Risks highlighted in DBRS’s first Swedish analysis ‘not uncommon’

DBRS published a first Legal & Structuring Framework (LSF) assessment of Swedish covered bonds yesterday (Thursday), highlighting some shortfalls but noting these are “not uncommon” and have mitigating factors, while also citing covered bonds’ connectedness to the economy as a strength.

The rating agency said the report is intended to give market participants an insight into the characteristics it takes into account when analysing Swedish legislative covered bonds (säkerställda obligationer, or SO). DBRS’s LSF assessments are one of the four pillars used when assigning ratings under its European covered bond rating methodology.

“On the positive side this is a very established jurisdiction and the covered bonds are very much fundamentally connected to the real economy,” said Vito Natale, head of covered bonds and surveillance at DBRS. “This leads us to believe that if there were a market disruption then the sovereign is likely to intervene, and would have the ability to do so.”

DBRS said holders of SOs are afforded strong protection in the event of issuer insolvency by the Swedish Covered Bonds Act and the Swedish Preferential Rights of Creditors Act (förmånsrättslagen).

However, the rating agency also cited residual risks particularly associated with SOs that mean investors may not be repaid according to the terms of their investment, albeit with certain mitigants:

The independent inspector is required to report to the Swedish Financial Supervisory Authority (SFSA, or Finansinspektionen) only annually – although they are under obligation to continuously monitor the proper maintenance of the register, and report to the SFSA more frequently when necessary.

There is no specific requirement for an issuer to maintain a minimum amount of liquid assets in the cover pool. It added, however, that the issuer is required by law to ensure that the payment flows regarding the assets in the cover pool, the derivative contracts and the covered bonds enable the issuer to satisfy its payment obligations towards the bondholders and derivative counterparties.

No cover pool administrator can be appointed ahead of an issuer insolvency. Moreover, a bankruptcy administrator would represent at the same time the potentially conflicting interests of both covered bondholders and unsecured creditors of the issuer.

The Swedish legal framework implies a concept akin to that of excessive overcollateralisation (OC) that could cause assets to be removed from the cover pool after an issuer insolvency. DBRS said that in the event of issuer insolvency, no OC can be removed before covered bondholders and other privileged creditors have been repaid in full. It added, however, that the insolvency administrator has the right to use cover pool assets that are deemed excessive to fund advance dividend payouts to other creditors. DBRS said it understands this is a remote event and that regulation provides for certain mitigating factors.

“If you’re taking as a comparison the German legal framework, for example, then there are some shortfalls of the Swedish legal framework,” said Natale. “But the shortfalls we have highlighted all have mitigating factors and are not uncommon.

“If you are comparing it to some other frameworks, for example the Spanish framework, then you would be more or less on an equal footing, except that the Swedish sovereign is much stronger.”

DBRS published its first LSF assessment of Germany’s Pfandbrief Act in April, having earlier published analyses for Austria, Belgium and France. Further LSF assessments for Denmark and the UK are expected to follow.