In its Covered Bond Market Insights report, S&P Global Ratings presents the local covered bond market, explains how the relevant legal framework works, provides an overview on the local mortgage market, and compares key characteristics of the existing programs.

In our view, stable ratings and outlooks on issuers and a strong sovereign will continue to support ratings stability for Swedish covered bonds in the medium term, despite the COVID-19 pandemic.

S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions, but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Overview: Sweden, A Nordic Benchmark

The Swedish covered bond market is relatively young but continues a long tradition of mortgage bonds funding property purchases in the country. Until the mid-2000s, specialized Swedish mortgage institutions issued unsecured mortgage bonds. Because mortgage banks had limited business scope, the mortgage bonds were regarded as covered by mortgages even if not directly linked to mortgage collateral by law. Once implemented in 2004, covered bond regulation converted existing mortgage bonds to covered bonds. Covered bonds now make up approximately 50% of all debt issued by Swedish Monetary Financial Institutions.

Today, Sweden has one of the top 5-largest covered bond markets together with Denmark, Germany, France, and Spain, with outstanding issuances totaling €244 billion at end-2019. However, public euro-denominated benchmark covered bond issuance from Sweden was only €5.1 billion in 2019, below the yearly average observed since 2010 (see chart 1).

Chart 1

Chart 2

Swedish Government And Central Bank Will Provide COVID-19-Related Support

Following the outbreak of COVID-19, the government has announced support packages totaling more than Swedish krona (SEK) 800 billion, or 17% of GDP. Additionally, the Swedish central bank (Riksbank) announced it would increase securities purchases during the year by up to SEK300 billion. The purchases include government and municipal bonds, covered bonds, and securities issued by nonfinancial corporations. The aim of the purchasing program is to support demand, output, and employment in Sweden and provide broad support to credit supply in the Swedish economy. We do not expect these support packages will be fully utilized, but do not exclude the possibility that further support will be made available.

We expect Riksbank's monetary policy will remain loose until at least 2022, and anticipate covered bond yields will remain at historically low levels.

European Covered Bond Framework Could Change Swedish Law

In September 2019, the European Parliament approved the final version of the directive and regulation on covered bonds harmonization. Following publication of the directive and regulation in the Official Journal of the European Union, national authorities have 18 months to integrate the new rules into their national legislation, and an additional 12 months to apply them. The alignment of the Swedish legislative framework with the best practices of the European Banking Authority is medium (see "Harmonization Accomplished: A New European Covered Bond Framework," published April 18, 2019).

The overcollateralization requirements of the EU's final directive for covered bonds seem compatible with Sweden's current law, but adjustments to the law's liquidity requirements, which rely largely on the issuer's own liquidity management, such as guarantees, liquidity lines from the parent bank and active repurchase of outstanding bonds by the issuer, may be necessary. To help mitigate liquidity risk, Swedish issuers may consider adopting covered bonds with soft bullet structures. Furthermore, it is unclear if limits on bank exposures will affect the derivative setup in Sweden, which often relies on derivative agreements with a single counterparty.

Due to Swedish covered bonds' hard bullet format, we adjust the uplift for lack of liquidity coverage. The implementation of 180 days of liquidity cover would allow for an additional notch of collateral-based uplift over the issuer's jurisdiction-supported rating level (JRL) under our covered bonds criteria.

Sweden's Mortgage Market Not Immune To COVID-19 Effects

We expect the impact of the COVID-19 pandemic, particularly on the economy, will affect house prices in nearly all European markets this year. House price growth in Sweden has been stabilizing since late 2017, despite continually increasing household debt. In our view, the Financial Supervisory Authority's measures, aimed at faster amortization and lower loan-to-value mortgages, have gradually strengthened household balance sheets. However, the progress in reducing household indebtedness is exclusively thanks to the use of macroprudential measures. Since the onset of COVID-19, we have observed a temporary relaxation on amortizations, but expect this will revert as the situation stabilizes.

Since 1994, toward the end of the 1990s crisis, Swedish house prices have experienced a remarkable run of almost uninterrupted growth. The 2008 financial crisis, a more recent correction caused by amortization requirements, and the outbreak of COVID-19 have done little to alter the general view of elevated house prices. The market's positive development has both supported and been supported by continued issuance of Swedish covered bonds. In 2019, the volume of outstanding covered bonds had increased to SEK2.5 trillion up from SEK1.6 trillion in 2010.

Chart 3

Sweden's Covered Bond Framework

Swedish covered bonds are issued on the basis of the Swedish covered Bonds Issuance Act ("Lag 2003:1223 om utgivning av sakerstallda obligationer") and complementary regulation on the issuer license, valuation procedures, eligible assets, asset and liability management, and maintenance of cover register ("FFFS 2013:01"). The Act came into force in 2004 and has been amended on several occasions.

All issuing institutions must have a specific license to issue covered bonds to ensure that the covered bonds are part of the individual banks' long-term business model. Most Swedish mortgage assets are originated and covered bonds issued by separate mortgage bank entities, like Swedbank Hypotek AB, Stadshypotek AB, Nordea Hypotek AB, The Swedish Covered Bond Corp., and Länsförsäkringar Hypotek AB (LF Hypotek), for example. However, covered bonds can also be issued directly from a bank's balance sheet, as is the case with SEB AB and Landshypotek Bank AB. For those issued directly from the balance sheet, legislation protects and segregates the cover pool post issuer insolvency.

