SpareBank 1 Boligkreditt (Spabol or the Company) was founded in 2005 and issued its first Euro benchmark in September 2007, a 1 billion, 3 year covered bond. 2017 is the 10th year of issuing covered bonds and Spabol is an important source of funding for the banks in the SpareBank 1 Alliance. On average 1/3 of all residential mortgage lending from the SpareBank 1 Alliance banks in Norway has been funded via Spabol covered bond issuance. The banks sell originated loans which meet a series of quality checks to SpareBank 1 Boligkreditt’s cover pool.
The relationship between covered bond issuer and banks are regulated by Norwegian law, but also by contract between Spabol and each bank. This is a source of the cover pool’s credit risk strength and diversification. The law requires that a special entity, separate from the parent institution(s) issues cover bonds. The main objective of this feature of the law is to segregate the assets over which investors in covered bonds and pari passu counterparties in hedging swap contracts have a first priority right in case of insolvency, second it provides for a simple, transparent balance sheet. The contractual arrangements are such that the parent banks are obligated to support the cover pool in times of stress and emergencies with additional equity (above paid in equity for regulatory capital adequacy purposes) and liquidity. Additionally, and more relevant for ongoing operations, parent banks need to maintain reserves of mortgages for the cover pool, in case LTVs in the pool increase due to valuation declines in the housing market. In the Alliance, reserves are calibrated so that the Company’s cover pool can withstand sudden house price declines of 30 per cent. The cover pool, however, is continuously extremely robust due to the process of qualification that each mortgage goes through in order to be eligible for the pool. This means that customer credit scores, customers past behavior, as well as income and loan metrics and correctness of documentation and registration determine the share of mortgages that qualify for the cover pool. With reference to the 1/3 of Alliance banks’ mortgages financed through the pool, another approximately 30 per cent of loans are pre-qualified, but not transferred (or sold) from the banks.
Ownership is tied to the relative volume of mortgages. Because covered bond entities in Norway are credit institutions, the same capital requirements apply as to all banks in general. A transfer (a sale) of mortgages to the cover pool therefore requires an equity injection. Through the year, mortgages continue to be sold to the pool, and equity is raised from the Alliance banks at irregular intervals. At the end of each year, ownership shares are reset depending on the then prevailing relative positons of the banks with regards to mortgage volume in the cover pool. At year-end 2016, the equity shares of the banks were:
|No of Shares||in per cent|
|SpareBank 1 SMN||12,081,960||19.09 %|
|SpareBank 1 Nord-Norge||9,247,688||14.61 %|
|SpareBank 1 SR-Bank ASA||8,778,079||13.87 %|
|Sparebanken Hedmark||12,823,943||20.26 %|
|BN Bank ASA||3,820,090||6.03 %|
|SpareBank 1 BV||3,811,059||6.02 %|
|SpareBank 1 Østfold Akershus||2,817,655||4.45 %|
|Sparebanken Telemark||2,669,547||4.22 %|
|SpareBank 1 Ringerike Hadeland||2,322,759||3.67 %|
|SpareBank 1 Nordvest||1,390,766||2.20 %|
|SpareBank 1 Modum||921,156||1.46 %|
|SpareBank 1 Søre Sunnmøre||823,622||1.30 %|
|SpareBank 1 Hallingdal Valdres||758,599||1.20 %|
|SpareBank 1 Gudbrandsdal||587,012||0.93 %|
|SpareBank 1 Lom og Skjåk||451,547||0.71 %|
The ownership shares determine the pro rata and joint obligations of the banks. As mentioned above, a shareholders agreement provide for additional equity contributions to be made in case of sufficient impairments in the cover pool while a shareholders note purchasing agreement regulates when the banks themselves will need to buy covered bonds from Spabol. Neither the covered bond issuer nor the banks expect that any of these agreements would ever be drawn upon. In fact they were constructed to formalize and exhibit the strong cohesion between Spabol and the banks which exists anyway. Each bank is obligated to perform its share of each agreement’s commitment based on its pro rata equity share in Spabol, details of the agreement are in the SpareBank 1 Boligkreditt Prospectus document. Furthermore, in case of other Alliance banks being unable to participate under either agreement at the point of draw down, each bank is additionally taking on the commitment of its pro rata share a second time.
