Rating action

Scope Ratings today assigned first-time AAA ratings with a Stable Outlook to the Norwegian covered bonds (obligasjoner med fortrinnsrett) issued by the fully owned mortgage subsidiary of Sandnes Sparebank (SSB), SSB Boligkreditt AS (SSBB).

Click here to access the full rating report.

Rating rationale

The AAA covered bond ratings reflect the BBB+ bank rating with a positive outlook assigned to SSBB, further enhanced by cover pool support. Up to eight-notches of credit support can be provided to the covered bonds following Scope’s covered bond cover pool analysis. The distance between the issuer rating and the programme rating are seven notches, which provides the programme with a one-notch buffer against a bank downgrade. Fundamental credit support factors provide five notches of uplift above the bank’s rating effectively providing a rating floor at AA.

Key rating drivers for the covered bond ratings

• Sound issuer credit rating (positive)
• Cover pool support reflecting:
  (i) Overcollateralisation (positive): available overcollateralisation of 16% shields the covered bonds from market and credit risks and is well above the minimum 8.5% that supports the uplift;
  (ii) Sound credit quality: low credit risk even under the highest rating stresses (positive);
  (iii) Maturity mismatches (negative): high asset-liability mismatch risk from slow scheduled amortisation of cover assets compared to a relatively fast redemption profile for the covered bonds 
• Fundamental credit support resulting from the strength of the Norwegian legal and BRRD framework, which supports a five-notch uplift to the issuer rating (positive).
   

Rating-change drivers

The Stable Outlook on the covered bonds reflects the expected stable credit performance of SSB, SSBB and its mortgage borrowers. Scope’s covered bond outlook also reflects its expectation that the issuer will maintain its prudent covered bond programme risk profile. The agency expects that both the parent and the direct issuer will remain willing and able to continuously provide the overcollateralisation needed to support the strong credit quality of the covered bonds.

Provided that the covered bond programme’s risk structure does not change materially, current covered bond ratings supported by the cover pool could remain unchanged up to a one-notch downgrade of the issuer – also supporting the Stable Outlook on the covered bonds.

Cover pool supports highest rating achievable

As of 30 September 2018, SSBB’s NOK 7,488m cover pool supports a rating uplift of at least seven notches on top of the BBB+ issuer rating for the NOK 6,453m of covered bonds. The available overcollateralisation is 16.0% based on outstanding covered bonds.

Scope considers 8.5% supporting overcollateralisation to be commensurate with the uplift. The credit risk contribution to the supporting overcollateralisation is low reflecting the sound credit quality of the fully domestic, NOK-denominated and floating rate cover pool. The covered bond programme is not materially exposed to market risk as the covered bonds and the cover assets are fully denominated in NOK. Further, SSBB issues both fixed and floating covered bonds, but the latter are swapped into floating coupons until the bonds’ maturity.

Most of the rating supporting overcollateralisation is needed because of the programme’s high asset-liability mismatch. The mismatch is 6.8 years, resulting from the weighted average life of the cover pool (11.6 years, based on the legal maturities of the mortgage loans) and the weighted average life of the outstanding covered bonds (4.9 years, taking the soft-bullet structure into account). Asset-liability mismatch risk is partially mitigated by the soft-bullet structure (a contractual 12-month maturity extension if the issuer is unable to service a maturing covered bond) together with sufficiently high overcollateralisation.

Cover pool composition

The cover pool predominantly comprises mortgage loans, but also registered substitute assets which can be split into bank deposits of NOK 100m and highly rated bonds of NOK 289m (predominantly Norwegian mortgage-covered bonds). The mortgage cover pool is secured by Norwegian granular, first-lien residential mortgage loans denominated in Norwegian kroner. As of September 2018, the loans were granted to 4,342 obligor groups. Scope assesses the cover pool as granular, with an average loan size of NOK 1,484,000 (around EUR 153,000). The top 10 largest obligors only account for 1.2%.

The average indexed whole loan to value (LTV) is 54.9%. This LTV is calculated based on the maximum drawable amount for the 36% (by maximum drawable amount) interest-only loans (flexible loans) in the cover pool. Such loans have an embedded credit line that can be redrawn without a new credit approval. Flexible loans will only be granted if the loan’s LTV does not exceed 60%. Another 27% of the mortgage loans have an interest-only period. Such loans are normal annuity loans but split into a cover- and out-of-cover portion. The loan parts exceeding the LTV limit stipulated by the covered bond legislation, are typically granted by the parent bank and amortise first. The eligible loan part only starts amortising when the out-of-cover pool loan is fully repaid. The remaining loans are normal amortising loans.

The collateral is primarily located in Rogaland (90%), Oslo (5%) and Akershus (3%). The bank operates in the Stavanger region, which itself is exposed to the more volatile oil industry in the western counties of Norway. 78% of the mortgage pool is secured by single-family or terraced houses and another 21% by apartments. Altogether around 8% of the loans are exposed to common debt from housing associations with an average LTV on common debt of around 13%.

Fundamental credit support: the Norwegian legal framework and resolution regime provide a five-notch uplift

Two notches of fundamental uplift are driven by the agency’s positive view of the Norwegian legal covered bond framework. Another three notches are based on Scope’s assessment of the support the resolution regime affords the issuer and the systemic importance of Norwegian covered bonds.

