic and almost 100% relates to residential mortgages.
Austestad, SpareBank 1: Our exposure is purely domestic.
EUROWEEK: Timo, how would you describe the composition of the Aktia MB cover pool? Some 89% of this is accounted for by Finnish residential assets and the remaining 11% by housing company loans. What is the difference between the two from a credit perspective?
Ruotsalainen, Aktia MB: Aktia MB probably represents the purest of Finnish residential credit risk. Some of the other lenders in Finland have a slightly different approach, with a number of non-residential mortgage assets in their cover pools.
In terms of the credit quality, there is very little difference between housing company loans and individual mortgages, but if anything housing company loans would be slightly lower risk because housing companies function like co-operatives. Residents forming a housing company are jointly liable for its loans, which have very low LTVs. But Aktia MB has had no credit losses in its history, so the credit quality of both is very high.
EUROWEEK: How closely do investors look into this detail?
Laurence Ribot, Natixis: The unusual thing about the Danske deal we led recently was that the cover pool was half residential, half commercial. We had very few questions about that, which shows that investors’ decisions are largely based on confidence in the issuer and its jurisdiction.
Andreas Denger, MEAG: The most important factors in covered bond analysis are currently sovereign risk, issuer default risk, negative headline risk, future investor demand and, of course, the quality of the cover pool. There are small differences from one jurisdiction to the next, but the general level of investor protection is high.
EUROWEEK: Strong legislation is obviously important for investors. But what do you demand from covered bond issuers themselves?
Denger, MEAG: Enhanced transparency is one improvement that could be made without the need for any legislative change. This is why the Covered Bond Investor Council (CBIC) is having discussions on this topic and has created a dedicated working group to address this issue.
EUROWEEK: How have issuers’ investor bases been evolving?
Austestad, SpareBank 1: Domestic investors hold between 40%-45% of our outstanding debt. The remainder has been issued internationally, mainly in euros, and German-speaking investors are the biggest takers of those bonds.
We also started to issue in US dollars in 144A format last October and we had a strong response from the US investor base. We have six outstanding euro denominated benchmark issues and one in dollars. We expect our issuance will be divided roughly 50/50 between euros and US dollars, with US investors taking all the dollars and German-speaking investors buying about 50% of our euro issuance.
EUROWEEK: Did investor demand for Norwegian bonds remain stable during the crisis?
Austestad, SpareBank 1: During the crisis, there was a specific scheme set up by the Norwegian government, so we did not enter the market in 2009 until late November.
From the time we started issuing in 2007 the waters in the market were rough, because there was already uncertainty over Northern Rock. Ever since then the perception among investors has been that Norwegian covered bonds are a low-risk, safe-haven investment.
This means we can probably issue in the market when we need to, albeit at prices dictated by investors at the time. But we issued four or five international transactions last year and demand has not been an issue.
Erikson, Swedbank: Swedbank’s balance sheet structure is such that we have hardly any dependence on unsecured finance. Two years ago we had unsecured funding needs to cover loan financing of more than Skr200bn. That is now zero, so we’ve achieved a lot since then in terms of tweaking our balance sheet.
The result is that almost all our funding is based on covered bonds to support our Swedish mortgage business. The rest we can gather through deposits as we are the largest deposit-taker in our home market.
Looking at the mix we generate in kronor versus other currencies, that will depend partly on the pricing. But over time we’ve said that of a total outstanding volume of about Skr500bn-Skr550bn, we would expect to have between Skr300-Skr350bn in domestic covered bonds. The rest will be mainly in benchmark issues in euros and to some extent US dollars. We’re launching a 144A programme in the first half of this year.
We would also expect to have Skr50bn-Skr100bn in private placements and other smaller markets where we don’t do benchmarks, as well as German registered covered bonds.
In terms of maturities, the Swedish market is very much a five year market, whereas we would look at tapping the euro and US dollar markets for maturities of up to seven years.
Kvist, SEB: SEB only needs term funding for mortgage lending, which makes covered bond issuance the natural instrument for term wholesale funding.
Up until the passage of covered bond legislation in Sweden in 2004, mortgage lending had been financed through the issuance of senior housing bonds bought essentially but not exclusively by domestic investors. So there is a very strong domestic investor base.
