To conduct a covered bond business is easier if you have a legal framework made for this purpose. When the Norwegian framework was drafted SpareBank 1 Boligkreditt, together with other potential issuers took an active part in the drafting and kept close contact with rating agencies and rating advisors.
This has ensured one of the best legal frameworks for covered bonds and aids us in achieving a top rating and the confidence of investors from many different jurisdictions.
The legal framework allows for covered bonds to be issued only by specialist mortgage finance companies, whose objective it is to mainly finance its activities by the issuance of covered bonds. SpareBank 1 Boligkreditt is such a specialist mortgage finance company. All we do is purchase retail mortgages and finance them, mainly by issuance of covered bonds.The objective of the framework is to ensure timely payment to counterparties and investors and to ring fence the covered pool assets in an event of default. This is done by strict limitations on the business, the specialist principle, the risk allowed to be taken, the restrictions on mortgages and the control mechanisms applied. The most important issue is however the protection of the covered investors if the issuer goes bankrupt. This is achieved by several rules and principles applied.
For retail mortgages the loan to value (LTV) must be below 75% when the loan enters the pool. For commercial loans the LTV has to be less than 60%. We do not mix commercial loans into our retail pool, but has established a separate covered bond issuer, SpareBank 1 Næringskreditt, for that purpose. All real estate has to be valued by an independent appraiser and according to our credit policy that valuation should not be older than 12 months. According to section 2-31 in the Act the company must perform an asset ratio test to ensure that the assets in the pool are larger than the liabilities at all time. Loans, interest rate contracts and foreign exchange contracts shall all be valued at net present value. In the test loans in arrear for more than 90 days are not included, but they are still a part of the pool. The real estate prices are to be monitored, and if there is a significant drop we are obliged to make new valuation calculations. If the LTV should move above 75% after such new valuation, the amount above 75% will be left out of the asset test, but still remain as part of the pool.
The Act and sub-legislation allows for little interest rate risk, and even less currency risk. To comply with the fact that all our mortgages at present has a floating interest rate that can be changed within 6 weeks notice, all our major loans and investments are hedged from other currencies to NOK, and from any fixed interest rate to 3 months floating rate. With regard to liquidity we are required to at all time have a positive cash flow. In addition to this we are also subject to general bank regulations, like capital adequacy, large single customer exposure and liquidity regulations, and we are supervised by the Norwegian Financial Supervisory Authority.
The issuer must at all times keep an updated pool register which contains detailed information about all assets and liabilities covered by the pool. This is monitored by an independent inspector. The register provides strong, but not conclusive evidence that the claim is given the preferential position. The conclusive evidence is the intention of the parties, proven by all evidence available. Pursuant to the Act, loans and receivables included in the cover pool may not be assigned, pledged, or made subject to any set off. However, an exemption regarding the prohibition against set-off has been made in relation to derivatives agreements, as further described in the Act and sub-legislation.
As long as the pool makes timely payment and no halt-of-payment has been declared, an issuer bankruptcy will only result in a change of management as an administrator will be appointed by the court and replace the management. The pool will be kept running and make timely payment. The administrator can obtain new funding as in ordinary course of business.
In case the pool is deemed unlikely to make timely payment a halt of payment will be introduced by the administrator. The assets will then be liquidated and the cash will be transferred first to those that have a preferential claim, according to the net present value of that claim. Any remains will go to creditors without the preferential claim. If there are insuffient funds to cover the preferential claims, the remaining pool claim will be a claim towards the assets outside the pool, but with a pari passue ranking with the unpreferential claims.
For further information we refer to our Global Medium Term Covered Notes Programme.