Rating action

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

Key rating drivers

Sound issuer rating (positive)¹. The A- issuer rating with a Stable Outlook reflects the parent’s (Sandnes) well-established franchise in south-west Norway, solid and resilient earnings capabilities, and reassuring prudential metrics.

Cover pool support (positive)². Cover pool support is the primary rating driver and adds eight notches of maximum credit uplift, reflecting:

1. Cover Pool Complexity Score (positive). Scope has classified the interplay between complexity and transparency with a CPC Score of ‘1’, allowing for a maximum additional uplift of up to three notches on top of the fundamental uplift.
    
2. Overcollateralisation (positive). Available overcollateralisation of 22.8% shields the covered bonds from market and credit risks and is well above the minimum 4.0% (unchanged) that supports the cover pool uplift.
    
3. Sound credit quality (positive). The granular and fully residential cover pool with a low loan-to-value ratio has low credit risk even under the highest rating stresses.
    
4. Asset-liability mismatches (negative). Asset-liability mismatch risk arises from the slow scheduled amortisation of the cover assets against the faster redemption of the covered bonds. The issuer regularly maintains short-term substitute assets to mitigate short term liquidity risk.

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 cover pool’s credit quality.

Rating-change drivers

The 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 and enables enough cover pool support to achieve the highest rating; 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 view of the issuer’s stable credit quality. 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.

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 SSBB’s mortgage loans were made using an inverse Gaussian distribution. Based on credit performance data provided by the bank (including IFRS9 reporting, internal information on rating migration as well as loan-level probabilities of default) and benchmarking, Scope derived an effective lifetime mean default rate of 8.0% (annual 42 bps, down from 10.5%). The volatility of defaults (weighted average coefficient of variation) was assumed to be 60%. The agency calculated an asset recovery rate ranging between 98.8% in the base case and 81.9% (up from 79.5%) in the most stressed scenario.

Scope applied rating distance-dependent market value declines to establish stressed recovery rates. Assumptions reflect the Norwegian housing market’s developments and unique characteristics. Scope also applied a fire-sale discount of 20%, reflecting a value discount on properties sold under non-standard market or distressed conditions. Scope’s stressed security value haircuts for the properties securing the mortgage loans range between 45.0% and 62.5% (depending on the location of the property).

Overall, credit risk accounted for 2.4 pp (down from 2.7 pp) of the 4.0% supporting overcollateralisation. Credit risk has decreased since Scope’s previous analysis, driven by higher recoveries (as a consequence of lower loan-to-value levels) and Scope’s lower expectation on the pool’s mean default rate.

Scope analysed substitute asset defaults with a non-parametric distribution by performing a Monte Carlo analysis. Scope assumed 2% of global correlation, 10% per country and another 10% for the asset type. Conservatively, Scope derived the default expectation using the issuer’s credit assessments for all exposures. The low default rate of 0.1% and very high coefficient of variation reflect high individual credit quality but also very high obligor concentration. Recovery assumptions on the substitute assets range between 100% 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 and reflect its amortisation structure. The latter was calculated assuming that all ‘flexible’ loans were fully drawn and would remain interest-only until their expected maturity.

Market risk accounts for 1.6 pp (up from 1.3 pp) of the 4.0% supporting overcollateralisation. Market risk arises from the slow scheduled amortisation of the cover assets against the faster redemption of the covered bonds, all issued as soft bullet with a one-year extension.

The analysis incorporated 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. The 26.9% of fixed-rate covered bonds are fully hedged into floating rates until the respective scheduled maturity and, according to their terms and conditions, convert into floating rate during the extension period.

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 (1%) and high (up to 15%) prepayments to stress the programme’s sensitivity to unscheduled repayments. The programme is most sensitive to high prepayments that create a large amount of cash and reduce 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.

Scope assumed a stressed recovery lag of 24 months for residential loans originated by Sandnes. The recovery timing is based on an analysis of Norwegian enforcement processes, considering that the collateral’s regionality and strong dependency on the more volatile oil sector may 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 programme’s sensitivity was also tested to reinforce the programme’s break-even overcollateralisation, specifically against compressed asset margins (down by 50%), a liquidity premium of up to 200 bps, prepayments of up to 25%, and front-loaded defaults.

Rating driver references
1 SSBB’s issuer rating
2 SSBB’s reporting (Confidential)

Stress testing
No stress testing was performed.

Cash flow analysis
The cover pool-supported Credit Rating uplift is based on a cash flow analysis using Scope Ratings’ covered bond model (CobEL version 1.0). The model applies Credit 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 methodologies used for this Credit Rating and Outlook, (Covered Bond Rating Methodology, 18 May 2021, General Structured Finance Rating Methodology, 14 December 2020 and Methodology for Counterparty Risk in Structured Finance, 8 July 2020), are available on https://www.scoperatings.com/#!methodology/list.
The model used for this Credit Rating and Outlook is (Covered Bonds Expected Loss Model version 1.0), available in Scope Ratings’ list of models, published under https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other 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 Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 Ratings’ definitions of default and Credit 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 factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Rating if the Credit Rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit 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 Ratings’ internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Rating originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data. Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Rating and Outlook and the principal grounds on which the Credit Rating and Outlook are based. Following that review, the Credit Rating was not amended before being issued.

Regulatory disclosures
The Credit Rating and Outlook is issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Rating and Outlook is UK-endorsed.
Lead analyst: Mathias Pleißner, Director
Person responsible for approval of the Credit Rating: Karlo Fuchs, Managing Director
The Credit Rating/Outlook was first released by Scope Ratings on 19 December 2018. The Credit Rating/Outlook was last updated on 14 November 2019.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures 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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