S&P notes Swedish moves to reduce ALMM risk

Standard & Poor’s said on Tuesday that a Swedish Bankers’ Association proposal to suggest a reduction in the required level of amortisation to a 50% LTV ratio could help reduce asset-liability mismatch (ALMM) risk in covered bond programmes, but highlighted that issuers have already reduced this since 2008 by extending the duration of their funding.

S&P noted the association’s plan, which was released on 7 October, in the context of ongoing discussion about whether legislation should require borrowers to amortise their mortgage loans.

“We consider that the current lack of formal amortisation plans is one reason why Swedish programmes have higher target overcollateralisation (OC) levels than those seen in some other markets,” said the rating agency.

It also noted that the Swedish central bank had in June stated that a lack of amortisation is a potential destabilising factor for the housing market and economy.

S&P said that the Swedish Bankers’ Association’s proposal to lower its recommended LTV ratio limit for borrowers with no amortisation from 75% to 50% for new mortgage loans likely stems from the industry’s desire to avoid legal changes to mortgage requirements from a newly-elected government looking to limit private borrowers’ debt levels. The rating agency noted that the proposal has been welcomed by the government.

The rating agency meanwhile noted that Swedish issuers have already been managing their ALMM risk by extending their funding profiles substantially since 2008, becoming less reliant on short term funding and issuing covered bonds with longer maturities instead. At the same time, they have maintained OC above the target credit enhancement under S&P’s ALMM criteria to achieve their target ratings.

S&P cited figures showing the liability-weighted average maturity of five Swedish covered bond issuers increasing from a range of 1.89-2.39 in 2008 to 2.67-3.78 in 2011 and 2.45-3.93 in 2014.

“We believe that a number of factors may explain the extended duration of Swedish covered bond issuers’ funding profiles,” it said. “Issuers have focused on ALMM management, partly to comply with Basel III’s net stable funding ratio (NFSR) liquidity requirement, but also to lower the target credit enhancement or increase the maximum potential ratings uplift under our ALMM criteria.

“Another contributing factor has been investors’ preference for covered bonds with longer maturities as they continue to search for better yields in the current low interest rate environment.”

S&P noted that the move to longer funding has stalled somewhat in the past two years and said this could indicate a preference among investors for shorter-dated bonds.

“In our view, Swedish covered bond issuers benefit from longer funding profiles, as increasing covered bond maturities create a better match between the mortgage assets and bond liabilities, and could reduce the target credit enhancement or increase the maximum potential ratings uplift under our ALMM criteria,” it said.

“We would expect tighter amortisation requirements to reduce ALMM risk and target OC levels in some programmes further, but may also see issuers returning to shorter covered bond maturities to match the cashflows of the new faster amortising mortgage loan assets.”