Interview: Eivind Hegelstad, SpareBank 1 Boligkreditt

Eivind Hegelstad, COO and head of investor relations at SpareBank 1 Boligkreditt, spoke to The Covered Bond Report’s Neil Day about the bank’s plans for 2013, its high profile in the US dollar market, and whether or not the Norwegian regulator is right on asset encumbrance.

Has 2012 been a challenging year?

Overall it was a very good year for us in that Norwegian covered bonds were in high demand. But there are always some challenges that we have to deal with on more of a micro level, one of which is swap costs and the availability of currency swaps coming back into Norwegian kroner.

There’s also of course the challenge of hitting the market on a good day. Given all the volatility, that can make a big difference.

You’ve historically hit the markets in some quite turbulent times, from your debut back in 2007 that was one of the first deals after the first break in issuance right when the crisis began…

We also issued a five year bond in euros in November 2011 on a day the Financial Times said was the toughest of the euro crisis so far. I guess we were a little bit unlucky in terms of hitting a day where volatility was so high and probably paid up a little bit, but there was overwhelming demand after all.

And we were also the first issuer from Norway in the euro market late in 2009 after the freezing of the markets post-Lehman and the Norwegian government swap arrangement.

And this year, what was the most challenging deal?

I would definitely say that the deal we had the longest deliberations over was the seven year dollar bond in early November. That represented an extension of our maturity curve out to seven years and it was only the second seven year dollar covered bond ever, after Handelsbanken in September. And unlike Handelsbanken we didn’t have a very big initial anchor order.

That represented a fair challenge to us. We did a full two weeks of marketing in the US prior to that, and had also been in the US in May and before that in March. A lot of investors on the roadshow in October told us that they would not be buying anything longer than five years and only really a handful, or maybe a little bit more than a handful of investors said yes, they would be interested in a longer dated deal. That was investors we met — of course there are many other investors in the US as well, and it did come together very nicely in the end with a fairly good book.

We didn’t do any long maturities in euros this year — we did a seven year, but we didn’t go to 10 years.

Another challenge — but certainly more of a benign issue — has been allocations once a deal is done. That has sometimes been a little difficult given large oversubscriptions.

What are your plans for 2013?

While the general direction is clear, the funding needs of the banks are continuously evolving. Because we are a specialist funding vehicle for the issuance of covered bonds and we serve an alliance of banks — the SpareBank 1 Alliance — we collect the funding needs from all of our banks on a rolling basis — and so annual targets are not something that we necessarily put a lot of emphasis on, nor do we publish them.

We have built the covered bond issuance book here from 2007 through to 2012 — so more than five years — and it’s maturing a bit now in that we won’t be ramping up volume in terms of buying large quantities of additional mortgages from our banks. In other words, we are probably starting to level out in terms of the overall size of our balance sheet, and that’s why we expect the overall volume to be down in 2013 from 2012.

We already prefund one year ahead, so in terms of looking at redemptions it will be the 2014s that we will be looking at, and we can do that more opportunistically.

You must be one of the top covered bond issuers in terms of the number of dollar benchmarks you have done in dollars. Does that surprise you?

It doesn’t surprise me now, but if you’d have asked me back in 2009 when I started working at SpareBank 1 Boligkreditt it would have surprised me to know that a relatively small bank from Norway was going to go on and become the most frequent covered bond issuer in the dollar market.

But now that the US dollar covered bond market has developed and we’ve experienced a warm welcome there, because many investors are looking for high quality assets from a macroeconomically and otherwise strong region, it is not surprising anymore. But of course, standing back and comparing the situation in 2009 or early 2010 before we started thinking about the dollar market to how it is now, it is quite fascinating to see how far we — and the US covered bond market in general — have come.

Why are you so active in dollars?

When we decided to go to the US in the spring of 2010 and started preparing the 144A programme it was mainly because we felt that it would probably be a little bit too much to put four benchmarks per year — which we have issued in 2012 for example — into the euro market alone. Perhaps in hindsight we could have done four bonds in 2012 in the euro market, too, but that wasn’t clear in 2010. In the future we still expect, with the resolution of the euro crisis at some point, that three or four bonds from one issuer would probably be overloading the euro market a little bit. So it is to have that second leg to stand on, and have that investor diversification in the US dollar market.

Having entered the US dollar covered bond market, it is also a matter of being consistent, of returning to the market on a regular basis given that the market is open and pricing is roughly consistent with the pricing achievable in euros. At the moment there is a Nordic group of issuers in the US and it is important that the Nordic curve remains active versus the other regions in the world that are or will become US covered bond issuers.

What stands out about the US market?

