Rating action

Scope Ratings has today affirmed its AAA ratings with a Stable Outlook for the Norwegian covered bonds (obligasjoner med fortrinnsrett) issued by Landkreditt Boligkreditt AS, the fully owned mortgage subsidiary of Landkreditt Bank AS (both A-/Stable).

Key rating drivers

Sound issuer rating (positive). Landkreditt Boligkreditt’s issuer rating of A-/Stable is fully aligned with the rating of its parent, Landkreditt Bank, the leading provider of financial services to Norway’s agricultural sector.

Cover pool support (positive). Cover pool support is the primary rating driver and adds at least six notches of credit uplift, reflecting:

1. Overcollateralisation (positive). Available overcollateralisation of 17.4% shields the covered bonds from market and credit risks and is well above the minimum 5.0% that supports the cover pool uplift.
    
2. Sound credit quality (positive). Granular, fully residential cover pool with low loan-to-value (LTV) has low credit risk even under the highest rating stresses.
    
3. Asset-liability 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, also taking their soft bullet structure into account. Currently, the cover pool does not include additional, short-term substitute assets.

Fundamental credit support (positive). The strength of the Norwegian legal covered bond and resolution framework supports up to five notches of uplift above the issuer rating and effectively provides a floor against a deterioration in the credit quality of the cover pool.

Rating-change drivers

Scope’s Stable Outlook on the covered bonds reflects: i) the continuous availability of high overcollateralisation, which provides a significant buffer against a rise in credit and market risks; ii) Scope’s view that European covered bond harmonisation will not negatively impact the fundamental support factors relevant for the issuer and Norwegian mortgage-covered bonds in general; and iii) Scope’s Stable Outlook on the credit quality of the issuer.

The covered bond ratings may be downgraded if: i) the issuer’s credit quality deteriorates by three notches or more; ii) risk in the covered bond programme increases and the overcollateralisation provided no longer supports a six-notch rating uplift; or iii) there is a deterioration in Scope’s view on fundamental support factors relevant to the issuer and Norwegian mortgage-covered bonds in general.

Quantitative analysis and assumptions

Scope’s projections of default on Landkreditt’s mortgage loans were made using an inverse Gaussian distribution. Based on credit performance data provided by the bank (historical delinquencies, portfolio loss rates) and benchmarking, Scope derived an effective lifetime mean default rate of 10% (annual 60 bps) and a volatility of defaults (coefficient of variation) of 50%. The agency assumed an asset recovery rate ranging between 100% in the base case and 88.5% in the most stressed scenario. In its loss given default analysis, Scope assumed that the credit lines for flexible loans were fully drawn and paid interest only until their expected maturity, assuming a loan term of 15 years.

Scope applied rating distance-dependent market value declines to establish recovery rates. Assumptions reflect the agency’s 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 45% and 57.5% (depending on the location of the property).

Overall, credit risk only accounts for an unchanged 1.5 pp of the 5.0% supporting overcollateralisation.

The rating agency used the resulting loss distribution and default timing to project the covered bond programme’s losses and reflect the programme’s amortisation structure. Scope also incorporated the impact of rating distance-dependent interest rate stresses in its analysis. The covered bond programme is relatively insensitive to interest rate stresses as cover assets and covered bonds are both floating rate.

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 was added to the rating distance and scenario-dependent discount curve. Scope derived 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 15%) 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 mismatch arises from the weighted average life (WAL) gap of 7.0 years between the assets’ WAL of 11 years (based on their legal terms) and the bonds’ WAL of only 4.0 years, up from 3.7 years in the previous analysis.

Market risk accounts for 3.5 pp of the 5.0% supporting overcollateralisation, down from 5.5 pp in the previous analysis, reflecting the reduced asset liability maturity mismatch.

Scope assumed a recovery lag of 18 months for residential loans originated by Landkreditt. The recovery timing for the mortgage loans is based on an analysis of Norwegian enforcement processes, considering that the collateral is most exposed to the Oslo and Akershus regions for which liquidity is higher than Norway’s rural regions.

Scope applied country- and asset-type-specific servicing fees which the cover pool needs to pay annually. The rating agency assumed a servicing fee of 25 bps for the residential mortgage loans.

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). 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 methodology used for this rating and rating outlook was the Covered Bonds Rating Methodology. This methodology is 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 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 4 April 2018. The ratings/outlooks were last updated on 2 April 2019.

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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