At the end of a year that leaves Norway as one of few covered bond markets to have grown, Susanna Rust spoke to Stein Sjølie, director at Finance Norway, about home-grown initiatives to boost secondary market liquidity, the importance of top tier LCR status for covered bonds, and signs of a cooling off in the housing market.

The European Banking Authority (EBA) is apparently not going to recommend that covered bonds be treated as Level 1 assets under the CRDIV Liquidity Coverage Ratio (LCR) — what is the Norwegian perspective on this?

The EBA did a survey looking at the availability of Level 1 liquid assets in different markets and they found that in the Danish market and the Norwegian kronor market there would be a deficit if covered bonds were not included as Level 1 assets. So the seriousness of this problem has already been observed by the EBA and by national supervisory authorities. Something has to be done. If the supervisory authorities want Norwegian banks to comply with the regulation they have to make it possible to comply. That’s our point of view.

Those countries with large covered bond markets and stable sovereigns want to have covered bonds as part of Level 1 liquidity buffers so that there is a large enough pool of liquid securities for banks to meet all their requirements for high quality liquid assets. In some other countries the state wants to have a priority for government bonds, so to speak, but it’s always a question of who is going to buy all those government bonds from sovereigns that are in less good shape. If you look at the proposal government bonds from some countries that have restructured their debt, like Greece for example, would be eligible as Level 1 assets even if the rating agencies rate them as junk, whereas you may not use triple-A rated covered bonds from countries like Germany or the Nordics. We think that is not very logical. In Norway the secondary market for covered bonds might not be looked upon as that liquid, but we are working on that.

In what way? Can you give examples of some initiatives?

There is trading in the secondary market and there have been developments making it more liquid, and we are trying to see what can be done and are taking some small steps in the right direction. Now, for example, it will be possible to lodge indicative prices on the Oslo Stock Exchange, which will make prices more transparent I think. Many banks and investment firms post prices on Bloomberg, but that’s not a trading platform. Oslo Børs is a trading platform and all Norwegian covered bonds are registered and traded on that stock exchange, but that trading has not been very transparent because usually when a bank or investment firm sells or buys a bond it is done in-house and later on the prices are disclosed on the stock exchange, but you don’t have transparent real prices during the day for example.

Now it will be possible for all these banks and investment firms that trade in the bonds to make indicative prices on Oslo Børs. That may increase the visibility and transparency of prices in the secondary market, so that’s one step.

The Norwegian covered bond market is also a relatively young one. It hasn’t been around for as long as the Danish and Swedish markets, so it will take some time but we see an increase in secondary market activity. There are buyers and sellers in the market — local and institutional investors and mutual funds and other investors that are eager to have this market and want to trade it.

Then there is also a combined initiative from the Norwegian Fund and Asset Management Association (Verdipapirfondenes forening (VVF)) and Norsk Tillitsmann, a trustee firm. They have created a set-up that aims to publish prices on all traded Norwegian bonds, including covered bonds. Mutual funds need daily prices and the aim is for the prices to be published on some sort of website or platform that is being worked on. All these initiatives are market-led. They are small steps of course but we think that together they will help the market take off so it can become more liquid. The Norwegian covered bond market is now a larger market than the Norwegian government bond market and probably more liquid in a sense that there is more trading. Around 70% of Norwegian government bonds are held by foreign institutional investors and they keep them. Only a very small portion comes to the market so that reduces the availability of the government bonds.

One of the main issues for Norwegian covered bonds in 2013 was the Financial Supervisory Authority’s scrutiny of the use of the funding instrument from an asset encumbrance perspective — has that issue been settled?

As I see it is settled. The supervisor will focus on what is going on in the various banking groups by looking through to the individual banks and groups and how they manage the transfer of mortgages to the covered bond issuing institution. If they find that something has to be done they may give some recommendation but so far we haven’t heard of this having happened. There will be no formal regulations on this. It’s a satisfactory approach from our point of view.

There has been quite a lot of focus on the Norwegian mortgage market in recent years and the FSA has tightened risk weights …

Yes, there has been a tightening of regulation, both on risk weights and lending guidelines, with the FSA advising banks and credit institutions not to give mortgages with loan-to-value ratios above 85%. That has been working as well as the tightening of the risk weights.

At the same time is the government not speaking about wanting to ease mortgage lending standards?

Yes, well, the new government has been speaking about that but I don’t know how that will end up. So far the new minister of finance has just written to the FSA to ask about how these guidelines are practiced and implemented and probably there will be an answer from the FSA that the guidelines will be monitored and practised in a flexible way, meaning that there are guidelines but that if borrowers may demonstrate that they are able to finance higher LTVs then it will be up to the individual banks how they manage that. I don’t foresee any large changes in that respect.

How have house prices been developing recently?