Analysis of the Norwegian covered bond legal framework

In Scope’s view, Norway has one of the strongest covered bond frameworks in Europe. It meets the rating agency’s criteria for protecting covered bond investors in a going or gone concern of a bank and allows the assignment of the highest credit differentiation.

Resolution regime and systemic importance considerations for SSBB’s covered bond programme

SSBB’s covered bonds benefit from an additional three-notch uplift reflecting a bail-in exemption and support from a strong stakeholder community. The uplift reflects a combination of: i) a moderate to high likelihood that the covered bond issuer will be maintained in a resolution scenario; and ii) the high systemic importance of covered bonds in Norway. The agency recognises the low visibility and limited importance of SSBB as a covered bond issuer. In general, Norwegian covered bonds from resolvable and very visible issuers can benefit from up to four additional notches of support.

Quantitative analysis and key assumptions

Scope’s projections of default on mortgage loans use an inverse Gaussian distribution. Based on credit performance data provided by the bank (historical delinquencies and loan level default probabilities) and benchmarking, Scope derived an effective, weighted average lifetime mean default rate of 11.5% and a volatility of defaults (weighted average coefficient of variation) of 60%. The agency assumes an asset recovery rate ranging between 99% in the base and 73.8% in the most stressed scenario. In its loss given default analysis, Scope assumes that the credit lines for flexible loans are fully drawn.

Scope applies rating distance-dependent market value declines to establish recovery rates. Assumptions reflect the agencies analysis of Norwegian housing market developments and their unique characteristics. Scope’s stressed security value haircuts for the properties securing the mortgage loans range between 52.5%-60% (depending on the location of the property). For the most stressful scenario Scope applies an additional illiquidity adjustment of 5% for properties above NOK 5m, 13% for properties above NOK 10m and 20% for properties above NOK 20m. No additional haircut is applied under base case stresses.

Scope analyses the credit risk of the substitute assets with a portfolio analysis framework assuming an asset correlation factor of 25% for the covered bonds and 100% for the sovereign/ municipal exposure as well as other single exposures within the substitute assets. Conservatively, the agency uses the banks’ credit quality for all exposures to derive a default expectation for the sub-portfolio. The respective non-parametric distributions can be described with a mean default rate of 0.1% and a coefficient of variation of 1,136%. The low default rate and very high coefficient of variation reflect the high individual credit quality but also the very high obligor concentration. The agency assumes an asset recovery rate ranging between 100%% in the base and 40% in the most stressed scenario.

Scope uses the resulting loss distribution and default timing to project the covered bond programme’s losses and reflect the programme’s amortisation structure. The latter is calculated assuming that all flexible loans are fully drawn. The rating agency also incorporates the impact of rating distance-dependent interest rate stresses in its analysis. The covered bond programme is most sensitive to a scenario in which interest rates increased after two years and plateau at 10% thereafter.

To calculate a net present value for the cover pool in the event of an asset sale, a liquidity premium for Norwegian residential mortgage loans of 150 bps is added to the rating distance and scenario-dependent discount curve. The same premium is as assumed for the substitute assets (predominantly Norwegian mortgage-covered bonds). Scope derives this liquidity premium by analysing the long-term development of trading spreads for Norwegian and other ‘core country’ covered bond spreads.

Scope tested for low (0%) and high prepayments (up to 25%) to stress the programme’s sensitivity to unscheduled repayments. The programme is most sensitive to low prepayments as the large maturity mismatch requires asset sales in order to make timely payments on the bonds. The agency assumes that the cash account paid interest equalling the respective reference rate (no spread). This limits the programme’s sensitivity to negative carry, particularly in a high prepayment scenario.

Scope assumes a recovery lag of 24 months for residential loans originated by SSBB and 48 months for the substitute assets. The recovery timing for the mortgage loans was based on an analysis of Norwegian enforcement processes, considering that the collateral’s regionality and strong dependencies on oil may temporarily lengthen the overall recovery process.

Scope applies country- and asset-type-specific servicing fees the cover pool needs to pay annually. For the residential mortgage loans, Scope assumes a servicing fee of 25 bps and 10 bps for the substitute assets.

Cash flow analysis

In order to determine the cover pool-supported rating uplift, Scope performed a cash flow analysis to establish an expected loss for the covered bonds. The cash flow analysis uses the scheduled cash flows of the cover assets and covered bonds as a starting point. Scope applies rating distance-dependant stresses to simulate the impact of increasing credit and market risks on these cash flows. The cash flow analysis also includes the impact of stressed asset sales and other variables such as changing prepayment speeds or servicing costs.

Stress testing

No stress testing was performed.

Methodology
The methodologies used for the covered bond ratings and outlook were the Covered Bonds Rating Methodology and the General Structured Finance Rating Methodology. The methodologies are available on www.scoperatings.com.

Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rated entity participated in the rating process.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity, third parties and Scope internal sources.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the rating action, the rated entity was given the opportunity to review the rating and outlook and the principal grounds on which the credit rating and outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and outlook is issued by Scope Ratings GmbH.
Lead analyst: Karlo Fuchs, Executive Director
Person responsible for approval of the ratings: Guillaume Jolivet, Managing Director
The ratings/outlooks were first released by Scope on 19.12.2018.

Potential conflicts
Please see www.scoperatings.com. for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2018 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstrasse 5 D-10785 Berlin.

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