Estonia Banks Plan Mortgage Bond Market to Cut Costs

Estonian banks, led by the local unit of Stockholm-based Swedbank AB, plan to create a mortgage bond market to reduce borrowing costs and spur the revival of capital markets in the euro area’s newest member.

The Estonian Banking Association probably will decide later this week to take legal steps needed to start trading the bonds, Swedbank Chief Executive Officer Priit Perens said in an interview in Tallinn yesterday. He declined to estimate the market’s potential size or when mortgage bonds may be offered.

Estonian banks, including units of Stockholm-based SEB AB and Nordea Bank AB, have cut reliance on funding from Nordic parents after Lehman Brothers Holdings Inc.’s 2008 collapse burst a property bubble, shut off credit flows and triggered the world’s worst recessions in the Baltics. Estonia’s decade-old mandatory private pension system mostly invests fund abroad because of illiquid local markets and as the government holds back on selling new bonds to meet budget surplus targets.

“The main reason to do this is to finance our activities more cheaply,” Perens said. “In Sweden, there is a clear difference in prices of mortgage-backed bonds and senior unsecured bonds. It would definitely also be a suitable instrument to boost the local capital market.”

The Estonian bond market has contracted by nearly half since before the global crisis, while activity in both the primary and secondary market has dropped by almost 95 percent, according to the central bank. The total volume of bonds issued in Estonia amounted to 518 million euros ($691 million) at the end of August, or 3.2 percent of gross domestic product, central bank data shows.

Credit-Default Swaps

With no outstanding bonds, investors speculate on Estonia’s creditworthiness by trading credit-default swaps, whose cost for five years has plummeted to 64 basis points, the fifth-lowest in the euro area, from a peak of 737 in 2009, according to data compiled by Bloomberg.

The $22 billion economy may expand 3 percent this year and 4 percent in 2014, when it’s due to reach its pre-crisis level, the central bank estimates.

Estonian mortgage bonds should also attract foreign investors drawn to the country’s relatively low indebtedness in the private and public sectors, Perens said.

“We see mainly local pension funds as potential investors,” Perens said. “I myself think these bonds would be rather suitable for foreign investors, mainly funds that want to invest in this region. But the first prerequisite is that some sort of market is created in Estonia.”

Liability Diversification

The private sector debt-to-GDP ratio was about 140 percent at the end of the first half of 2012, according to central bank data. Public debt-to-GDP was 9.6 percent last year, the lowest in the European Union, Prime Minister Andrus Ansip told Bloomberg in an interview on Jan. 31.

A mortgage bond market “would help banks to diversify the structure of their liabilities, meaning it would create an additional way to attract capital,” Jaak Tors, the head of the financial stability department at the central bank, said in an e-mailed response to Bloomberg questions. “Still, it would definitely need to be analyzed what would be the effect of such instruments on banking, what risks it would entail.”

Before it's here, it's on the Bloomberg Terminal.