The housing market is cooling off a bit now. It’s difficult to say whether it is due to the tightening of regulations or if it’s a case of a turning point after a relatively long upturn. Maybe we’re seeing that the market has come to a point where it is changing direction. House prices had been increasing year by year for several years now and it is cooling now. We have passed a point where the prices don’t increase any more. Some say they may fall. I am careful about making any prognosis but this autumn at least there has been a cooling off of house prices.

We’ll see in the months to come and if this is a stabilisation or if there will be a further fall. There hasn’t been any dramatic change in the economic environment outside of the property market so therefore you probably would not expect a dramatic change in house prices either.

What is the operating environment for Norwegian banks?

At the moment it is very positive. Banks have positive net interest margins on their banking business and are making good profits. Their loan losses are moderate and banks are generally concentrating on cost reduction now because competition is fierce. Full year results will probably be very good for this year.

So there is a positive operating environment and signs of the housing market cooling, so all of that bodes quite well. What challenges do you anticipate?

It’s a bit strange when you have an economy like the Norwegian one where general costs are much higher than in the neighbouring countries. Norwegian industries are going fairly well but there is cost competition with the neighbouring countries. It’s very difficult in some way for some of the traditional industries, of which there isn’t much left, like forestry or metal industries. They face a difficult economic environment especially when all the neighbouring countries have spare capacity. There is higher unemployment and much lower wages in the neighbouring countries and industries in those countries have spare capacity so how long can an economy like Norway run a comfortable growth at this high wage level when it is open to competition from neighbouring countries. This is a challenge for Norwegian business and the economy, there is no doubt about that.

European policymakers recently reached agreement on key features of the new EU bail-in framework. What position are Norwegian banks in in terms of having enough bail-inable debt?

Norwegian banks will have to have bail-inable debt like all European banks. They have pretty large volumes of senior debt, mainly short term and medium term as the long term senior debt during the last years was to a large extent replaced by covered bonds. The banks, of course, also have large volume of non-guaranteed deposits. The Deposit Guarantee Scheme in Norway guarantees up to half of customer deposits based on a guaranteed level of Nkr2m (Eu237,457). If you maintain that level of guarantee deposits there will be pretty large sum of bail-inable unguaranteed deposits and if we have to adjust the guarantee level to the European one, which is Eu100,000, then even more deposits will be bail-inable.

Looking ahead to 2014 is the glass half full or half empty in your perspective?

I think growth will be slower next year in the Norwegian economy and as the banks operate in the Norwegian economy therefore I think credit growth will be slower than up to now. In particular, when the housing market is cooling off there will be less credit growth from mortgage lending and less credit growth generally from the banking sector next year. I think there will be a bit of a soft landing of the economy, so to speak. There will be less growth in the covered bond market. There is a certain refinancing need for maturing bonds, including under the final term of the swap agreement with the government that was put in place as a crisis resolution tool in 2008-2009. The government swapped T-bills against covered bonds and most of these have matured already but there is still the final term next year and these loans will have to be refinanced in the market, but I think that will go pretty well.

One of the themes of 2013 was a debate about SME backed covered bonds and regulators focus on boosting lending to SMEs. Is there any talk of this in Norway?

I don’t think so, not really. It’s understandable that European politicians want to restart financing of SMEs when you look at the economic situation and low growth but in Norway that hasn’t been a big issue. The corporate sector is financed. Large corporations have financed themselves in the bond market, which means that the banks have capacity to finance the smaller and medium sized companies on their banking book but that is very traditional banking business. SMEs can find the necessary funding. It’s not an issue here and I don’t think covered bonds will be used as an instrument for SME financing. Some Norwegian issuers have started using covered bonds for commercial real estate and that may continue but at a relatively modest level.

Are the Norwegian issuers supporters of the ECBC Covered Bond Label? And of the decision to make CRD-compliance rather than UCITS-compliance a qualification criterion for the Label?

Yes, they support the Label. The major issuers will adhere to the Label and we were in favour of the alignment with the CRR.

What other big issues are there for the Norwegian banking sector?

What we want is for our regulators to implement the new European regulations in accordance with what is agreed upon on at the European level and not to be a forerunner but to keep regulations aligned. To some extent the standards in Norway are higher. The CRDIV/CRR will be effective from 1 January 2014 in European countries but that is not the case in Norway. It will be implemented probably during the third quarter of 2014 so it is a bit delayed. The Norwegian regulators have picked and chosen some items from the CRD and strengthened them, like with capital ratios. It has also been decided now to implement a countercyclical buffer, which will be implemented from 1 July 2015.

The European authorities like EBA and ESMA are not part of Norwegian regulations yet and I think that is also something that Norwegian authorities have to implement in order to comply with European regulations. We have always been a part of European regulations and we don’t want to be seen to be diverging from that or as a country that isn’t complying, so to speak.