Co-published Covered bonds guide: Norway
Covered bond legislation: a guide
Johan Christian Kongsli, Karl Rosén and Børge Grøttjord of Grette offer a detailed overview of covered bond legislation in Norway
N
orwegian covered bond legislation is based on EU legislation. Regulated covered bonds in Norway are all
UCITS compliant, are eligible as collateral in the European Central Bank (ECB), and have a reduced risk weighting in relation to EU capital adequacy requirements.
The issuer Norway permits covered bonds issuance by either: • Special covered bond issuers (SCBI) – the covered bond issuer has the status of a credit institution but does not generate any credit business by itself. The SCBI will usually be owned by one or more banks (the sponsor banks) that provide short term credit to the issuing vehicle; or
• Specialist issuers – the covered bond issuer is a credit institution generating its own credit business and refinancing it via covered bonds.
Most Norwegian banks have established an
SCBI either independently or in conjunction with one or more other banks. There are no requirements for the sponsor bank to provide any operational support or guarantees to the SCBI. In practice, the SCBI will have one or more credit facilities with the sponsor bank. Such credit agreements will usually have very few restrictions on the drawing rights of the SCBI, allowing it access to credit even if it has defaulted on payments under the credit facility or other payment obligations. For the sponsor bank, and certainly in the case of savings banks, mortgage lending will be one of their core activities. Given the likely impact on the funding prospects of the bank should it allow an SCBI subsidiary to fail, there is in any case a very strong incentive for the sponsor bank to support the SCBI as long as the sponsor bank itself is not in default.
The cover pool A preferential claim The cover pool is legally protected by legislation so that in the event of bankruptcy, debt negotiation, liquidation or public administration of the issuer, the owners of the
62 IFLR/July/August 2013
covered bonds will have a preferential right to the assets in the cover pool. The default of the sponsor bank should not trigger any claims against the assets of the cover pool since these have been transferred to the SCBI. This preferential right supersedes any preferential rights in accordance with the Norwegian Creditors Security Act. The owners of the covered bonds are also entitled to timely payments of all due amounts using the assets of the cover pool during any bankruptcy proceedings or other administration of the issuer.
Eligible assets In order to ensure the fiscal strength of the cover pool and minimise risk, only eligible assets may be included in the cover pool. Eligible assets are: • residential mortgages with a loan-to-value (LTV) ratio of less than 75%;
• mortgages secured by other real estate than residential property with an LTV ratio of less than 60%;
• public sector loans guaranteed by public entities within the EEA and the OECD;
• assets in the form of derivative agreements; • substitute assets provided that they do not add up to more than 20% of the value of the cover pool;
• loans secured by other registered assets (such as airplanes and ships) could become eligible assets provided that the LTV ratio and other relevant requirements have been determined within relevant regulations. At present no such regulations have been issued.
Combining and changing assets Norwegian covered bonds are typically based on homogenous asset cover pools consisting of either residential or commercial (other real estate) mortgages. There are, however, no restrictions prohibiting the mingling of different assets. The value of the cover pool must always
exceed the value of the covered bonds secured by the cover pool assets. Accordingly, the issuer may have to add additional assets to the cover pool in order to ensure that this
requirement is fulfilled. In practice, since the issuer is a separate entity from the sponsor banks originating the mortgages, additional assets can be added to the cover pool by the sponsor bank selling mortgages to the SCBI on credit.
Value of the cover pool The valuation of mortgages is based on a prudent estimate of the value of the property, as determined by a person without any involvement in the credit granting process. In practice, automated valuation models are commonly used both for loan origination and for tracking collateral values. The value of the cover pool (including
derivatives agreements) must at all times exceed the net present value of the covered bonds (the net present value test). Three main factors affect the net present value test. First of all, changes to the value of the properties. Secondly, changes in currency exchange rates. In Norway, a significant number of covered bonds are issued in currencies other than NOK, while most mortgages will be in kroner. And third, changes in interest rates, due to any disparity between the interest rates of the mortgages and the covered bonds. Changes in asset values due to currency and interest rate changes should, however be offset by derivatives contracts. The issuer is required to carry out periodic
stress tests to document that the conditions of the net present value test are met. There are no requirements as to the frequency of such tests other than the general requirement that risks must be managed prudently. There are no requirements for mandatory
over-collateralisation in Norway. However, it follows from the net present value test that the value of the cover pool shall at all times exceed the value of covered bonds with a preferential claim over the pool. This means in effect a requirement for some over-collateralisation. Although over-collateralisation is not
required in Norway, Norwegian issuers of covered bonds may still in practice follow internal guidelines for over-collateralisation in order to ensure the best possible credit ratings. The cover pool is required to have sufficient liquidity to meet bondholder claims. This entails that the issuer must ensure that the payment flows from the cover pool enable it to meet its payment obligations towards covered bond holders and derivatives counterparties at all times (the interest coverage test), and secondly, the issuer must maintain a minimum liquidity buffer that forms part of the cover pool as substitute assets. The size of the required liquidity buffer is
not specified in the regulation, other than that it must be prudent. In the first draft of the regulation, it was proposed that the liquidity
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