Swedish legal covered bond framework ‘above average’, says Moody’s

Sweden’s covered bond legal framework is above average, with strengths outweighing weaknesses, Moody’s said on Monday upon releasing the second in a special series of reports that assess and rank a common set of legal features in covered bond jurisdictions.

Moody’s inaugurated the new series of reports in May with an analysis of Norway’s covered bond legal framework and at the time told The Covered Bond Report that the initiative is designed to facilitate comparability and represents an extension of the rating agency’s efforts to provide transparency.

The reports can be used as a resource for analysing a country’s covered bond legal framework on a standalone basis and also in comparison with other frameworks, said the rating agency.

The Swedish Financial Supervisory Authority (FSA) in July published new draft regulations under the country’s covered bond law, due to come into effect at the beginning of March, but they are presently only available in Swedish. Moody’s said that it may update its report on the Swedish legal framework when the new regulations come into force and an English language version is available.

Jane Soldera, vice president, senior credit officer at Moody’s, said that Sweden’s prevailing covered bond legal framework has a number of strengths that lift it above the average.

The rating agency cited as important strengths features such as the law restricting loans backed by commercial property to 10% of the cover pool, and loans more than 60 days past due not being eligible to be included in cover tests.

The Swedish covered bond legal framework has more strengths than weaknesses, according to Moody’s, with the lack of a minimum overcollateralisation level specified by the law being an example of a weakness.

“However, the value of the cover pool assets must always be greater than the value of covered bonds on a nominal and net present value basis,” said Soldera, “and issuers may commit to holding a certain minimum amount of overcollateralisation.”

Other key positives identified by Moody’s include: the cover pool administrator having broad powers to enter into senior ranking liquidity loans and other arrangements to mitigate refinancing risk following issuer default; and that cover pool hedging agreements cannot provide for early termination upon insolvency of the issuer, and collateral posting or counterparty substitution should be provided for if counterparty credit quality deteriorates.

And set-off risk could be mitigated in the case of issuers that are specialist credit institutions and therefore do not take deposits, said Moody’s.

“Certain other strengths of the law may offer less protection due to market practice,” added Soldera.

For example, even though the law provides for material interest rate and currency risk stresses, in practice, if these risks are swapped the swaps are taken into account when performing the stresses, even though the swaps (in particular, any swap with the issuer’s parent) may not survive issuer default.

“The law also provides covered bondholders with a senior unsecured claim on the issuer, but the value of that claim may be limited if the issuer is a specialist entity with few assets outside the cover pool,” added Soldera.

The rating agency on 20 August raised the Timely Payment Indicators of seven Swedish covered bond programmes from “probable” to “probable-high”, citing as the two main factors driving the new TPI the strong liquidity and spread performance of Swedish covered bonds during the 2008-2009 crisis and the market’s importance to domestic funding and investment. n