Norwegian banks have strengthened their credit underwriting standards, according to a survey by the country’s FSA, noted Moody’s today (Wednesday), saying that this is leading to an overall improvement in the credit quality of covered bond collateral.

According to the results of a lending survey by the Norwegian Financial Supervisory Authority (Finanstilsynet), banks have reduced the proportion of the riskiest loans that they originate, said Alexander Zeidler, vice president, senior analyst, and Alix Faure, assistant vice president, analyst, at Moody’s.

This improves the credit quality of the cover pools that back covered bonds, they said.

The lending survey covers 7000 loans originated by the 30 biggest banks (reflecting 88% market share) in August and September 2013. The results of the survey were published on 5 November.

Moody’s said that the proportion of interest-only (IO) loans is falling, having dropped by half within two years to a low of 11.7%, and that the average length of IO periods has shortened from around four years to three.

“The decrease in the proportion of IO loans and the shortening of IO periods are credit positive for the collateral quality as it requires borrowers to better adjust their spending habits to suit their loan repayment requirements,” said Zeidler and Faure.

Another positive trend is that the proportion of high loan-to-value (LTV) loans to young borrowers has fallen, according to the analysts. Loans with an LTV exceeding 85% are down to 15% of new production from 17% last year. The share of high-LTV loans to borrowers younger than 35, who typically are first time buyers and at higher risk of becoming delinquent, fell from 34% to 27.7%.

“We see this reduction in the proportion of high LTV loans as a positive development as the LTV is a key driver of the collateral credit risk,” they said.

In addition, the vast majority of borrowers would be resilient to a rise in interest rates, according to Moody’s, which noted that because most Norwegian loans are floating rate the FSA’s lending guidelines require banks to test borrowers’ affordability if interest rates rise by 5 percentage points.

Although the quality of banks’ credit underwriting standards has improved overall, this is partly offset by an increase in the proportion of flexible loans to young borrowers at higher LTV levels, noted Moody’s.

The analysts said that the share of FlexLoans of all residential loans has marginally decreased, from 25.5% to 23.5%, after years of increases.

“This decrease in the proportion of FlexLoans is credit positive as these loans are riskier than fully amortising loans because their principal can increase over time through additional loan draws, and such draws are likely to occur in an economic downturn,” said Zeidler and Faure.

However, banks are granting more FlexLoans with high LTV ratios to young borrowers than before, which is credit negative, they said.

The share of loans above 70% LTV to younger borrowers has increased to 20.7% from 14.5% last year, noted the analysts.