We will always need to swap any foreign currency we raise back into Swedish krona, so I always tell international investors that they should never fear being swamped by over-supply of Swedish covered bonds. Our domestic investor base will always pick up about two-thirds of total issuance and roll-overs.
The remaining third has largely been in euros, with some privately placed Swiss francs. But US dollars are now being added to that, and earlier this month we roadshowed a SEB US dollar covered bond in the US which we are issuing purely for diversification purposes.
Tunestam, SBAB: We have a long term strategy of achieving a 50/50 distribution between international funding and domestic Swedish krona funding.
The total composition of our outstanding funding is still skewed slightly towards Swedish kronor, which accounts for a little less than 60% of the total. That is a reflection of our issuance during the crisis, when there were times when only the domestic market was open.
We’re keen on continuing with our strategy of funding diversification both on the covered bond side and in our senior unsecured funding. We have seen a higher degree of interest from foreign investors as a result of the crisis but also because Sweden and the Nordic region as a whole has traditionally been perceived as a safe haven in the Euroland context.
We have always had big demand from Germany for Scandinavian paper in general and for our paper in particular. We have also been increasing our presence in the Swiss market, and we have seen an increase in demand from central banks in central and eastern Europe.
Erikson, Swedbank: German investors are also our main source of international demand. Over the last year, there has been strong demand from German investors across all maturities, whereas going back a year or 18 months, they were looking for longer tenors. In our September 2014 issue earlier this month, German investors accounted for more than a third of the book.
EUROWEEK: Do foreign investors buy your covered bonds in kronor, or just in euros?
Tunestam, SBAB: Mainly in euros. We had interest from foreign investors in the Swedish domestic market before the crisis. That investor base diminished during the crisis, not for any fundamental reasons, but mainly because the Swedish krona is a small currency and there was a flight to what were perceived as the most liquid currencies. Now the Swedish krona has started to strengthen again as a result of the performance of the economy and because the Riksbank has been one of the first central banks in Europe to hike rates. So we may see a higher share of foreign investors in the domestic market.
Erikson, Swedbank: We also find that foreign investors stick to buying our bonds in euros. The krona bonds are bought largely by domestic investors. Over the last two years the international investor community has become slightly less internationally-minded.
Kvist, SEB: Foreign investors’ share of our covered bond stock in krona has ranged from 5%-20% depending on the spread and currency outlook at the time. But in terms of real underlying foreign institutional participation, most is in our euro denominated issues.
Littorin, Nordea: We had some Eu89bn outstanding in covered bonds as of December 2010. Denmark accounts for Eu43bn and Sweden for Eu39bn. Our other two platforms were only established last year. Norway has Eu4bn equivalent outstanding, and Finland about Eu3bn.
Local investors form the core of our investor base. The Danish, Swedish and Norwegian platforms are set up targeting mainly domestic investors, whereas the Finnish platform is focusing more on the euro market. Throughout the crisis we were able to continue to tap each of these markets and maintained our market access throughout the turbulent times.
We began diversifying our investor base in euros in 2006, using Nordea Hypotek in Sweden. We now mainly use Nordea Bank Finland for our international issues and we plan to continue to gradually expand our international issuance as a complement to the core domestic markets. Today, we are also monitoring the opportunities in the dollar market.
EUROWEEK: Arve, you mentioned the dollar market earlier. How do the costs compare of dollar and euro issuance versus Norwegian krona?
Austestad, SpareBank 1: The Norwegian krone market remains the cheapest source of funding for us, typically by about 10bp. But there is a limit to how much demand there is in the local market, given that the government wealth fund is not permitted to buy domestic debt.
When it comes to a comparison between dollars and euros the costs vary day by day, and is mainly a product of the cross-currency basis swap. The important thing for us is to ensure that we retain access to both markets.
EUROWEEK: What has SBAB’s approach been to the US dollar market?
Tunestam, SBAB: We have not yet issued in dollars. I think more Scandinavian issuers will look to the US dollar covered bond market this year as a further source of diversification, including ourselves.
EUROWEEK: How is Aktia MB’s investor base distributed, and have you seen any changes in the geographical structure of your investor base in the last couple of years?
Ruotsalainen, Aktia MB: About 30% of our investors are from Germany. Finland represents about 25%, followed by Denmark, Norway and the UK with about 6% each. In my time here I’ve only issued one bond which was a shortish three year transaction which we had to issue late in the season because it took the rating agencies about three months to read through our new legislation. So most issuers weren’t able to do anything last autumn until after November, which may distort the demand picture, but in that issue domestic take-up was slightly lower than we anticipated. On the other hand, Danish investors have been very supportive of our last two deals.
