Rating action

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

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

Key rating drivers

Sound issuer credit rating. SSB and SSBB both have ratings of BBB+ with a Positive Outlook.

Cover pool support is the primary rating driver and adds at least seven notches of credit support, reflecting:

1. Overcollateralisation (positive). Available overcollateralisation of 23.8% provides protection against market and credit risks and is well above the 5.0% minimum that supports the highest credit quality.
    
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 sensitive against high prepayments. As such cost of carry and loss of excess spread is a risk driver and not the sale of cover assets. Interest rate mismatch risk is negligible.

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

Rating-change drivers

The Stable Outlook on the covered bonds reflects Scope’s expectation that i) the credit performance of SSB, SSBB 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 maintain the current rating up to a one-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 September 2019, SSBB’s NOK8.23bn cover pool supports a rating uplift of at least seven notches above the issuer rating for the NOK6.65bn of covered bonds.

The overcollateralisation needed to support a seven-notch cover pool uplift and thus the highest rating reduced to 5% from 8.5% since the last review. 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. Scope has also revised its portfolio default expectation downwards.

The cover pool is mainly exposed to credit risk, accounting for 2.6pp of the 5% 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 2.4pp and are mainly driven by asset-liability mismatches. The market risk contribution reflects the cost of carry and lost excess spread in a high prepayment scenario. The high prepayment scenario also mitigates the potential risk of asset sales resulting from a longer average legal maturity of the cover assets compared to the maturity of outstanding covered bonds. Interest mismatches are insignificant as the 34% of fixed rate bonds are fully swapped into floating rates until the bonds’ scheduled maturity. All covered bonds and the cover assets are fully denominated in NOK.

Stable cover pool composition

The cover pool predominantly comprises mortgage loans, but also registered substitute assets of highly rated bonds (6.5%). The mortgage cover pool is secured by Norwegian granular, first-lien residential mortgage loans denominated in Norwegian kroner. As of September 2019, the loans were granted to 4,614 obligor groups. Scope assesses the cover pool as granular, with an average borrower loan exposure of NOK1.67m (around EUR167,000). The top 10 largest obligors only account for 1.2%.

The average indexed whole loan to value is at a low 54.9%. This LTV is calculated based on the maximum drawable amount for the 34% (by maximum drawable amount) of 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. Such loans do not materially add credit risk as flexible loans will only be granted if the loan’s LTV does not exceed 60%. Another 29% 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 cover pool is regionally concentrated and focussed on the banks home region Rogaland (90%), Oslo (5%) and Akershus (2%). The bank operates in the Stavanger region, which itself is exposed to the more volatile oil industry in the western counties of Norway. Concentration risk and the higher volatility are reflected in the default distribution used to analyse the credit risk of the cover pool. 79% of the mortgage pool is secured by single-family or terraced houses and another 21% by apartments. Only around 8% of the loans are exposed to common debt from housing associations. Credit risks arising from such cover assets are seen as low as the average LTV on common debt is only at around 10%.

The above key characteristics of the mortgage cover pool remained stable with only minor variation compared to our analysis one year ago.

Fundamental credit support provides a five-notch uplift

Two notches of fundamental credit support uplift are driven by Scope’s positive view of the Norwegian legal covered bond framework. The framework meets the rating 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. SSBB’s covered bonds benefit from a bail-in exemption and support from a strong stakeholder community. However, Scope recognises the low visibility and limited importance of SSBB as a covered bond issuer.

Quantitative analysis and 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 10.5% (annual 55 bps) using a ‘90 days past due’ definition, based on credit performance data provided by SSBB (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 60%. The agency calculated an asset recovery rate ranging between 97.9% in the base case and 79.5% 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 haircuts 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 17% 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 0.1% and very high coefficient of variation (1,136%) reflect high individual credit quality but also the very high obligor concentration. Asset recovery rate assumptions range between 90.2% in the base case and 60.1% 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 was 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 of the mortgage loans. 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 strong asset margins.

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. The same was assumed for the substitute assets.

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 1.0.2). 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 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 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 19 December 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
© 2019 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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