Luminor Bank is on track to issue the first covered bond and highest rated debt instrument from the Baltics, after it received a Aa1 rating for its planned issuance under Estonian legislation, which the issuer highlighted will evolve from an Estonian to a pan-Baltic cover pool.

Moody’s assigned the provisional Aa1 rating to Luminor’s planned mortgage covered bonds (hüpoteekpandikiri) on 13 January after the European Central Bank (ECB) on 19 December issued the Estonian-headquartered bank a licence to issue covered bonds following an assessment of the Estonian Financial Supervision Authority (Finantsinspektsioon).

“This is a very important step for Luminor to reach a fully independent funding structure and continue to improve our stability and liquidity position,” said Luminor CFO Jonas Eriksson upon receipt of the licence. “It is also an important milestone in the development of the Baltic financial markets.”

Although Lativa and Lithuania are working on covered bond frameworks and a pan-Baltic market is being targeted, Estonia is the only one of the three countries to have enacted legislation yet – last year – and Luminor is set to be the first issuer from the region.

However, Luminor is active across the Baltics – Estonia constitutes 27% of its loan portfolio, Lativa 29% and Lithuania 44% – and is working towards offering pan-Baltic exposure in spite of the lack of legislation in the other two countries, according to Max Ehrengren, who was formerly head of treasury and ALM.

“We are facing a situation where Estonia is the only country that has legislation in place,” he told The CBR. “They are working on it in Latvia and Lithuania, but it will most likely not exactly mirror the Estonian legislation. Many features – such as LTVs and liquidity buffers – will probably be the same, but Latvia and Lithuania will most likely feature an off-balance sheet structure whereas we are looking at on-balance sheet under the Estonian legislation.

“However, we are not super-dependent on what will happen in Latvia and Lithuania as we will issue under Estonian legislation – firstly with only Estonian assets, but in the long run we will add Latvian and Lithuanian assets in to the Estonian cover pool under the Estonian law, allowing for a pan-Baltic cover pool. So investors will be exposed to a dynamic cover pool that will be increased with Latvian and Lithuanian assets to support further issuances.”

Moody’s rating is based on an initial cover pool of €733m and expected issuance of €500m, and Ehrengren noted that when preparing the debut issuance, the favourable treatment of benchmark size in regulatory and other respects is being taken into account, also given that Luminor’s cover pool could in future reach some €3bn-€3.5bn. Indeed, proponents of a pan-Baltic market have touted such cross-border issuance as a way for issuer’s in the region to achieve critical mass.

According to Ehrengren, Luminor has yet to update its EMTN programme with the latest covered bond information, before launching the inaugural deal.

“The process might have taken slightly longer than we originally anticipated, but we are here now with both the licence and the rating,” he said. “Considering it is the first time in Estonia under the new law, it went relatively smoothly, and regarding the rating it was clear that Moody’s definitely has a lot of experience when it comes to new jurisdictions.”

With its Aa1 rating, the covered bond issuance would be the highest-rated debt instrument ever from the Baltics, according to Ehrengren. Luminor has a Baa1 deposit rating from Moody’s, while Estonia is rated A1, and Latvia and Lithuania A3.

Ehrengren said the new product should carry a variety of benefits for Luminor.

“First of all you have the diversification – you are not reliant only on senior when it comes to wholesale funding – and secondly it is very positively priced,” he said. “And thirdly, it’s a funding source that has been reliant also in times of volatility if you look at it historically.”

Olof Sundblad has taken over as Luminor’s head of treasury from Ehrengren, who is returning to Nordea, which with DNB was the bank’s co-parent before a Blackstone-led consortium took a majority stake in the bank autumn of 2019.