Rating action

Scope Ratings has today affirmed its AAA rating with a Stable Outlook on the Norwegian covered bonds (obligasjoner med fortrinnsrett) issued by Totens Sparebank Boligkreditt (TSBB), the fully owned mortgage subsidiary of Totens Sparebank (TSB).

Additional programme-specific information and research are available on scoperatings.com

Key rating drivers

Sound issuer credit rating (positive). TSB and TSBB both have ratings of A- with a Stable Outlook.

The cover pool support adds at least six notches of rating uplift, reflecting:

1. Overcollateralisation (positive). Available overcollateralisation of 21.2% shields from market and credit risks and is well above the 4.0% minimum that supports the cover pool uplift.
    
2. Sound credit quality (positive). The cover pool is granular, well-diversified, fully residential and has a low loan-to-value (LTV) ratio. This results in low credit risk, even under the highest credit stresses.
    
3. Maturity mismatches (negative). The programme is most vulnerable to high prepayments, which results in a build-up of cash and a reduction in available excess spread.

Fundamental credit support (positive). The strength of the Norwegian legal and BRRD framework supports a five-notch uplift to the issuer rating.

Rating-change drivers

The Stable Outlook on the covered bonds reflects Scope’s expectation that i) the credit performance of TSB, TSBB and its mortgage borrowers will remain stable; and ii) the issuer will maintain the prudent risk profile of the covered bond programme. The agency expects both the parent and the direct issuer to remain willing and able to provide sufficient overcollateralisation to support the strong credit quality of the covered bonds.

Cover pool support would remain unchanged up to a two-notch downgrade of the issuer, provided that the covered bond programme’s risk structure does not change materially. This also supports the Stable Outlook on the covered bonds.

Cover pool supports the highest achievable rating

As of 30 June 2019, TSBB’s NOK 2.76bn cover pool supports a rating uplift of at least six notches above the issuer rating for the NOK 2.28bn of covered bonds. The available overcollateralisation is 21.2% based on the outstanding covered bonds.

The overcollateralisation required to provide a six-notch cover pool uplift and support the AAA ratings has halved to 4% from 8%. The reduction in supporting overcollateralisation is driven by changes to Scope’s recovery and cash flow assumptions, namely, changes to Norwegian security value haircuts and the addition of interest paid on the cash account to the cash flow analysis. Credit and market risks in the programme did not change materially compared to last year.

The cover pool is mainly exposed to credit risk, accounting for 2.3pp of the 4% rating-supporting overcollateralisation. Even so, credit risk remains low on an absolute level, reflecting the strong credit quality of the granular, purely domestic pool of residential borrowers.

Market risks account for 1.7pp and are mainly driven by asset-liability mismatches. The programme is most exposed to a high prepayment scenario. The market risk contribution reflects the cost of carry due to lower excess spread.

Maturity mismatches have reduced since the last analysis, via the issuance of additional bonds with longer maturities. 75% of the current outstanding covered bonds have been issued since Scope’s last analysis (based on September 2018 data). This has raised the bonds’ weighted average remaining life to around 4.1 years from 2.6 years; both figures consider the one-year extension option.

Cover pool composition

The cover pool is predominantly secured by Norwegian residential mortgage loans denominated in Norwegian krone. It also comprises substitute assets, mainly other highly rated Norwegian covered bonds. The bank operates primarily in the Mjos region in south-eastern Norway, mainly in Oppland (44%), Akershus (26%), Hedmark (15%) and Oslo (11%) as of June 2019.

The granular mortgage pool consists of 1,731 loans granted to 1,671 obligors. The average loan size is NOK 1.47m (around EUR 1.5m). The largest obligor accounts for only 0.4%. Granularity has improved since Scope’s last review because the mortgage portfolio grew by 15%.

Most of TSBB’s cover pool continues to be backed by mortgage loans secured by single-family houses (72%), followed by apartments (12%) and shares in housing associations (9%). The LTV was 55% and has increased by 2pp since the last review, also driven by the 15% top-up of newly originated loans into the portfolio.