I am working on further diversifying our core investor group and we’re looking at other alternatives, perhaps by issuing in Swiss francs or in registered Namenspfandbrief format.
Ribot, Natixis: One of the important features of the Nordic market is the strength of the domestic bid. Domestic investors often account for about 25% of the books, which is a comfort, and I don’t expect this share to diminish.
An interesting theme of the market in 2011 which we did not see in 2010 has been the extension of duration among Nordic issuers, some of which are now going out to 10 years. In 2009 there was a Danske 10 year issue but this year we’ve already had 10 year issues from borrowers such as Nordea and SpareBank 1. Issuing 10 year bonds is a good way of developing the investor base, especially among insurance companies, which are very strong players in this market. They are likely to become more and more interested in the covered bonds as a result of the Solvency II rules.
We are seeing more and more new investors coming into the covered bond market. Much of this is driven by Basel III and Solvency II regulation. That is positive for the Scandinavian market because it has such a good track record.
EUROWEEK: Ola, Nordea recently issued a 10 year Eu1bn benchmark. Is this part of a strategy to extend duration?
Littorin, Nordea: We have used the strength of our name to gradually extend the duration of our funding over the last couple of years, and we see covered bonds as the most cost-effective and practical instrument to use for longer term issuance. The 10 year euro transaction we did in February, which was the first time we stepped beyond seven years in benchmark format, was an example of that. We will continue to monitor opportunities up to 10 years, and we would even consider going beyond 10 years using registered covered bonds.
EUROWEEK: Moving on to spreads and relative value in the market, what levels has Aktia MB traditionally traded at relative to your peers? And which borrowers would you see as being in your immediate peer group?
Ruotsalainen, Aktia MB: I would benchmark us relative to our Finnish peers rather than the other Nordic covered bond issuers. Both Sweden and Denmark have fairly deep domestic markets. That creates a lot of domestic demand, whereas in Finland the local investor base has always had a focus on diversification throughout the EU area.
But comparing ourselves to our peers in Finland, they are jumbo issuers, so you need to take into account the possible liquidity premium. Due to our rating and size we have paid levels of about 10bp-15bp wider than what our local competitors, such as Pohjola, Sampo and Nordea, might achieve. But it is certainly positive that these issuers are in the market, because it means we can now talk about a Finnish curve, which was not possible in the past.
Austestad, SpareBank 1: The trend for us has been one of spread tightening relative to other jurisdictions, although maybe not as much as would be justified based on a true reflection of the risk differential. Nevertheless, the trend has been very clear which is that Norwegian spreads have tightened compared with Swedish and Danish spreads. That is understandable given the macroeconomic backdrop.
EUROWEEK: Looking at spreads from an investor’s standpoint, is there room for more tightening?
Denger, MEAG: On the one hand, there are a number of arguments on the pro side. These include reduced contagion from the euro-area periphery, fundamentals that are still sound, availability of domestic demand and the increased relevance of the euro Scandinavian covered bond market.
On the other, performance has been quite good and spreads are already relatively tight, raising questions about the potential for any further tightening. Although there is little cause for concern about the prospects for the region’s housing markets, if clear signals of a deterioration emerge, some investors might change their views on the market. I’m not saying I expect such a situation but I can’t rule it out either.
The prospects for demand in the Scandinavian covered bond market are also linked to the future performance of euro-area sovereigns. The current pick-up offered by sovereign and covered bonds in countries like Italy, Spain, Portugal and Ireland is huge compared to Nordic covered bonds. If risk appetite returns and we see a stabilisation of spreads in peripheral countries, demand for Nordic covered bonds in euros is likely to decline.
Lamy, BNPP AM: On a relative value basis we clearly see Nordic covered bonds as attractive, especially in the case of Norway and Finland. As I said before, these markets are cheaper than Pfandbriefe, although a lot of the strengths are already priced in.
From a fundamental perspective, we would expect the convergence between the Nordic region and Germany to continue. But the German investor base is so big, and supply is diminishing with the public sector collateral pool shrinking, that the downward pressure on spreads in Germany is maintained.
