Ralf Burmeister, Deutsche Asset & Wealth Management

Nordic FIs & Covered spoke to Ralf Burmeister, senior portfolio manager, Deutsche Asset & Wealth Management, about his views on Nordic banks, covered bonds and regulations.

The Nordic majors recently reported their 2014 results. What did you make of them?

I’d say they are resilient. The results underline that in Scandinavia, at least, the banking business model works — they make money. It wouldn’t be fair to highlight individual banks, but there were anyway no really negative surprises. It was more of the same, which is to say, very solid results.

Do you see value in covered bonds from Nordic issuers?

With the exception of Finland being part of the Eurozone, obviously the Nordics are a little bit distinct in that regard, so if there were any kind of safe haven flows and panic-driven risk-off moves out of the Eurozone, stable and solid countries like Sweden, Norway and partly Denmark should benefit from that. It’s the beauty of having your own currency, if you are not linked to the euro in times of trouble.

On the other hand, if you look at the currency situation, at the latest move from Switzerland and now the fight of the Danish central bank, it’s not always easy. But in these turbulent and volatile times it might be seen by the market as more positive if you have your own central bank and can better fine tune your policies and steer your economy than if you are somehow co-mingled in the huge Eurozone where there is one central bank rate for all of the different regions. If you have one nation, one country, and one central bank — there is something to that.

When it comes to where relative value is in terms of spreads, I think the possibility of QE in certain of these countries was underestimated. The market didn’t price in that, for example, Sweden could embark upon its own QE — there was only some talk in the press and some noise around the Swedish central bank and how it might react to the situation in the Eurozone. So there was still some value to be found, with the yields and spreads not as artificially supressed as we see in the Eurozone because of the buying programme. They still offer a pick-up compared to their peers that are within the scope of CBPP3, and there is still the possibility of QE driving them tighter.

If you look at the moves in Denmark, for example, yields have truly collapsed. We started the year with Danish 10 year yields at 80bp and now we are at 20bp — that’s a dramatic move. We started with a significant pick-up in terms of Denmark over Bunds, they were at 30bp above Bunds, and now they are well below Bunds. That gives you a sense of what is going on and what the central bank’s battle has been in recent weeks.

Regarding the Eurozone, it is clear from the fact that we have a third buying programme that covered bonds have become a regular tool of central bank policy. It’s not as of today the case in the other Nordic markets, but it could be at some point in the future.

The housing markets in the Nordic markets have offered different reasons for concern in recent years and indeed the authorities have taken a variety of actions. What are your views on this?

The housing market is always a potential weak spot in those countries, but you have to drill down a little bit deeper — or at least that’s what we try to. There are differences, for example, if you look at the development that we have in Norway and in Sweden. Average incomes are rising, which wasn’t necessarily the case in US in the run-up to the sub-prime crisis. The other question is who’s buying.

Data we have from Eiensdomsverdi, the Norwegian real estate evaluator, for example, shows that the broad majority of people have more income, and are therefore affluent and have better affordability, and also that the top 10% percentile by income distribution is a heavy buyer of real estate, so it’s skewed toward those who really can afford it.

So, yes, we look at property prices, we look at affordability, we look in real terms, but we would also look at construction activity, for example. Of course if you have masses of construction like you had back in Spain that would start to make us worry and wonder. But if you still have building permits and construction at a relatively low level, that’s simply a potential recipe for a further squeeze and further house price increases — although as long as you don’t have a significant rise in unemployment we would not be too concerned.

Indeed, what do you want to see? If house prices are rising then, all things being equal, the value of your collateral is increasing as well, whereas if house prices are flat, you say: Ah! There’s no growth in the economy, so why should we invest there? Notwithstanding what you should do if house prices are dropping… So maybe from an investor’s point of view it is nice to see a modest increase, say, 3%-5% a year — although 5% in real terms is already quite decent, I guess.

So to cut a long story short, yes, we are watching this. It’s something you have bear in mind when investing there. I think it’s one of the potential sources of weakness, rather than the banks.

But still, taking into account the above and also if you look at migration figures, population growth, and a lack of supply of building plots, I’d say it’s somewhere in the yellow area, with a touch of green, perhaps.

You mentioned regulation: this hits banks as well as mortgage loans, origination standards, and effectively the extent to which banks can do mortgage business. So this has already been regulated and restricted, and this is what we like about those markets. As covered bond investors, we definitely look for safety, and we are by definition as covered bond investors not afraid of regulation because this is a heavily regulated product. And if steps have already been taken this is a reflection of the quality of the regulation, that they are trying to be pre-emptive. Whether or not they succeed is a different story, but at least they give it a go and try to prevent the building up of bubbles.

How might the fall in the oil price affect your view of Norway?

We will have to see. It’s something that firstly obviously concerns the Norwegian budget and it has yet to filter through into these figures. But, if I have the figures right, they had a surplus of 10%-12%, so if oil prices now drop the budget surplus simply decreases, that’s a luxury problem. But the economy as a whole is clearly heavily dependent on oil, so you will have spillover effects on the oil industry, on machinery, equipment and so on — that’s understood. But it’s a question of where you start at, and the level of per capita income and so on is so high that others would still envy it if you took 10% away.

So yes, it’s something we look at. Do we as a covered bond investor have a particularly smart view on oil? No, so we are cautious. We wouldn’t dare to forecast that it is going back to $100 a barrel anytime soon, but we have received no news and no analysis that Norway is going to collapse in two months’ time due to the oil price. It’s a drag, agreed, but let’s wait and see how it feeds through. I think it’s more a general slowdown in economic activity than the Norwegian state going bust due to a lack of oil income.

Swedish issuers have begun using a soft bullet structure on euro benchmarks, while it is standard in Norway — and Denmark has introduced special maturity extension features under legislation. What do you make of such moves?

Actually, we are not the greatest supporters of switching from hard bullet to soft bullet and further on into any kind of other structures.

To be fair, we understand the necessity and the attractiveness from the issuer’s perspective — it means a better rating and lower collateral requirements with regard to the rating agencies, and you do not get any kind of regulatory punishment. If you look at UCITS, CRD compliance, LCR eligibility, there is no box to tick regarding whether you have a hard bullet or a soft bullet bond. And if you do not get a regulatory disadvantage, why would you opt for the hard bullet that makes your life as an issuer harder?

Meanwhile, if you are supposed to pay a pick-up in squeezed markets like these how much can it be, 10bp? Definitely not. So in terms of timing it is understandable and not very surprising that issuers are moving in that direction. Whether we like it or not, it will become more common in the future. We are prepared for that and it’s not a question whether we like it or not — we can handle it.

But as I said, in my view it results a bit too much from rating agency considerations. It does not really give you a true and fair picture of the underlying if you are just trying to optimise according to rating agency methodologies.

That said, if you look at Scandinavia, OK, that’s splitting hairs: they are not purely but almost exclusively triple-A paper. It’s a different story if you are, say, sub-investment grade and then you come up with a pass-through programme and jump back to investment grade again.

Do you look at Nordic covered bonds in their domestic currencies?

We could do, because we are familiar with the issuers and have no reservations regarding their quality nor their underlying pools. Whether it makes sense or not depends on whether we are allowed to run open FX risk, or if we are supposed to hedge it to the full extent. And then it obviously comes down to where cross-currency swaps are. Therefore it very much depends on the market situation at a particular time. Looking at the FX movements these days, there’s really a different answer from one week to the next.

But let me put it this way: no matter which krone or krona you are talking about, we think it’s a solid currency and we are not afraid of going there.