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 Verd Boligkreditt AS (Verd), which is jointly owned by 18 independent savings banks (hereafter referred to as the ‘owner banks’).

Rating rationale

Solid issuer rating (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. The cover pool support is the primary rating driver and adds at least six 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 2023, available overcollateralisation was 18.6%. This level provides protection against market and credit risks and is well above the unchanged 6.0% 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 52.0% and moderate granularity, with the top 10 exposures accounting for 1.1%.
    
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 with the weighted average life of cover assets being 8.2 years longer than the outstanding covered bonds. To meet scheduled maturities, asset sales under discounts might be needed. The covered bonds soft bullet structure and available over-collateralisation mitigates the 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 impacting the credit quality of the mortgage assets, its financial profile and/ or solvency position. It could be positively impacted by a sustained high-quality diversification of the mortgage assets and increasing relevance as a covered bond issuer.

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 6.6% with a coefficient of variation of 55%.

Scope assumed asset-recovery rates ranging between 98.9% in the base scenario and 76.0% 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 20% was applied to account for property sales under non-standard or distressed conditions. The total stressed security value haircuts for the properties securing the mortgage loans range between 52.5% and 57.5% (depending on the location of the property). On top, Scope applied 2.5% for variable costs and fixed NOK 70,000 for liquidation costs.

We analysed the substitute asset defaults with a non-parametric distribution. The default expectation is based on credit assessment of the cover assets. The low default rate of 0.05% and very high coefficient of variation of 931% reflects the high individual credit quality but also the high obligor concentration. We have applied a correlation framework accounting for geographical and obligor type concentration. The individual asset recovery rate assumptions ranged between 100% in the base case and 50% in the most stressed scenario. For the substitute assets we assumed a stressed portfolio recovery rates of 76.2%.

Credit risk contributes with 2% to the 6.0% rating-supporting overcollateralisation, 1pp below 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 also taking into account the collateral’s regionality. 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 4pp (up from 3%) of the 6.0% rating-supporting overcollateralisation. Market risks relate to compressed excess spread and asset-liability mismatches.

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

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 1.1). 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 methodology used for this Credit Rating and Outlook, (Covered Bond Rating Methodology, 24 May 2023), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The models used for this Credit Rating and Outlook are (Covered Bonds Expected Loss Model Version 1.1; Portofolio Model Version 1.1), 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 and Outlook and the principal grounds on which the Credit Rating and Outlook are based. Following that review, the Credit Rating and Outlook were 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: Fatemeh Torabi Kachousangi, Associate Analyst
Person responsible for approval of the Credit Rating: Karlo Fuchs, Managing Director
The Credit Rating/Outlook were first released by Scope Ratings on 15 May 2019. The Credit Rating/Outlook were last updated on 20 December 2022.
 
Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use/exclusion of liability
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