Moody’s positive on Norwegian, Swedish FSA amortisation moves

Regulatory proposals from the Norwegian and Swedish FSAs that detail amortisation requirements would be credit positive for the respective covered bonds, according to Moody’s, which cited the substantially lower default expectations of mortgages with the LTV levels that borrowers would have to amortise down to.

Moody’s on Monday said that recommendations from Norway’s Finanstilsynet on Tuesday of last week (17 March) to tighten mortgage underwriting standards, if implemented, would help maintain stable asset quality and limit the growth of household indebtedness in a low interest rate environment, and improve the credit quality of mortgages in issuers’ cover pools.

Finanstilsynet put forward the measures to dampen the risk of financial instability in response to a letter from the Ministry of Finance asking if it would be appropriate to introduce measures to dampen house price and credit growth.

“A weaker outlook and increased uncertainty about the Norwegian economy will in isolation contribute to dampening households’ desire to borrow,” said Finanstilsynet. “There is a risk that the prospect of long-lasting low interest rates and easy access to credit will cause the strong growth in debt and house prices to persist.

“That would further increase households’ debt burden and help to maintain demand for goods and services for a time, but such a development is not sustainable. The risk of a subsequent sharp setback and financial instability would thus increase.”

Finanstilsynet proposed a minimum 2.5% annual amortisation from the first year for all mortgages until the loan-to-value ratio (LTV) falls to 65%.

“The proposed rule reflects a tightening because the current guidelines require amortisation only down to 70% LTV, and do not quantify a minimum annual amortisation,” Moody’s said. “Indeed, our default rate expectation for a residential loan with a 65% LTV is just about half of our default expectation for a loan with an 85% LTV, reflecting the increased risk of high LTV loans.”

Finanstilsynet also proposed that while new mortgage loans should remain restricted to a maximum LTV of 85%, personal guarantees that are often provided by parents for first time buyers would no longer be allowed as a justification to exceed the limit.

Also among the suggested standards is a requirement that banks assume a six percentage point increase of the interest rate when checking borrower affordability, up one percentage point from the previous stress rate requirement to reflect lower interest rates forming the basis of the calculation. Banks would no longer be allowed to bypass the stress test based on special prudential assessments of borrowers’ circumstances, Moody’s noted.

The regulator recommended that the Ministry of Finance establish the underwriting requirements in regulation, whereas current requirements are only guidelines.

“This step is positive because it would stop banks from deviating from the underwriting requirements, and give the regulator a basis for tighter supervisory follow-up action,” said Moody’s.

It noted that the Norwegian regulator’s move is the latest in numerous steps taken in recent years to ensure financial stability and prevent overheating of the residential lending market.

“Finanstilsynet’s proposal is timely because it comes as the Norwegian central bank has indicated a willingness to cut interest rates further over the next couple of months to support the economy,” it added.

The Norwegian regulator said in a statement on its proposals that it had looked at how similar policy instruments had been applied to contribute to financial stability in other countries.

The Swedish FSA (Finansinspektionen, or FI) meanwhile on 11 March made its country’s latest move to address growth in household indebtedness by announcing that it would require mortgages originated from August to be amortised down to a LTV of 50%, and Moody’s said on Monday that this would be credit positive for Swedish covered bonds because it would constrain indebtedness and build up home equity.

FI proposed that mortgages with a loan-to-value ratio over 70% should be repaid down by a minimum of 2% of the original loan each year, while loans with a LTV below 70% should be repaid by a minimum of 1% annually until the LTV has reached 50%.

Moody’s said covered bonds from Länsförsäkringar Hypotek and issuance from Skandiabanken backed by Swedish mortgages, both rated Aaa by the agency, would benefit the most from the proposed rules because their Swedish residential mortgages comprise 91% and 100% of their cover pools, respectively.

“Over time, increased amortisation would reduce the average LTVs in covered bond asset portfolios,” said Moody’s.

The rating agency noted that the requirement would have a countercyclical element because LTV variations resulting from house price changes would only be factored in every five years at the earliest.

“The amortisation of the loans should therefore lead to sustainable reductions in asset portfolio LTVs, albeit at a slow pace given that the regulation is only applicable to new loans,” said Moody’s. “To indicate some of the benefit of this, our default rate expectation for a loan with a 50% LTV is just about half of our expectation for a loan with a 70% LTV, reflecting the increased risk of high LTV loans.”

The proposed regulation is now being submitted for consultation before being passed on to FI’s board of directors for a final decision. If enacted, the new rules are intended to take effect from 1 August.

“FI’s proposal would further counter the current lack of an amortisation culture among mortgage borrowers, thereby supporting the credit quality of mortgage loans backing covered bonds,” added Moody’s.