Scope sees top uplift for Danish, Swedish covered

Aug 7th, 2015

Danish and Swedish mortgage-backed covered bonds will generally benefit from a maximum six possible jurisdiction-related notches of uplift from their issuer rating under Scope Ratings’ methodology, it said last Friday (31 July) when indicating how Europe’s five largest covered bond jurisdictions will be treated under its methodology.

Scope highlighted the fundamental factors that it considers explain the strong credit profile of covered bonds. Under the rating agency’s methodology, the most important driver of covered bonds’ credit differentiation are credit relevant aspects of legal frameworks and bank recovery and resolution regimes.

Up to two notches of uplift from a bank’s Issuer Credit Strength Rating are allowed based on Scope’s analysis of legal frameworks and up to a further four notches on an analysis of the relevant resolution regime. Three extra notches are allowed based on its cover pool analysis, which is issuer specific.

In the new report, Scope said that mortgage and public sector covered bonds from the largest issuing European countries — Denmark, France, Germany, Spain and Sweden — are generally deserving of the maximum possible credit differentiation, including the full six notches relating to legal frameworks and resolution regimes owing to their recognition as important financing tools, with cédulas territoriales in Spain the only exception.

“Covered bonds in the above countries are generally based on robust legal frameworks and have high systemic relevance supporting the classification,” the rating agency said. “The benefit of a local legal framework and local translation of BRRD generally apply to all issuers of the same covered bond type within that country.”

Scope cited the high systemic relevance of covered bonds in Denmark and proactive stakeholder community as meaning support for the asset class is likely to remain strong.

The rating agency noted that outstanding covered bonds represent 147% of Danish GDP as of January 2015, the highest share worldwide, while mortgage banks’ domestic covered bonds account for the largest share of tradable debt in Danish debt capital markets and are the most important refinancing instrument for mortgages in the country.

It added that, from a domestic investor’s perspective, mortgage covered bonds have a central role as they are not exposing investors to foreign exchange risk, with almost 80% held domestically as of June 2014.

“We expect the systemic importance of mortgage covered bond funding in Denmark to remain high for the foreseeable future and for regulators and other stakeholders to remain supportive and active,” Scope said.

“Discussions surrounding the entry into the capital market union, the impact of European supervision for Danish banks, as well as the application of MREL for mortgage banks has again crystallised the importance of mortgage covered bond issuers and mortgage financing for the Danish economy.”

Meanwhile, Scope said that although Sweden has been notified by the European Commission of its incomplete translation of the BRRD it expects Swedish regulators to broadly follow the framework and ensure covered bonds’ preferential status because of the interconnectedness of Swedish financial institutions.

The rating agency noted that Swedish issuers are very active both internationally and domestically, with outstandings well above Eu200bn and annual new issuance at around Eu50bn in past years.

“Given the strong focus of Swedish banks on mortgage lending and refinancing them primarily via covered bonds, outstanding mortgage covered bonds represent more than 50% of Sweden’s GDP,” the rating agency said.

“Also from an investor’s perspective covered bonds are systemically important both resulting from the importance in banks portfolios for liquidity management as well as local investors’ need for Swedish krona-denominated and high credit quality investments.”

With domestic stakeholders also active in identifying challenges to the product, Scope said these factors support its view that Swedish covered bonds will continue to receive strong support.

Meanwhile, more niche covered bond types, although eligible for the maximum two notches of legal framework-related uplift, will generally benefit from a smaller credit differentiation versus issuer ratings, Scope said.

Danish ship-backed covered bonds are limited to two notches of uplift, with only one issuer using the product and some Eu5bn (Dkr37bn) of issuance outstanding. Scope said the product’s lesser level of stakeholder support is also evidenced by a 2014 derogation of ship covered bonds as eligible assets by the Danish central bank.

Scope also noted that certain issuer-specific factors could affect the fundamental analysis in its methodology, meaning the results highlighted in the report may not automatically apply to all covered bonds.

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