The latest information on the rating, including rating reports and related methodologies, is available on this LINK.

Rating action

Scope Ratings has today affirmed its AAA ratings with a Stable Outlook for the Norwegian covered bonds (obligasjoner med fortrinnsrett) issued by Verd Boligkreditt AS (Verd), a specialised mortgage bank jointly owned by nine independent savings banks (owner banks).

Key rating drivers

Sound issuer rating (positive). Verd’s sound investment grade credit quality is based on the investment-grade credit profiles of its nine owner banks. The owner banks in southern and western Norway are well established in their local markets and have reassuring prudential metrics. Verd is a specialised residential mortgage institution with the right to issue covered bonds. Unlike most covered bond issuers, Verd is not a subsidiary of a single parent bank.

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

1. Overcollateralisation (positive). Available overcollateralisation of 20% shields the covered bonds from market and credit risks and is well above the unchanged minimum 4% 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). The programme is most vulnerable to high prepayments, accumulating cash and reducing the programme’s available excess spread.

Fundamental credit support (positive). The strength of the Norwegian legal covered bond and resolution framework supports up to four 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 (Verd) and its owner banks. The agency expects the owner banks and the direct issuer to remain willing and able to continuously provide sufficient overcollateralisation to support the strong credit quality of the covered bonds.

The covered bond ratings may be downgraded if: i) the issuer’s credit quality deteriorates by one notch or more; ii) risk in the covered bond programme increases and the overcollateralisation provided no longer supports a seven-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.

Scope’s credit view on the bank could be negatively impacted by a deterioration in the credit quality of the mortgage loans available for transfer and the owner banks’ ability to meet obligations under the servicing and shareholder agreements. A change in the composition of the owner banks could also change the diversification of assets, a driver of Scope’s assessment of Verd. More explicit details regarding support mechanisms (e.g. liquidity support) for Verd would be viewed positively.

Quantitative analysis and assumptions

Scope’s projections of default on Verd’s mortgage loans were made using an inverse Gaussian distribution. Based on credit performance data provided by the bank (IFRS9 reporting and background documentation, static delinquency history and loan-level probabilities of default) and benchmarking, Scope derived an unchanged effective lifetime mean default rate of 10.5% (annual 57 bps). In addition, Scope used an average cure rate of 55%, which effectively reduces the annual default probability to 24 bps. The volatility of defaults (weighted average coefficient of variation) was assumed to be 55%. The agency calculated an asset recovery rate ranging between 98.1% in the base case and 81.3% in the most stressed scenario. In its loss given default analysis, Scope assumed that the credit lines for flexible loans were fully drawn and would remain interest only until their expected maturity.

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. On top of this, Scope applied a fire-sale discount of 30% reflecting the value discount of properties sold under non-standard market or distressed conditions. Scope’s stressed security value haircuts for the properties securing the mortgage loans range between 50% and 62.5% (depending on the location of the property).

Overall, credit risk only accounted for 1.2 pp (from 1.8 pp) of the 4.0% supporting overcollateralisation. Credit risk improved if compared to Scope’s initial analysis. This is driven by: i) revised market value decline assumptions for properties located in the south western part of Norway (2.5% down); and ii) lower LTVs. While the average LTV decreased only slightly to 52.6% (from 53.3%), loans with an LTV of 70% and above accounted for 13.7% only (by maximum drawable amount) compared to 17% one year earlier.

Scope analysed the substitute asset defaults with a non-parametric distribution by performing a Monte Carlo analysis. Scope assumed a correlation factor of 25% on the covered bonds. Conservatively, the issuer’s credit assessments were used for all exposures to derive a default expectation. The low default rate of 0.1% and very high coefficient of variation (1,062%) reflect high individual credit quality but also very high obligor concentration. The agency assumed an asset recovery rate ranging between 100% in the base and 59.9% in the most stressed scenario.

Scope used the resulting loss distribution and default timing to project the covered bond programme’s losses and reflect its amortisation structure. The latter was calculated assuming that all ‘flexible’ loans were fully drawn.

The rating agency also incorporated 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 increase after two years and plateau at 10% thereafter. Scope did not give benefit to hedges which swap fixed bond coupons into floating because certain documented elements could introduce additional credit risk for the covered bonds. Their impact is marginal, however, given that only 5.3% of outstanding covered bonds pay a fixed coupon. The documentation has already been revised by the issuer to address these limitations. If this documentation is used for new hedges, Scope will take them into account.

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. The same premium was assumed for the substitute assets (predominantly Norwegian mortgage-covered bonds). 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 25%) to stress the programme’s sensitivity to unscheduled repayments. The programme is most sensitive to high prepayments creating a large amount of cash and reducing the transaction’s excess spread. In contrast, a low prepayment scenario in which assets need to be sold at a discount because of maturity mismatches from the long-dated assets produces lower levels of overcollateralisation supported by the high asset margin.

Market risk accounts for 2.8% pp (up from 2.2%) of the 4.0% supporting overcollateralisation. Market risks are related to interest rate mismatches and asset liability mismatches. Compared to the last analysis they have increased to reflect the programme’s sensitivity to scenarios combining margin-compression and frontloaded default timings.

Scope assumed a recovery lag of 24 months for residential loans originated by Verd’s member banks. The recovery timing for the mortgage loans is based on an analysis of Norwegian enforcement processes, considering that the collateral’s regionality and strong dependencies on the more volatile oil sector may temporarily lengthen the overall recovery process.

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

The agency also tested the programme’s sensitivity to compressed asset margins (down to 80 bps), a liquidity premium of up to 300 bps and front-loaded defaults in order 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). 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, published 26 July 2019. This methodology is available on https://www.scoperatings.com/#!methodology/list. The model/s used for this rating(s) and/or rating outlook(s) is/are available in Scope’s list of models, published under: https://www.scoperatings.com/#!methodology/list. Information on the meaning of each rating category, including definitions of default and recoveries can be viewed in the “Rating Definitions - Credit Ratings and Ancillary Services” published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. 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. Guidance and information on how Environmental, Social or Governance factors (ESG factor) are incorporated into the rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.

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, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0.
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 15 May 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
© 2020 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.
Scope Ratings GmbH, Lennéstraße 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Director: Guillaume Jolivet.