Interview: Tamás Tóth, MNB

Nov 1st, 2012

Tamás Tóth, portfolio manager, Magyar Nemzeti Bank (Central Bank of Hungary), shares his thoughts with The Covered Bond Report on why Nordic covered bonds performed well this year and the potential for further tightening in local markets.

Is the performance of Nordic covered bonds this year justified?
There are three reasons why they have performed so well this year. First, after the two LTROs most covered bond spreads tightened massively due to the increased liquidity in the system. Second, Nordic countries have their safe haven status, so in the middle of the euro crisis they were very well bid. And last, but not least, as core government bond yields have been at historic lows, some investors have switched into other safe assets, triple-A rated assets, which provide some pick-up versus govvies. This created ongoing demand for covered bonds while supply was limited.
So these three factors contributed to the massive tightening of Nordic covered bonds. And the reason why they didn’t tighten as much as their triple-A rated peers — for example, the UK, France and Australia — is simply that they were not as wide initially, so they didn’t have as much room to perform.

Is the position of the Nordic countries outside the euro-zone a factor?
It’s an important factor that that one considers when making an investment decision. In my view Nordic covered bonds provide safety and at the same time a kind of geographical diversification.

Could the recent improvement in sentiment towards peripherals change the outlook for the Nordics?
The risk-on sentiment and the flow to the periphery could indeed be a little bit negative for the Nordics. However, due to rating constraints many investors cannot buy peripheral bonds at all at the moment, so they just stay with the core countries. But they might perhaps have some room for the UK and Australia.

Do you have any concerns about the Nordic economies, such as house prices?
Yes and no. Firstly, house prices clearly rose to a high level, especially in Norway and Sweden, where we haven’t experienced a large correction yet — although in Denmark house prices have fallen to their lowest level since 2005.
It is of course a concern and many investors are worried about it. But on the other hand growing populations — especially with immigration — and low interest rates keep demand high, while supply is very low and limited. For example, recently I was in Sweden and heard how much time it takes to get approval to build a flat or a new property — it takes years — so supply will remain low.

Do you see value in any particular parts of the market?
In the front end, let’s say up to three years, there is not too much room for them to perform. They almost trade like German Pfandbriefe. In the medium and longer parts of the curve they might be a good choice as they are relatively stable and they have lower spread volatility than their peers.
I am not so bullish on Danish covereds in spite of the pick-up they provide versus the other Nordics, and therefore favour the other three countries. And currently we are underweight in the front end and a bit overweight in the medium and longer parts of the curve.

Danish issues trade wide of their Nordic peers — is that justified?
In my opinion the premium is justified. First of all the Danish housing market is suffering a bit, with house prices having been declining since 2007. The outlook for the Danish economy is not so rosy, either, and the financial sector is under pressure. Moreover, to my understanding Danish households have the highest debt-to-income ratio in the world. As for the issuers’ senior unsecured ratings, the biggest euro covered bond issuer in Denmark, Danske Bank, is currently slightly lower rated than its peers in the other Nordic countries.
On the positive side, Denmark is probably the best jurisdiction in terms of legislation, being the oldest and strongest. Overcollateralisation levels and loan-to-value ratios are similar to other Nordic covered bonds.
But all in all I think the premium is justified. Where I see some value when it comes to Danish covered bonds is in the very front end, up to six months, and in local currency swapped back to either euros or US dollars. For example Nykredit or Realkredit Danmark issues. This trade is mainly driven by the FX swap, but in implied euro yields it gives a significant pick-up versus triple-A alternatives in the front end — although it includes some swap counterparty risk. And if you have a good Nordic business partner finding the appropriate bonds shouldn’t be a concern.

How is liquidity in Nordic covered bonds?
So far this year my experience has been that the increasing demand and the limited supply decreased liquidity a bit. However, it is still OK. More and more investors are competing for the bonds and primary market activity decreased lately. In the front end of the curve there are some profit-takers, so you can find bonds. But in the longer tenors it might be a bit trickier. So if you are looking for a bid you will easily get very competitive prices for almost all jurisdictions and names, but if you are looking for an offer, it might be a bit harder to find.

Do you have any final thoughts?
There is still some potential for further tightening in the local covered bond markets of the Nordic countries. For example, a Nordea Hypotek three year Swedish krona bond trades at 20bp over mid-swaps and around 78bp over Swedish govvies.
There is clearly a currency diversification process amongst central banks, with more looking to diversify away from the euro and looking for currencies like Swedish kronor, Norwegian kroner and Danish kroner. Initially they are introducing government bonds into their portfolios, but then maybe they can switch into covered bonds as well — since they are also triple-A rated — and this can drive spreads tighter.

The views expressed in this interview are those of the portfolio manager and do not necessarily represent official positions of the Magyar Nemzeti Bank, the central bank of Hungary.

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