Interview: Per Tunestam, SBAB

Per Tunestam, treasurer, SBAB spoke to Nordic FIs & Covered after the launch of it’s senior unsecured benchmark this week, discussing modifications to its funding strategy and new regulations.

When talking about the senior unsecured deal SBAB did this week you mentioned that the bank’s ALM strategy has changed somewhat — in what way and why?

Our previous strategy was for our funding to be split roughly 50/50 between domestic and international issuance, and this worked very well for us, with funding diversification being the overall guiding star, if you like. This is still the case, but we are slightly reducing our international funding to help mitigate the accounting effects from basis swaps, which has caused swings in our P+L results. The effects are magnified for a specialised entity like ourselves with domestic lending only, and are due to accounting rules without having any real meaning, so to speak.

It nevertheless creates an explanatory burden for our board and senior management towards, for example, media in Sweden, and also produces a lack of predictability in terms of results going forward. So in order to help produce more stable results we chose to slightly reduce our foreign funding. Our ALM strategy still has at its foundation a very well-functioning domestic market, which gives us comfort to make the adjustment to our international funding.

During the last year we also experienced very heavy deposit growth. Previously we hadn’t really viewed deposits as part of our funding but given last year’s performance this has changed and it also affected our ALM strategy and will probably do so going forward. The deposit growth is the result of a new SBAB strategy to move into the Swedish retail savings area. By offering attractive deposit rates we have been able to attract more deposit volumes and then we will roll out a number of savings related products over the years to come to also start competing in that segment. The effect of the deposit growth is that it has decreased our capital markets dependency, which is very positive from a funding diversification point of view.

You mentioned two main reasons for the revised ALM strategy — are there any other aspects to it?

The effect that it will have is that we will focus more on the Swedish krona market and be a slightly less frequent issuer in the euro market. We will still be a regular issuer in the euro market but we think that probably we will be able to supply the euro market with one to two benchmark deals per year, across senior unsecured and covered bonds, depending of course on market circumstances.

But our goal is to be present in those markets on a regular basis. If the market situation remains good we could also of course consider other markets that we have been active in in the past, for example in Swiss francs. We have also tapped the Japanese yen market in Samurai format and we also have an Aussie dollar covered bond programme prepared, which we have not yet utilised. But we view those markets as additional possibilities to our two core markets, Swedish kronor and euros. Our historical pattern of behaviour in the other currency markets I mentioned is the best guide to our future behaviour there. With regards to the Swiss franc market we have done both senior unsecured and covered bonds. In the Japanese yen market we have done senior unsecured and we haven’t done anything yet in the Aussie dollar market, but the establishment of a covered bond programme is a leading indicator of what kind of transaction we would do if we were to enter that market.

Would it be fair to assume that you are done with your senior unsecured funding for 2013 and that you may instead look to do a euro benchmark covered bond?

It could be the case that we come with a euro covered bond. First of all out of this year’s overall funding needs of approximately Eu6bn equivalent we have taken care of about half of that need. So for the fall I think it’s more likely that we will do a euro covered bond rather than a senior unsecured, but at this stage I don’t want to set that in stone. We try to be as flexible and as responsive to investor demand as possible and follow the market continuously, but that’s the broad picture that I can give at this stage.

How do you view the relative attractiveness of covered bonds versus senior unsecured issuance, for example bearing in mind asset encumbrance?

We reached our natural balance between covered bond funding and senior unsecured funding already a few years ago, before the asset encumbrance debate surfaced, with a rough 60/40 split between covered bonds and senior unsecured. We don’t see that changing a lot and the reason behind that strategy is really one of conservativeness and prudence. We do not want to over-utilise our covered bond franchise and our covered bond-eligible assets. We need to be cautious and to always maintain sufficient reserves for our covered bond pool to have an adequate balance between the two funding sources, even though covered bonds, all else being equal, obviously provide us with much more attractive funding levels. Part of our funding strategy is to try to utilise the covered bonds for medium to longer dated issues and senior unsecured for shorter to medium dated issues, and that’s how we will try to do things going forward as well. But then of course depending on the future growth of our balance sheet and any shifts we will have to adapt our funding plans accordingly.

