Restrictions on covered bond issuance as discussed by the Norwegian FSA last week would be detrimental to financial stability, a Finance Norway official told The Covered Bond Report. He also discussed a possible change to treatment of mortgages on second homes in cover pools.

Finanstilsynet (the Financial Supervisory Authority of Norway) last week raised the prospect of restrictions being placed on covered bond issuance and of higher capital charges for the heaviest issuers. The regulator cited risks to issuers’ funding profiles and the impact of asset encumbrance on unsecured creditors.

Finanstilsynet’s move came as a surprise and is misguided, according to Stein Sjølie of Finance Norway (FNO), which provides the secretariat for the Norwegian Covered Bond Council.

“We understand that the supervisor may be a bit worried about price developments in the residential market because house prices have gone up relatively steadily for a long period,” Sjølie told The CBR. “But we see the regulator’s proposal for regulating the covered bond market as not being well aimed in order to contain price developments in the housing market.

“We fear that this sort of regulation, which could restrict how much a banking group may issue in covered bonds, will be detrimental to financial institutions’ access to the markets. It could be detrimental to the development of the general bond market in Norway, which we are eager to stimulate. And it may also be harmful to financial stability, because we see covered bonds and the development of a larger and better bond market in Norway as ways of securing financial stability in the future.”

Sjølie said that the regulator’s announcement came after the Ministry of Finance wrote to Finanstilsynet at the end of June asking it to review Norway’s covered bond framework given the strong growth in the market since its inception in 2007. He said that FNO told the government it is happy with the way the market has developed and that the regulations might only require a couple of minor technical clarifications.

“So far we have found regulations for Norwegian covered bonds to be appropriate,” said Sjølie. “They have worked well and the rating agencies have given them a good score. And we have made a template in accordance with the ICMA Covered Bond Investor Council standards. So our view so far has been that this has been a proper regulation – made in harmony with the government five years ago.

“We were therefore a bit puzzled when we saw this proposal for a new regulation. However, I’m a little unsure whether it is a proposal for a regulation or just the supervisor thinking aloud.”

Sjølie said that any changes to regulation along the lines of Finanstilsynet’s comments last week would take time to be finalised and implemented.

Moody’s on Monday said that any shift to more unsecured funding prompted by possible restrictions on covered bond issuance could prove challenging. While noting that Norwegian issuers have generally been successful in accessing capital markets on an unsecured basis, Moody’s analyst Soline Poulain sounded a note of caution over the implications of the regulator’s thinking.

“The availability and cost of unsecured funding can be more volatile, particularly at times of market stress,” she said. “Depending on banks’ ability to readily access unsecured funding at appropriate costs, we believe that a shift to more unsecured funding may prove challenging, partly offsetting the benefits of senior bondholders’ improved subordination position.”

She said that the country’s largest banking groups have transferred the highest proportions of loans to covered bond issuing vehicles, meaning that the biggest banks would see the biggest shifts in their funding structures should any cap be introduced by the regulator.

However, Poulain said that such regulations would be credit positive for unsecured creditors.

“More limited covered bond issuance would be credit positive for unsecured creditors because it would limit the amount of good quality loans pledged as covered bond collateral, thereby improving the amount and quality of assets available to unsecured bondholders and depositors in a liquidation,” said Poulain.

Florian Hillenbrand, senior credit analyst at UniCredit, said that he was surprised at this “tough statement” that such a regulation would have an explicitly credit positive impact, particularly given Moody’s comments about the potential challenges of unsecured funding.

“Hence, implicitly, Moody’s accepts the positive effect that covered bonds have on PD, while also suggesting that the LGD effect outweighs the positive effect,” he said. “This stands in dramatic contrast to what has happened over the last few years when banks have been able to keep their heads above water (i.e. not defaulting on unsecured debt) by using covered bonds.

“Furthermore, Moody’s current comment asks why we have not yet seen downgrades of a senior bank rating justified by a more pronounced use of covered bonds or, to be more precise, a higher volume of assets encumbered.”

Hillenbrand questioned why Spanish institutions had not then been downgraded when they began issuing covered bonds, since cédulas issuance encumbers the whole mortgage book under Spanish law, and why there have not been downgrades of issuers who set up programmes during the crisis and encumbered large amounts of assets through covered bonds issued for accessing ECB facilities.

Second home LTV reclassification possible

Meanwhile, a change to regulation that is being considered is to the way mortgages on second homes are treated in the Norwegian covered bond framework, according to Sjølie.

To date, these have been included alongside residential mortgages on first homes. However, he said that with the regulator considering that LTVs on second homes should have the same limit as for commercial mortgages, 60%, rather than the 75% limit on residential mortgages, they could also be reclassified as commercial mortgages.

“I don’t find that logical given that they are still homes,” said Sjølie.

He said that any such regulation could affect institutions with second home mortgages in their cover pools because issuers have generally chosen to restrict their programmes to either residential or commercial collateral, and not a mix of the two.

However, a funding official at an issuer who had not yet heard of the development said that it would have little impact given the low proportion of such mortgages in the issuer’s cover pool.

Sjølie said that a consultation on the proposal is underway and any regulation could be in place by year-end.