Photographer: Kristian Helgesen/Bloomberg

Oil Crash Seeps Into Norway's $120 Billion Covered Bond Market

  • Mortgage lender turns to other debt to fill collateral pool
  • Use of covered bonds increases risks of cross-ownership

Amid a combination of bonds coming due and rising liquidity needs, Norway’s second-largest issuer of covered bonds, SpareBank 1 Boligkreditt, is using fewer home loans to backstop its roughly 181 billion kroner ($22 billion) in outstanding debt.

The Stavanger-based lender is filling up its collateral pool with government debt, derivatives and covered bonds, including its own. While investors and analysts are still confident in the safety of Norwegian mortgages, the intertwining commitments of covered bonds backstopping other covered bonds are raising concerns.

“The general problem with high liquidity requirements for these companies is that an investment in a covered bond issuer partially and indirectly also becomes an investment in other covered bond issuers,” Daniel Berg, global head of fixed income and currencies at DNB Asset Management, a unit of Norway’s largest bank, said in an e-mail. “Bonds are tied closely together. The market is the therefore more entangled.”

These types of entanglements, through bond deals or derivatives, have proved fatal for financial systems before, playing a major part in the crisis that erupted in the U.S. in 2007 and the collapse that brought down the economy of Iceland in 2008.

Still, overall, there’s nothing “dramatic” about the situation, Berg said. “Sparebank 1 Boligkreditt is among the most diversified, liquid and transparent covered bond issuers out there and is one of my favorites.”

While Norway, western Europe’s largest oil producer, has so far been able to avoid an outright recession despite a collapse in crude prices, its western oil regions have been hard hit. In the oil capital Stavanger, home prices have slid about 11.5 percent from a peak in May 2013. By comparison, values have jumped 26.5 percent over the same period in the capital Oslo, which is less impacted by the oil crash.

SpareBank 1 Boligkreditt, which gets its loans from a nationwide alliance of savings banks, says its AAA rated covered bonds are perfectly safe and its loans have no defaults. The entire collateral pool is made up of about 13 percent of supplementary assets, within the 20 percent limit set by Norwegian law. That may rise to 30 percent with special approval from the Financial Supervisory Authority.

"The reason why we hold liquidity reserves is a precautionary principle to meet future maturities falling due, this is also in line with regulatory requirements already introduced or expected to be implemented,” said Arve Austestad, the chief executive of the lender. “This has nothing to do with available mortgages or lack of desire from banks to transfer loans."

According to Austestad, stress tests show that house prices could plunge 30 percent overnight and the bank would still be able to maintain the requirements of the rating agencies. The covered bonds are 9 percent over-collateralized and the additional assets will cover the maturity payments coming due over the next 12 months, he said.

“In a situation where there are no more mortgages, and house prices fall, we need substitute assets to maintain the same security levels for investors,” he said, speaking generally of the industry. While acknowledging that there’s a “systemic risk” using mortgages as collateral it’s an investment we know, he said.

Moody’s Investors Service last week put a negative rating on the whole Norwegian banking sector because of a “softening operating environment” due to the plunge in oil. It sees non-performing loans rising to about 2 percent by 2017 from 1 percent last year.

Covered bond issuance has boomed in Norway following last decade’s financial crisis. This has helped cut borrowing costs since most are sold abroad, but could also have increased the riskiness of the banking system since the safest home loans are brought off the balance sheet.

The rating company considers Norwegian covered bonds as “low risk, reflecting the strong credit profile of their issuers, conservative underwriting and loan inclusion standards, as well as Norway’s robust mortgage credit culture,” Oscar Heemskerk, associate managing director at Moody’s banking team, said in a statement. This “mitigates risks related to cross-ownership,” he said.

According to Austestad, the alliance of banks he relies on has 500 billion kroner in mortgages on their books.

“The use of covered bonds is not fully utilized,” he said. “They may keep reserves in case things become difficult.”

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