EUROWEEK: From a banker’s perspective, how do the Nordic markets compare with others in Europe in terms of credit quality and spreads?
Ribot, Natixis: The most important point as far as European investors are concerned is that the Nordic market is seen as a core, safe segment. It is still a segment that is relatively small in terms of bonds outstanding, with a market share of about 16% last year and about 13% of the jumbo market so far this year.
EUROWEEK: Does that relatively small share mean that some Nordic issuers have to pay a liquidity premium? For example, Aktia MB’s total outstanding is just Eu2.375bn. Is that a disadvantage?
Ruotsalainen, Aktia MB: It’s true that our issues have not always been well traded in the secondary market, with Eu1m here and Eu1m there changing hands. Unfortunately the pricing in the secondary market does not therefore always give a very accurate reflection of the credit quality.
Aktia MB’s owner groups represent a share of about 13%-14% of the Finnish mortgage market. Aktia Mortgage Bank is a funding vehicle for its owners, which are Aktia Bank and the savings and independent co-operative banks in Finland, but we don’t yet have all the mortgages that the banks have on their balance sheets. We are growing all the time, but our growth is gradual and controlled. So in terms of the size and regularity of our issuance we will follow the pattern we follow today in the next few years.
As soon as we reach a critical mass, we will be able to start issuing in jumbo size, which is one way of addressing the liquidity challenge. Luckily the market is more receptive to smaller issue sizes than it used to be.
Lamy, BNPP AM: We’re seeing more and more issuers from the Nordic countries, and clearly for the bigger ones I am not concerned about liquidity, which is closer now to Germany and France. But we have also seen more small issuers come to the market, and there may be a problem with liquidity among these, especially if they’re not triple-A rated.
Ribot, Natixis: I agree that before the crisis issuing in relatively small size was a problem for some Nordic issuers, and some investors were reluctant to invest in issues from smaller borrowers because of their size, which at the time was far below jumbo standard.
This is no longer a problem because sub-jumbo issuance is becoming more common. So liquidity is now a very different issue to what it was before 2008. Investors are focusing much more on credit quality and fair pricing than on liquidity.
To go back to your question about relative spreads, the German market is a special situation because its pricing dynamics are very much driven by domestic investors and by the relatively high level of redemptions. The French segment, which is very active and regarded as a core part of the market, is much more comparable with the Nordic market.
Denger, MEAG: To pick up on the comments about liquidity, the problem of how jumbo covered bonds are traded on the secondary market is not easy to solve. It is understandable that a return to pre-crisis bid/ask spreads is not manageable, but at some trading desks we are still quite close to the poor liquidity levels and bid/ask levels that we saw at the peak of the crisis for many covered bonds. There is clearly room for improvement.
Tunestam, SBAB: If you go back a few years, Swedish covered bonds were priced slightly above French Obligations and German Pfandbriefe. Today we price below France, and from a fundamental point of view it should only be a matter of time before we price level with or even through the German covered bond market. There is no reason why Sweden should price at a premium to Germany.
Kvist, SEB: Through our German subsidiary we also issue Pfandbriefe, and I’ve often been asked why they should trade through our Swedish covered bonds. The only answer I could ever come up with is that it is a function of brand-recognition. The Pfandbrief brand is second to none. But asset quality-wise, and in terms of liquidity, so are Swedish covered bonds.
That was reflected to some degree in the crisis when Swedish spreads were stable in relative terms, as well as since the crisis, when spreads have tightened. In the last 12 months, Swedish spreads have traded through France and narrowed versus Pfandbriefe.
Ribot, Natixis: The spread between Germany and Scandinavia is narrowing, which reflects the fact that spreads are widening in Germany and tightening in the Nordics. I expect this to continue, and it will impact on pricing in the primary market, as well as secondary levels. Even with a heavy new issue pipeline, Scandinavian borrowers are the only issuers that are still able to price in line with, or even tighter than, they did in January.
Market conditions are very positive with issuers all the way down to the Spanish second tier banks able to print transactions. But if the market were to turn bearish, it would once again concentrate flows towards the core segments.
Philippe Hombert, Natixis: On the subject of spread narrowing, what is interesting is that, even when spreads are very tight, we have still seen very successful deals. For example, the last issue we did for Swedbank was priced very tight at mid-swaps plus 30bp, but the book was still above Eu2.1bn, which allowed Swedbank to print Eu1.5bn, which is its biggest ever covered bond. This shows that Nordic covered bonds are still seen as very safe but also that they still offer good relative value.
