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 18 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 as a funding vehicle for its owners, a group of 18 Norwegian savings 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 Category (positive). Scope has assigned a Cover Pool Complexity category of low. This category 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 governance uplift. (ESG factor)
    
2. Overcollateralisation (positive). As of 30 September 2022, available overcollateralisation was 18.1%. This level provides protection against market and credit risks and is well above the increased 6.0% (from 5.0%) minimum that supports the cover pool uplift. The higher supporting overcollateralisation is driven by our increased risk scoring in light of the tense economic situation, more conservative value haircuts and higher than average loan-to-value and default scoring for loans added by shareholders from the LokalBank Alliance (LBA) alliance. LBA members are contributing since 2020 to Verd and as of September 2022 accounted for 16% of total mortgage loan balance of Verd.
    
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 50.9% and moderate granularity, with the top 10 exposures accounting for 0.4% only.
    
4. Market risks (negative). There is no foreign currency or interest rate risk. All bonds are denominated in local currency (NOK) and issued floating rate – matching the profile of the cover assets. However, the programme is exposed to maturity mismatches given that the weighted average life of the loans (disregarding prepayments) is 9.2 years longer than that of the covered bonds. This exposes the programme to potential asset sales under discounts in a stressed environment. The bonds’ soft-bullet maturity profile and available over-collateralisation reduce risks.

Governance support (positive)³. Governance 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. (ESG factor)

One or more key drivers of the credit rating action are considered an ESG factor.

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 governance 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 evidence that the various agreements with the owner banks do not function as expected and or a deterioration in the credit quality of the mortgage assets, potentially stemming from a change in the composition of the owner banks. It could be positively impacted by a sustained high quality diversification of the mortgage assets reflecting Verd’s greater systemic importance as a funding vehicle.

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 7.7% with a coefficient of variation of 55%.

Scope assumed asset-recovery rates ranging between 98.5% in the base scenario and 76.7% 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 25% was applied to account for property sales under non-standard or distressed conditions in more rural arears of Norway. The total stressed security value haircuts for the properties securing the mortgage loans range between 55% 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.

Due to the immaterial share of substitute assets, Scope considered the sub-pool as a single exposure against a financial institution rated A- combined with a typical three-year maturity and a stressed recovery rate of 50%.

Overall, credit risk accounts for 3.0% of the updated 6.0% rating-supporting overcollateralisation, 1.0pp above that of the previous review.

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 low prepayments in a low rate interest scenario. In combination with high maturity mismatches high amounts of assets are to be sold under discount to meet the covered bond’s extended maturity. 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 an unchanged 3.0% of the 6.0% 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, 25 April 2022; General Structured Finance Rating Methodology,17 December 2021), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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-governance/definitions-and-scales. 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://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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 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 Outlook and the principal grounds on which the Credit Rating 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, Senior Director
Person responsible for approval of the Credit Rating: Nicolas Hardy, Executive Director
The Credit Rating/Outlook was first released by Scope Ratings on 15 May 2019. The Credit Rating/Outlook was last updated on 8 February 2022.

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
© 2022 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Analysis GmbH, Scope Investor Services GmbH, and Scope ESG Analysis 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.