Fundamental credit support provides a five-notch uplift

Two notches of fundamental credit support uplift are driven by the agency’s positive view of the Norwegian legal covered bond framework. It meets the agency’s criteria for protecting covered bond investors in a going- or gone-concern of a bank and results in the highest credit differentiation.

Another three notches of uplift reflect 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. TSBB’s covered bonds benefit from a bail-in exemption and support from a strong stakeholder community. Scope recognises the low visibility and limited importance of TSBB as a covered bond issuer.

Quantitative analysis and key assumptions

Scope’s projections of default on mortgage loans use an inverse Gaussian distribution. Scope derived an effective weighted-average lifetime mean default rate of 9.5% (annual 40 bps) using a ‘90 days past due’ definition, based on credit performance data provided by TSBB (probability-of-default back-testing, static delinquency history, and loan-level probabilities of default) and benchmarking. The volatility of defaults (weighted average coefficient of variation) was assumed at 50%. The agency calculated an asset recovery rate ranging between 97.4% in the base case and 77.7% in the most stressed scenario.

Scope applied rating-distance-dependent market value declines to establish recovery rates. Assumptions reflect developments in the Norwegian housing market and its unique characteristics. An additional fire-sale discount of 20% was also applied, reflecting the value discount of properties sold under non-standard or distressed conditions. The total stressed security value haircut for the properties securing the mortgage loans range between 45.0% and 57.5% (depending on the location of the property).

Scope analysed substitute asset defaults with a non-parametric distribution by performing a Monte Carlo analysis. A bivariate correlation factor of up to 22% was assumed on the covered bonds and on the sovereign or municipal exposure. The issuer’s credit assessments were used for all exposures to derive a conservative term default expectation. The low default rate of 0.21% and very high coefficient of variation (1,353%) reflect the high individual credit quality but also the very high obligor concentration. Asset recovery rate assumptions range between 90% in the base case and 60% in the most stressed scenario.

Scope used the resulting loss distribution and default timing to project the covered bond programme’s losses. The analysis also incorporates the impact of rating-distance-dependent interest rate stresses. The covered bond programme is most sensitive to a scenario in which interest rates increase after two years and plateau at 10% thereafter.

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

Scope tested for low (0%) and high (up to 25%) prepayments to stress the programme’s sensitivity to unscheduled repayments. The programme is most sensitive to high prepayments, which would create a large cash balance and reduce excess spread. In contrast, a scenario in which assets need to be sold at a discount, due to the maturity mismatches from long-dated assets, produces lower overcollateralisation, supported by high asset margins. The agency assumes that any interest received on available cash equals the respective reference rate (no spread). This mitigates the programme’s sensitivity to negative carry, particularly in a high prepayment scenario.

Scope assumed a recovery lag of 24 months. The recovery timing for the mortgage loans was based on an analysis of Norwegian enforcement processes, also considering the collateral’s regionality.

Scope’s analysis assumed servicing fees of 25 bps for the residential mortgage loans and 10 bps for the substitute assets.

The agency also tested the programme’s sensitivity to compressed asset margins (down by 50%), a 200 bps liquidity premium and front-loaded defaults to reinforce the programme’s break-even overcollateralisation.

Stress testing
No stress testing was performed.

Cash flow analysis
The cover pool-supported rating uplift is based on a cash flow analysis using Scope’s covered bond model (CobEL version 1.0.1). The model applies rating distance-dependent stresses to scheduled cash flows to simulate the impact of increasing credit and market risks. The model outcome is the expected loss for a given level of overcollateralisation as well as the impact of stressed asset sales or variables such as changing prepayment speeds or servicing costs.

Methodology
The primary methodology for the analysis of the covered bond ratings and outlooks is the Covered Bond Rating Methodology. The secondary methodology used is our General Structured Finance Rating Methodology for the application of Scope’s idealised expected loss tables.
All rating methodologies are available on our website, 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 definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale.
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 and/or its agents 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 or outlook action, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst: Mathias Pleissner, Director
Person responsible for approval of the rating: Karlo Fuchs, Managing Director
The ratings/outlooks were first released by Scope on 30 October 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
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