Interview: Moody’s Jane Soldera

Jane Soldera, vice president, senior credit officer at Moody’s, spoke to The Covered Bond Report’s Susanna Rust about the rating agency’s stance on key issues facing Nordic covered bonds.

How do investor protections provided by Nordic covered bonds compare with those of other jurisdictions?

The Nordic legal frameworks per se are reasonably strong, but we wouldn’t really generalise across multiple jurisdictions. But looking more broadly at structural features in general of Nordic covered bonds it’s pretty clear that one of the strengths is that the covered bonds are supported by relatively highly rated banks in Sweden, Finland and Norway. Also, generally the collateral is of high quality, mostly consisting of residential mortgages with good quality borrowers and owner occupied property.

Focusing on particular features of the covered bonds themselves one thing that we think is credit positive, particularly in Denmark, Norway and Sweden, is the ease with which interest rates on the underlying collateral can be reset. We think that is a positive in terms of reducing refinancing stress, because if you need to transfer the asset pool of the covered bond to another entity it’s quick for that entity to reset the margin on the loan to the then current market price. In terms of weaknesses we would mention the material levels of refinancing risk in Denmark. We’ve commented on that previously in our research.

What is the outlook for the collateral backing covered bonds from the different Nordic countries?

We focus our comments on residential mortgages because, especially in Finland, Norway, and Sweden, they tend to dominate. We don’t have an official outlook for covered bond collateral so these are general observations. There is some risk of a correction to house prices in these countries, especially in Sweden and Norway. However, there are various protections in place for covered bonds against deteriorating collateral, which is why deterioration in collateral tends to have no or only limited impact on covered bond ratings. Our collateral scores are calculated to take into account stresses, including house price movements, so they already include a buffer.

Further, in terms of the housing situation generally we think there are some strengths in these countries. They typically have good quality underwriting, and the stronger the underwriting the more the risk of default is contained. They have reasonable social security protection and of course as of right now they have very low interest rates, which is a source of protection. There are some structural factors as well, such as housing supply constraints, especially in Sweden and Norway, and regulators’ moves to limit maximum LTVs. In Sweden in particular that seems to have helped constrain the market.

In Denmark, the collateral backing covered bonds faces more threats to its quality. Denmark is the only one of these countries where you see a lot of agricultural and commercial exposure backing covered bonds rated by Moody’s and there has been pressure on these asset types.

Generally speaking if a fall in house prices were sufficient to affect issuer ratings then that would clearly impact covered bonds, but saying that the outlook is stable on most Nordic banks outside Denmark.

Does the fact that Nordic issuers have access to strong domestic covered bond markets support their ratings in any way? If so, how?

It is supportive. It depends on how markets perform in difficult economic environments. The domestic investor bases in Denmark and Sweden have shown their resilience over the crisis. We look at two aspects, refinancing margins and timely payment indicators. A strong domestic market can help keep down refinancing margins a key component of refinancing risk. For instance, when sizing refinancing margins we look at the history of the spreads in the market, especially through the crisis in 2008, and whether the market remained open. Seeing that issuance can continue in the domestic market when international markets have limited liquidity shows the depth of the market and the resilience of the market and we take that into account in our refinancing margin.

Timely payment indicators will also be supported by a strong domestic market. The financial sector and authorities may be more incentivised to support a local market if covered bonds are considered an important systemic product. Covered bonds may, for instance, be a key source of mortgage finance. Local issuers and authorities are also likely to be highly concerned about the impact of a covered bond default on local investors. A local market might also be more receptive to the takeover of a failed issuer’s programme by another local bank. Local investors might be more inclined to continue buying the covered bonds because they understand the collateral and are familiar with the new issuing bank.

Moody’s recently published a report on Sweden’s covered bond legal framework — what are the main aspects?

We said that the framework has a number of strengths that lifted it above the average with respect to those particular features. Some positive features are the low limit on commercial properties in the cover pool, the requirement to remove loans in arrears, and that the framework makes clear that the administrator would have wide powers if the issuer were to default. So there are some credit positive features in the framework. We haven’t seen an English language version of the FSA’s proposals to update the framework. We understand that there is a proposal for a stress test of collateral value and that issuers would have to take some remedial action if it is shown that following such a fall the matching test could not be met. That stands out because it’s unusual. In isolation it would be credit positive, but we’ll have to see what happens as these are just proposals at the moment.

Has Moody’s observed any developments in Denmark that assuage its concerns about one year bullet bonds?

We haven’t seen anything that would change our current approach to Denmark. There have been a couple of developments with more general implications. The central bank has been quite pro-active in trying to get refinancing spread out across the year. While this may reduce the amount of assets that need to be refinanced at any point in time it doesn’t reduce the total amount that needs to be completed within a year.

The other development is that there has also been a push to get borrowers to move into longer maturities, e.g. three or five years, but we have not seen a marked move in this direction. Further, even if bonds backed by ARMs were pushed into longer maturities, we would continue to see material amounts of refinancing risk in most Danish programmes, as we do in most European covered bonds. Before ARMs, the Danish covered bond system had the lowest level of refinancing risk of any covered bond system in Europe. There are no developments that we are aware of that would return Danish covered bonds to a comparably low level of refinancing risk.

Moody’s downgraded Aktia Real Estate Mortgage Bank covered bonds by less than some market participants had expected after the issuer decided to cease public issuance — what was behind this?

This was due to us raising the TPI. There are various stages to determining a TPI and in one of the stages we look at the features of the individual programme and whether there are any that should be taken into account in terms of improving timeliness of payment.

Both programmes went into wind down. This has the effect of reducing much of the issuer’s discretion by reducing uncertainty about further asset additions (reducing substitution risk) and the potential for increased interest rate and currency risk. Further, the decision to segregate future cashflows for the benefit of the cover pool will mean a liquidity buffer is created which will increase over time and refinancing risk is reduced, as are the risks of credit losses. A combination of the above features led us to raise the TPI from Probable to Probable-High.