Norwegian plans could bolster covered quality, but spring supply surprise

Florian Eichert, senior covered bond analyst, Crédit Agricole CIB, explores how Norwegian regulatory initiatives could affect Norwegian covered bonds and affect supply dynamics in 2013. 

A lot of ink has already been spilled on the announcement by the Norwegian FSA in October that covered bond issuance could potentially be limited.

The FSA (Finanstilsynet) acknowledged the positive role covered bonds play, but stated that it was becoming concerned about asset encumbrance and also about the role covered bonds were playing in fuelling the housing boom in the country.

In general, while regulators are doing everything they can these days to make covered bond products stronger, they are beginning to try to move issuers away from relying solely on the funding provided by covered bonds and to save some firepower for worse times. This is a bit schizophrenic, as the introduction of bail-ins for senior unsecured debt played a big part in shifting the focus onto covered bonds in the first place — but this is not the place to get into a lengthy discussion about this.

In any case, on 19 December the Norwegians added to their asset encumbrance comments from October by suggesting higher risk weights for mortgages and proposing a strengthening of their covered bond product. Both comments fit perfectly into this picture — make the product stronger but try to avoid an overreliance on it as a funding source.

Plan to grant covered bond issuers access to central bank liquidity

On 19 December, the Norwegian Ministry of Finance asked the Norwegian FSA and the Norwegian central bank to consider granting Norwegian covered bond issuers a limited banking licence. Up until now, the so-called Boligkreditts have only had a licence as a credit institution.

Something that doesn’t sound like much — or like something that could only get analysts excited and not people with a life — is in fact a rather significant change:

If the status change were to be approved, the Boligkreditts would gain access to central bank liquidity, which is something they currently do not have.

Moody’s has already commented on the proposal, saying that this additional option for generating liquidity would “increase the likelihood of timely payment for covered bond holders”.

We do not see how this change could be enough to improve Norwegian Timely Payment Indicators even further as most already have TPIs of “high”. The exception to this is DNB with a TPI of “probable”, so it could be of help here.

Irrespective of TPI considerations, it would be a clear positive for Norwegian covered bond structures, however, as it would reduce liquidity risk.

Plan to raise risk weights for mortgages to as high as 35%

One of the concerns that the FSA highlighted in October was that overreliance on covered bonds at very attractive funding levels was leading to an over-concentration of Norwegian banks’ assets in mortgage lending, which in turn has been further fuelling the housing markets.

Limiting covered bond issuance was one way they discussed dealing with this concern. Even back in October, however, they stated that introducing hard covered bond issuance limits would have to be done in a way that did not undermine the established market.

Looking at the more recent comments from the Ministry of Finance, it seems to be beginning to take a slightly different approach to reach the same goal now. The Norwegians have started to discuss introducing risk weight floors for mortgage loans, which could go as high as 35%. In this respect Norway is following in the footsteps of Sweden, which recently introduced a floor of 15%. Norwegian banks typically use mortgage loan risk weights of around 10%-15% these days (according to Reuters, DNB used a risk weight of 12.8% at the end of 2011), so introducing 35% would mean that banks would need significantly more capital to back mortgage loans.

While this approach also tries to cool down the housing market and to channel lending activities away from mortgage lending into other markets such as SME lending, it does not affect funding plans for Norwegian issuers in the short run. It is a capital issue.

Bottom line for now?

Should the plans to turn Norwegian covered bond issuers into banks become reality this would reduce liquidity risk in Norwegian covered bond structures and improve the quality of Norwegian covered bonds. We doubt that it could push spreads even tighter from their current tight levels, however, should it be implemented.

At the same time, the fact that Norway seems to be turning its focus away from issuance limits and funding strategies to slow down its mortgage and housing markets towards increasing risk weights and hence capital could pose a slight risk for spreads.

We wrote in our covered bond issuance outlook for 2013 that the main risk for spreads in core sectors does not lie in, for example, deteriorating fundamentals in housing markets. The market is too squeezed at this point and will continue to be squeezed for this to become a significant factor (even though it should be, in an ideal world).

The main risk factor is covered bond issuance well exceeding issuance expectations by the market. And, while Norway was by far the most active Nordic country last year, many market participants expect significantly less activity in 2013 and a bigger focus on senior unsecured deals. Taking into account the latest comments from the Norwegian authorities, in 2013 issuers could focus to a greater extent on covered bonds for their wholesale funding than is commonly expected by many at the moment.