Because Norway is outside of the political European Union, EU Directives tend to take longer to be implemented in Norway, for example EMIR and BRRD are not yet implemented, but expected. However, as a member of the inner market through the European Economic Area agreement, Norway must implement EU Directives. In the area of banks and regulations of the banking industry, law and regulations are the same in Norway as in the EU. Consequences can therefore arise for special situations in Norway which have not been accommodated for in the EU regulation. One such area is the rules on largest exposures between banks, where a bank’s exposure to another banking institution is limited by 25 per cent of the bank’s Tier 1 equity capital, with a weighting of the exposures at 100 per cent. There is no exemption in the relationship covered bond issuer to parent banks, which must contribute the equity capital for the covered bond entity. This equity is an exposure of the parent banks vs. Spabol. However, for Norwegian Boligkreditt entities which are wholly owned by one bank, the weighting of exposures is a lower 20 per cent (as opposed to 100 per cent), disadvantaging covered bond issuers owned jointly by several banks. In practice, there is no meaningful limitation to covered bond issuance in the Alliance because SpareBank 1 banks have been required to increase their equity capital over several years, as have all banks. This comes as a function of the implementation of the EU’s CRD IV, on top of which Norway’s finance ministry has added a countercyclical buffer and Pillar 2 requirements (from 1.5 to 2.5 per cent, depending on institution). In Norway, the level of a bank’s risk-weighted assets has a floor, which is defined as 80% of what applying the Basel I regime would have resulted in. As a consequence, banks in Norway are very well capitalized compared to European and Scandinavian peers.
SpareBank 1 Boligkreditt issues a main portion of its financing in foreign currency, especially in Euros. Mortgage loans in the cover pool are denominated exclusively in Norwegian kroner at a variable rate, while bonds issued are typically fixed rate. Derivatives are employed to hedge the ensuing market risks. The operating model entails covering any such exposure fully, and for the whole duration of the outstanding bond, with a swap contract. While these contracts attract some costs, they are a prudent tool for removing market risks compared to other solutions and also best meet legal requirements. Another prudent element for SpareBank 1 Boligkreditt is to swap with external counterparties instead of with parent banks, and in particular to also diversify external swap counterparties. Swaps with a parent bank means that market risks could accumulate there, unless also mitigated. However, under the covered bond swaps the Company enters into, the collateral posting is one-directional only, from counterparties to Spabol. Therefore, at times of sharper moves in market variables, collateral volumes from a series of swap contracts hedging several billions of Euros of exposure could be material and could become a source of liquidity constraint for a parent bank not receiving collateral from the Company.
On average the SpareBank 1 banks are retail institutions, and their operations are exclusively in Norway. As much as 70 per cent of the aggregated balance sheet is lending to private households, and almost all of this is residential mortgages. Of the remaining lending to the corporate or business segment, the largest share is commercial mortgages for offices, warehouses, logistical centres, manufacturing centres, hotels and so on. Lending to other industries in order of size are business services, construction, utilities, industry and trade, maritime and offshore, followed by several others. The corporate segment is diversified and granular and SpareBank 1 banks are not present with lending to the cyclical shipping tanker industry for example, but which does have rich traditions in Norway.
Lending in Norway to household and businesses:
With their similar business profile, the banks have joined forces within the Alliance since 1996 on many efforts regarding operations processes, in order to be as efficient as possible and in this regard act as one concern. Today the work in the Alliance and in the banks is focused on further technological adaption, automation and providing customers with online platforms and options to conduct business. The SpareBank 1 Alliance is highly integrated on many levels, also though that the banks jointly own product companies, such as insurance and asset management. The banks and the units in the SpareBank 1 Alliance operate under the single brand name SpareBank 1, a very familiar financial brand name to Norwegians.
Loan quality in the SpareBank 1 banks is high, though due to some oil and oil services industry related exposures, both loan loss charges and loans in default as well as loans classified as at risk of default has increased over 2016. This increase is not due to a general trend across all SpareBank 1 banks, but occur in two banks with more oil related exposures as a share of their gross lending at the end of 2016, SpareBank 1 SR-Bank with 8,1 per cent of oil related exposures and SMN with less than half of this. The following chart illustrates the trend and level for the four largest Alliance banks as an average aggregate of overall lending
Loan quality and losses.
Source: banks annual reports for 2016
Defaults and problem loans in the retail (household) segment is very low. Cumulative loan loss provisions as an expression of this is 0.09 per cent as of 2016 for the four largest Alliance banks and only 0.03 per cent when considering only those loans which have been individually identified as impaired loans.The Boligkreditt balance sheet, where lending is solely for residential household mortgage purposes, remains as before very robust with no defaulted or problematic loans and a negligible level of arrears below 90 days.
Eivind Hegelstad is CFO / Investor Relations at SpareBank 1 Boligkreditt