One of the things I’ve learned from being on multiple roadshows in the US is that US investors are very enthusiastic about Norway and its macro story. It stands out, almost in an analogous way to the way that Canada stands out for them because of the strong macro there — the strong high North, if you will.

But we need to continue to massage the message over there. Clearly the market is now probably — and I’m guessing a little bit — over 100 investors, maybe as much as 150, in total. It should be a lot larger, and so we continually have to try to strive to get to a larger investor base overall in the market, all of us have to do that, but also to get more investors to participate in our books. We have well oversubscribed books, but we would hope to get a higher number of investors in there over time, too. Obviously one of the ways that we do that is to be present in the States and try to get meetings with investors all the time.

What do you think of the Norwegian FSA’s stance on covered bonds? And will any new limits in relation to encumbrance affect your activities?

The market here is differentiated between issuers, who have various levels of encumbrance. You need to take the specialist vehicles together with the banks, of course. If you look at DNB, they have a high degree of encumbrance, a high degree of transferring mortgages to their covered bond vehicle, of over 80%. On the other side, you have Terra having done a lot less. And we are at what we see as at a natural and comfortable level — we have bought about 43% of the mortgages from our banks.

We understand that you want to have a limit in place. We agree on the stance that there should be maybe a level beyond which it shouldn’t be natural for banks to take encumbrance. We think that what is important is that if indeed a limit is coming into place that it is a transparent rule, which is visible and understandable for everyone, and clearly communicated to the market, and that we don’t have individual, below-the-radar rules for different issuers. Norwegian values are openness, reliability and transparency, and I think those are the values that should apply in this case.

And in light of house prices, we also feel there should be a natural limit. It’s good to have unencumbered assets to transfer to a covered bond vehicle if house prices go into decline, where you may need to have substitute assets or need to top up a cover pool with lower LTV mortgages. From that point of view it’s also dangerous to have encumbered all of your assets from the get-go. You then are in a less flexible position to manage the pool in such an adverse house price scenario.

Do you have many questions about Norwegian house prices on your roadshows?

Yes. I don’t think I’ve met a single investor this year that hasn’t been interested in that question, and I’ve met many of them. We understand that optically the nominal house price index here has gone up a lot and it’s only natural to ask the question. And we do the same thing here internally.

But it comes back to fundamental factors. We have very high income growth — we have the highest GDP per capita in the world — except for a couple of outliers such as Luxembourg and Qatar — and it has been growing at a brisk pace for years. That translates into high income growth for households. We have no unemployment. We have also a lack of investment in the residential real estate sector for many reasons, so completely the opposite to the previous situation in Spain, for example. And then at the same time we have population growth, with people moving to Norway from Sweden and Denmark, but also from the core and peripheral European countries. So all these things obviously drive up house prices, and we tell that story.

Importantly, in our cover pool we run stress tests. We look at house price declines of 30% overnight, and we look at a house price decline of up to a cumulative 40% over a three year period while also at the same time increasing the probability of default each year. In the case where we look at a 40% cumulative decline over three years we double the probability of default, and then we multiply it by four and then nine times in the third year — so quite a stressed scenario. What comes out is that we are not losing meaningful amounts of capital. Our Tier 1 ratio dips a little bit, from just above 10% to just below 10%, and certainly all of the unsecured capital that together with our equity finances the overcollateralisation in the pool is intact.

But we do see that we need replacement assets in the cover pool to comply with the asset-liability matching that we are legally required to do, and such replacement assets would then have to come from our banks. In the scenario where house prices decline by 40% cumulatively over three years we need between Nkr9bn and Nkr10bn of substitute assets — and this is also the point where it is beneficial to have unencumbered assets on the banks’ balance sheets, because we can then tap into that and transfer assets to deal with the situation if that were the case. Operationally we are in a position where we could create low LTV mortgages by taking a share of a mortgage on a bank’s balance sheet with a first priority lien.

Of course a 40% decline or 30% overnight are very extreme scenarios, so when we stress test here I think it’s a proper stress test.

But to get back to the main point, house prices are driven by fundamental factors, but there is also the issue of the prevailing relatively low mortgage interest rates in Norway. They are maybe two-thirds of long run historical mortgage rates and that does drive up demand for houses as well. So there is going to be a flattening out or even a decline in house prices as a result of mortgage rates rising at some point, the timing of which is obviously not known to us. A gradual increase in mortgage rates and a gradual decrease or flattening of house prices would, I think, be a welcome scenario for most banks in Norway.

The SpareBank 1 Alliance banks underwrite mortgages in a proper way on a cashflow and income based principle in the first instance, where they also stress test people’s ability to pay a significantly higher rate of mortgage interest. In fact banks in Norway have been asked by the Norwegian FSA to do this and to add a 5% rate on top of the currently available rate offered to customers when considering most or many mortgage applications.