The general trend among banks is one of deleveraging, with FIG supply shrinking — does that capture the situation at SBAB?

No, on the contrary we expect our balance sheet to grow moderately. We took the decision to over time divest our corporate mortgage lending portfolio, which is a fairly small portion of our balance sheet today, but nevertheless with this new strategy of trying to cater and distribute to the Swedish retail savings area we expect to create more loyalty and a better foundation for future growth in our residential mortgage lending, which will remain our core business. So we do expect a growth of our balance sheet, which will also bring with it increased funding needs. But then we also expect future deposit growth, which depending on how that pans out will have an effect on our funding needs, and will probably also have an effect on the mix of covered bonds and senior unsecured. But for the time being we don’t see a change in the 60/40 distribution that I mentioned.

Asset encumbrance has become something of a hot topic — are you satisfied with the way the debate is unfolding?

The debate is interesting and relevant and it’s good that it’s being conducted. In the various discussions that I’ve seen over the past years there has been talk of the introduction of various limits and regulations from authorities and I think that would not be right. That is not the right formula. I don’t think there is one single formula that fits all in this subject. A high degree of asset encumbrance is very natural for some institutions, for example like ourselves, where you have a balance sheet dominated by residential mortgages. As such that brings with it, depending on your covered bond utilisation, a fairly high degree of asset encumbrance if you look at it optically. But it’s a very natural result for a mortgage institution. I think it’s also a very sound result, particularly when you consider the liquidity effects it brings with it. Even though it comes at the price of higher asset encumbrance it brings with it a very safe liquidity backstop.

When you look at financial institutions and banks, particularly mortgage banks, the most relevant risk in my opinion is liquidity risk and not credit risk. That means that the probability of default (PD) factor is relatively speaking much more important to consider than the loss-given-default (LGD) factor, which seems to be very much in focus in the asset encumbrance debate. That’s my view of asset encumbrance. I’ve seen the discussions in Norway where authorities are looking at this more closely and discussing whether to introduce limits. I think so far in Sweden the debate has been very balanced and healthy. The Swedish Riksbank, for example, has been very vocal about wanting to see increased transparency and reporting of banks’ balance sheets, but that doesn’t mean that you have to introduce limits on covered bonds. Swedish banks including ourselves are providing transparency. SBAB is already very transparent with the cover pool information we provide on our website. We signed up to the ECBC Label initiative and the national transparency template. I think transparency is good and the debate is good but one should be very cautious about introducing limits because I think that would be harmful in the long run.

Covered bonds meeting certain criteria look set for Level 1 LCR status under CRD IV — do you expect Swedish covered bonds to fall into this category?

I think they should make it into the Level 1 bucket, based on fundamentals. Sweden joined Demark in previous attempts to lobby for Level 1 status for covered bond markets that have a proven track record of being deep, liquid and historically very well-functioning, such as the Swedish and Danish markets. I think there is scope to include those covered bonds in the Level 1 category. The Swedish market really has proven itself over the years. We could issue covered bonds in the Swedish domestic market on the day Lehman filed for bankruptcy. Not very many markets can boast that sort of performance. And if that’s not Level 1 liquidity then I don’t know what is.

Whether I expect them to be included in Level 1 is a different story. I think the Swedish FSA has been pre-empting international and EU regulatory measures. They have been very conservative in introducing capital requirements for the Swedish banks, and they also introduced as of this year already a formal LCR requirement with a definition that is more conservative than the current definition proposed in the EU. In addition, Swedish banks have to comply with the LCR requirement on a combined currency basis as well as separately in euros and US dollars. Given those facts the likelihood of them allowing Swedish covered bonds to be treated as Level 1 is perhaps a little bit more difficult to gauge. I don’t know what to expect, but the fundamentals speak for Swedish covered bonds as Level 1 assets.