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Norway Curbing Mortgage Debt Is Bondholder Boon: Nordic Credit

November 29, 2012

Norway Curbing Mortgage Debt Is Bondholder Boon

The city center skyline stands illuminated at night, seen from the Ekeberg hill, in Oslo, Norway. Photographer: Tomm W. Christiansen/Bloomberg

Norway’s plan to curb the supply of covered bonds is pushing yields lower as investors benefit from regulatory efforts to cap growth in the nation’s housing debt.

The mortgage units of banks including DNB ASA and Nordea Bank AB (NDA) should limit the use of bonds backed by the safest collateral, according to a recommendation by Norway’s Financial Supervisory Authority last month. Banks risk cutting off their access to cheaper financing if they focus too narrowly on the bonds, the regulator warned.

“If a cap is put in place it will restrict supply, which should support even higher prices for covered bonds,” said Jonas Shum, a credit analyst at SEB AB in Oslo. “It adds to the appeal, because it makes them more secure for the investors.”

Norway’s covered-bond market reached about 780 billion kroner ($137 billion) this year, and the securities now make up about 20 percent of bank funding, the FSA estimates. Over-use of the bonds, which are backed by mortgages and therefore cheaper for banks to sell than loans passed on to businesses, may also be adding to imbalances in Norway’s housing market, the regulator warned in an Oct. 16 report.

Nordea’s benchmark floating rate note maturing in 2016 has gone from trading at a spread against the three-month swap rate of 70 basis points in January to just above 30 basis points on Nov. 27, according to a report by Nordea analyst Lars Erichsen.

Safety Trap

Oslo-based DNB (DNB) Boligkreditt AS, a unit of Norway’s biggest lender DNB, raised the issuance of AAA rated covered bonds to 370.3 billion kroner at the end of September from 363.3 billion kroner at year-end 2011, according to its third-quarter report. The lender is Norway’s biggest issuer of mortgage-backed bonds.

The debt’s safety is part of the problem, according to both the FSA and Norway’s central bank. Banks have been tempted to issue more of the securities in response to investor demand for top-rated assets. Yet by stacking all their financing in covered bonds, banks are eroding the appeal of their other debt classes, they argue.

“When you take something out of the balance of the bank, you put more risk on what remains,” Norway’s central bank Deputy Governor Jan F. Qvigstad said in an interview in Oslo on Nov. 27.

Norwegian debt securities have been coveted by investors fleeing Europe’s crisis. Covered bonds, which carry the same rating as Norway’s sovereign debt, have emerged as a popular asset class because they offer a yield premium relative to government bonds.

Bond Spread

The yield on Norway’s benchmark 2 percent bond due May 2023 rose 1 basis point to 2.12 percent. That’s about 74 basis points more than yields on similar-maturity German bunds and compares with a spread of 83 basis points at the end of May.

The central bank left its main rate at 1.5 percent in October, though Governor Oeystein Olsen has warned continued low borrowing costs risk spurring housing market imbalances. The bank has signaled rates may rise in the first half of next year.

The central bank has also called for higher risk weights on mortgages as a means to damp the country’s credit-driven housing boom. While the bank hasn’t proposed specific numbers, risk weights on mortgages of 35 percent to 40 percent “are closer to our thinking” than the 15 percent proposed by Sweden, Deputy Governor Qvigstad said this week.

Lending Shift

Norway’s banks have shifted lending to households from companies, Morten Baltzersen, the FSA’s director general, said on Oct. 16. That’s made it easier for consumers in the world’s fourth-richest nation per capita to take on record debt.

House prices have doubled since 2002, according to the Norwegian Association of Real Estate Agents, or NEF, and have risen an annual 7.4 percent so far this year. Household debt will rise to above 200 percent of disposable incomes next year, according to central bank estimates.

Banks are still trying to gauge the potential impact of the FSA’s recommendations on their funding costs.

“It’s hard to assess the consequences as long as we don’t have any more details” of the restrictions, said Paal Ringholm, head of credit research at Swedbank First Securities in Oslo. “It might limit the supply and as such it is a positive driver for the credit spread of covered bonds.”

Prussian Origin

Covered bonds were created in 1769, when Prussia’s King Frederick let aristocrats, churches and monasteries raise money by pledging their estates as security to investors. Denmark followed suit after the 1795 fire that destroyed Copenhagen. Last year, Europe’s market for the bonds was worth 2.7 trillion euros ($3.5 trillion), according to the European Covered Bond Council.

Mortgage-backed bonds typically have higher credit ratings than unsecured debt because they require borrowers to set aside assets that can be sold to pay investors if the issuer defaults. It pushes unsecured creditors lower down in the repayment queue.

Limiting covered-bond issuance would be “credit positive” for unsecured creditors because it would reduce the level of high-quality loans pledged as collateral, Moody’s Investors Service said in a report last month.

If banks can’t sell as many covered bonds, it would potentially increase their dependence on “more volatile” markets, Thomas Midteide, a spokesman at DNB, said in an e- mailed reply to questions.

‘Cheapest Funding’

“It means that their cheapest funding source is capped and that they will have to rely more heavily on the more expensive funding,” SEB’s Shum said.

DNB Boligkreditt raised 2 billion kroner with the sale of two covered bonds on Nov. 15, a day after selling 1 billion euros of 1.875 percent 10-year benchmark mortgage-backed securities at a spread of 33 basis points above the mid-swap rate.

“We are skeptical,” Jan Digranes, head of the banking and capital markets department at Finance Norway, which represents about 180 financial institutions in the country, said of the FSA’s recommendation.

“Norwegian authorities are worried about the housing market,” Digranes said in a telephone interview. Still,“it’s our view that the situation in the housing market is rather caused by the lack of supply of houses and flats than covered bond issuance by the banks.”

To contact the reporter on this story: Josiane Kremer in Oslo at

To contact the editor responsible for this story: Jonas Bergman at

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