Another important point about the Nordic market is that it offers investors diversification. Investors already have plenty of exposure to several countries, and Nordic covered bonds provide an appealing alternative to these markets. The Nordic markets are also benefiting from investors switching out of government bonds into the core covered bond market.
Erikson, Swedbank: The pricing of Swedish covered bonds certainly makes it hard to complain about being a Swedish bank in a European context.
But also there are more fundamental issues to be addressed in Europe in terms of secondary market liquidity and transparency of prices. That is where we need to focus, because credit quality itself cannot become much better than it already is. More harmonised covered bond legislation and product standardisation would enhance liquidity, and the more liquidity you have, the truer pricing becomes.
EUROWEEK: The potential for harmonisation in the covered bond market has been discussed for years. How feasible would this be, even on a Nordic basis?
Erikson, Swedbank: I’m not sure if it would be any easier to have a harmonised Nordic framework than a harmonised European framework. Clearly there are bodies in place to drive harmonisation in Europe that don’t exist to the same extent in the Nordic region, where harmonisation would need to be the product of goodwill and active co-operation.
In all the discussions about financial stability that we’ve had in the public domain over the last two years, I’m surprised that more of it has not been focused around enhancing liquidity and harmonisation of financial markets.
Littorin, Nordea: The tap issuance employed in the Nordic markets is one example of an area of harmonisation. Another example is the industry-wide agreements on LTV calculations in Sweden. Cover pool disclosure is an area where further harmonisation work can be pursued.
But we need to remember that although Nordic markets share a lot of similarities in terms of sovereign financial strength, a strong financial sector, and stable housing markets, there are also differences, for example on the product side, which may make harmonisation challenging.
EUROWEEK: The final Basel III rules were released in December 2010, confirming covered bonds as the only bank funding instrument eligible for liquidity buffers. What are issuers’ views of these regulations?
Kvist, SEB: The really important point about Basel III is that it does not give covered bonds enough credit. Key officials in Germany, Denmark and France have come together to continue to lobby for covered bonds to have fairer treatment under Basel III and Swedish covered bond issuers should be part of this movement. More specifically, we believe that in the liquidity reserve under Basel III, covered bonds should be afforded a much larger role. It is an irony that peripheral government bonds should enjoy a higher degree of liquidity reserve credit than triple-A rated covered bonds.
Austestad, SpareBank 1: We have to comply with the Net Stable Funding Ratio which in practice means we need to maintain liquidity for one year, meaning that we should be able to live without any external refinancing for 12 months. That’s a huge step for us, but it’s also a sound step because it makes us less dependent on the market. It’s also a positive development because it matches the maturity of assets and liabilities.
We’ll also be affected in the sense that although we are a standalone entity with exposure purely to very low risk residential mortgages, the Basel III leverage ratio may also be a hurdle. It will require us to have additional equity on board that we would not have needed had we been part of a consolidated group. Therefore we have to maintain a stronger capitalisation than covered bond issuers that are part of a group. For debt investors, I guess this is a positive thing, though.
Tunestam, SBAB: Obviously the key ratios that everyone is focusing on are the NSFR and the LCR. These will also have an impact on Swedish issuers.
The main impact will be on the treatment of mortgages and other collateral. The NSFR will probably mean that most issuers will seek to slightly extend their liability duration up until the implementation of the rule in 2018. In terms of the LCR the focus will be on getting more liquid reserves on to the balance sheet than before, although that may not be so relevant to covered bonds.
How the landscape pans out in terms of the capital ratios is still unclear but it does look as though the authorities would like to see higher capital ratios.
Of course we’ll comply with the regulatory requirements set out by Basel III but as we are operating in such a low-risk business, we feel we are already adequately capitalised.
Ruotsalainen, Aktia MB: Since we’re a relatively small entity with an SPV-style set-up, some of the Basle III requirements, particularly the LCR requirement, will be challenging. But we have already started preparing for this and I don’t see any of the challenges as insurmountable.
Erikson, Swedbank: We’re well positioned for Basel III in terms of our maturity structure and liquidity buffers. On the capital side we’ve communicated that it will have an impact on our core tier one of less than 50bp.