Rating action

Scope Ratings GmbH (Scope) has today affirmed the AAA rating with a Stable Outlook on the Norwegian covered bonds (obligasjoner med fortrinnsrett) issued by the specialised mortgage bank Verd Boligkreditt AS (Verd), which is jointly owned by 19 independent savings banks (hereafter referred to as the ‘owner banks’).

Key rating drivers

Solid issuer quality (positive)¹. Scope’s credit view reflects Verd’s low risk business model and the investment-grade credit profile of its owner banks. Verd is a specialised residential mortgage institution with the right to issue covered bonds.

Cover pool support (positive)^2,3. Cover pool support is the primary rating driver and adds seven notches of rating uplift. This is reflected by:

1. Cover Pool Complexity Score (positive). Scope has assigned a Cover Pool Complexity Score of 1. This score reflects the issuer’s management of the interplay between complexity and the transparency provided to investors. This allows for a maximum uplift of three notches on top of the fundamental uplift.
    
2. Overcollateralisation (positive). As of 30 December 2021, available overcollateralisation was 19.4%. This level provides protection against market and credit risks and is well above the unchanged 5.0% minimum that supports the cover pool uplift.
    
3. Sound credit quality (positive). The cover pool comprises well-diversified domestic residential mortgage loans. The cover assets benefit from a low average loan-to-value ratio of 50.1% and moderate granularity, with the top 10 exposures accounting for 0.5% only.
    
4. Market risks (negative). There is no foreign currency or interest rate risk. All bonds are denominated in local currency (NOK) and issued at floating rates – matching the profile of the cover assets. However, the programme is exposed to maturity mismatches. In the case of Verd’s covered bonds, these arise from stressed asset prepayments, reducing the available excess spread.

Fundamental credit support (positive)³. Fundamental credit support provides the covered bonds with four notches of uplift above our credit view on Verd. As such, three additional notches from cover pool support are needed to raise the covered bond rating to the highest achievable level.

Rating-change drivers

Scope’s Stable Outlook on the mortgage-covered bonds reflects the stable outlook on the issuer’s credit quality. The rating may be downgraded upon: i) a deterioration in Scope’s view on the credit quality of the issuer; ii) a deterioration in Scope’s view on fundamental support factors relevant to the issuer and Norwegian mortgage-covered bonds in general as well as on the interplay between complexity and transparency; and/or iii) an inability of the cover pool to provide an additional rating uplift.

Scope’s credit view on the bank could be negatively impacted by a material deterioration in the credit fundamentals of the owner banks or a change in the composition of the owner banks impacting the mix of mortgage assets negatively. It could be positively impacted by a change in the composition of the owner banks impacting the mix of mortgage assets positively or further clarity and details on the owner banks’ duties and obligations to support the credit fundamentals of Verd in situations of need.

Quantitative analysis and assumptions

Scope’s cash flow analysis projected defaults for the mortgage cover pool assuming an inverse Gaussian distribution. Scope derived an effective weighted-average lifetime mean default rate of 6.0% with a coefficient of variation of 55%.

Scope assumed asset-recovery rates ranging between 98.3% in the base scenario and 77.8% in the stressed scenario for the mortgage loans.

Assumptions for Scope’s rating-distance-dependent market value declines reflect developments in the Norwegian housing market and its unique characteristics. An additional fire-sale discount of 30% was applied to account for property sales under non-standard or distressed conditions in more rural areas of Norway. The total stressed security value haircuts for the properties securing the mortgage loans range between 52.5% and 67.5% (depending on the location of the property). On top of that, Scope applied 2.5% for variable costs and NOK 70,000 of fixed liquidation costs.

Scope analysed substitute asset defaults with a non-parametric distribution using a Monte Carlo method. A correlation factor of 22% was assumed. Conservatively, Scope derived its default expectation based on the issuer’s credit view of 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. The asset recovery rate assumptions ranged between 100% in the base case and 59% in the most stressed scenario.

Overall, credit risk only accounts for 2.0pp of the 5.0% rating-supporting overcollateralisation, 0.8pp below that of the previous review. The lower credit risk is driven by the lower lifetime mean default time applied to reflect the amortising nature of the mortgage loans in Scope’s cash flow modelling.

Scope used the resulting loss distributions and default timings to project the covered bond programme’s losses and reflect its amortisation structure. The analysis also incorporated the impact of rating-distance-dependent interest rate stresses as well as different prepayment scenarios. Scope tested for low (1%) and high (up to 15%) prepayments to stress the mortgage programme’s sensitivity to unscheduled repayments.

Scope assumed a recovery lag of 24 months for residential loans originated by the owner banks. This is based on an analysis of Norwegian enforcement processes, which reflects the fact that the collateral’s regionality and strong dependence on the highly volatile oil sector may cause delays in recoveries. A recovery lag of 36 months was assumed for the substitute assets.

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 25bps and 10bps for the substitute assets.

The cover pool’s net present value in the event of an asset sale was calculated by adding a 150bps refinancing premium to the rating-distance and scenario-dependent discount curve. The same premium was applied to 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.

The programme is most sensitive to high prepayments that create a large amount of cash and reduce the transaction’s excess spread. For the mortgage assets, Scope also tested the programme’s sensitivity to compressed asset margins (down by 50%), a 200bps liquidity premium and front-loaded defaults to reinforce the programme’s break-even overcollateralisation.

Market risk accounts for 3pp (up from 2.2%) of the 5.0% rating-supporting overcollateralisation. Market risks relate to both interest-rate and asset-liability mismatches.

Rating driver references
1. Verd Boligkreditt’s issuer credit view (Confidential)
2. Verd Boligkreditt’s public quarterly reporting 
3. Cover pool reporting (Confidential)

Stress testing
No stress testing was performed.

Cash flow analysis
The Credit Rating uplift is based on a cash flow analysis using Scope Ratings’ covered bond model (Covered Bonds Expected Loss Model 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.

Methodology
The methodologies used for this Credit Rating and Outlook, (Covered Bond Rating Methodology, 18 May 2021; General Structured Finance Rating Methodology, 17 December 2021), 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-EU. 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 was 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 are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Rating and Outlook are UK-endorsed.
Lead analyst: Mathias Pleißner, Director
Person responsible for approval of the Credit Rating: Benoit Vasseur, Executive Director
The Credit Rating/Outlook was first released by Scope Ratings on 15 May 2019. The Credit Rating/Outlook was last updated on 24 March 2021.

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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