In addition to general banking supervision, a bank issuing covered bonds is subject to a special form of supervision by the SFSA to ensure compliance with the covered bond law. The SFSA appoints an independent cover pool inspector to ensure that the register for the cover pool is properly maintained and to ensure compliance with the law's matching and market risk limits at all times. Derivatives must be entered in the cover registers, and payments to counterparties rank equal to covered bond creditors.

The limits set by Swedish law on loan-to-value (LTV) ratios for loans in the cover pool decides the eligible loan part, which benefits covered bond investors. Should the market value of the properties that secure the loans decline, LTVs above the regulatory limits will be ineligible for the cover pool.

Credits to the public sector, such as municipalities, are also permitted. Up to 20% of the cover pool value may consist of other liquid assets such as cash, government securities, and covered bonds issued by other institutions as substitute collateral. The SFASA can extend the limit to 30% on "special grounds".

Chart 4

Table 1

A key feature of the Swedish domestic SEK-denominated covered bond market is the tap issuance format, which allows issuers to frequently access the market in smaller issuance sizes. The tap market helps issuers matching assets and liabilities without having to rely on infrequent, and potentially uncertain benchmark issuance in the international covered bond markets.

Euro benchmark issuance remains an alternative and provides Swedish issuers with longer-term funding opportunities compared with the domestic SEK market. Euro-denominated funding also provides investor diversification, although its attractiveness depends on the cost of required swaps. As a result, the level of euro-denominated issuance has fluctuated over time and reflects the euro/SEK interest differential.

Focus On Amortization Continues

On June 1, 2016, regulation came into effect requiring further amortization of Swedish mortgages (1% annually for loans with an LTV ratio above 50% and 2% for loans with an LTV above 70%). Legislators introduced further requirements at the end of 2017. The amortization requirement introduced in 2016 was associated with the LTV ratio--the mortgage in relation to the value of the home--while the 2017 amendment required new borrowers with mortgages greater than 4.5 times their gross income to amortize an additional at least 1% of the debt each year.

Because the changes only apply to new mortgages, we have so far not observed significant changes to weighted-average maturities of mortgage loans in the cover pool (see chart 5).

Chart 5

We expect the ongoing focus on formal amortization requirements will be positive for asset and liability mismatch management in Swedish covered bonds, and lower the volume of interest-only loans.

Chart 6

The covered bond law requires that the nominal value of the assets is higher than the value of the liabilities at all times. Additionally, issuers must include 2% overcollateralization based on stress tests considering interest rate and currency risk. There are currently no further liquidity coverage tests in within the law.

Table 2

Mortgage Market Overview: COVID-19 Pushes GDP Down And Unemployment Up

Due to the impact of the COVID-19 pandemic, we have revised downward our expectations for the Swedish economy. We anticipate Sweden's real GDP will decline by 5.8% in 2020 before recovering by 4.0% in 2021. The government has initiated fiscal stimulus to support the economy, including committed guarantees, deferral of taxes and value-added tax, increased spending, and reduced payroll tax and revenue support.

We have revised our labor market forecasts for the next few years and expect an unemployment rate of 9.5% for 2021, up from 6.4% in 2018. Still, according to our forecasts, Sweden will have a lower unemployment rate than the EU average, but higher than that of peer countries.

The impact of the COVID-19 pandemic will push the Swedish economy into a recession in 2020. This is as a result of weak consumption due to the containment measures imposed by the government, as well as weak exports.

Table 3

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In 2018, national house price growth stagnated following year-on-year increases in 2016 and 2017 of 8%. House price growth reemerged over the course of 2019, but at moderate levels. Growth has continued in 2020, and we expect moderate growth for the year despite the impact of the pandemic.

We expect house prices will remain moderate in 2021 and 2022, partly due lower supply in residential property.

Features Of Swedish Covered Bond Programs

While relatively homogeneous, the Swedish covered bond market comprises covered bonds backed by a mix of assets: residential, commercial, multifamily, agriculture mortgage loans, and public sector debt. A cover pool can include different types of assets but the law limits the percentage of strictly commercial assets to 10% of the collateral pool. Generally low interest rates have made it challenging for issuers to use covered bonds to refinance public debt, and so it makes up a small fraction of cover pools.

Approximately 98% of outstanding covered bonds--Säkerställda obligationer (SOs)--issuance is backed by a mix of two types of collateral: residential mortgage-backed (including tenant-owner rights) and commercial mortgage-backed covered bonds. Swedish regulators consider multifamily properties as residential collateral, while we analyze their credit risk by applying our commercial real estate criteria (see "Related Criteria").

Residential mortgage loans:   The majority of Swedish residential mortgage loans are secured by single-family homes and have a variable interest rate fixed for less than a year, and borrowers are protected as for other consumer loans. The level of amortization depends on borrowers' LTV ratio, and multiple loan parts per borrower are common, where one part could be repayment and the other interest only. The mortgages backing Swedish covered bonds often include a portion of residential mortgage loans paying interest only until their contractual maturity date, which may be the next interest reset date (three months) or 40 years. In our analysis of credit risk in Swedish covered bonds, we consider that the issuing bank has defaulted and that the cover pool administrator is winding down the pool's assets to meet payments on the covered bonds. We understand that the administrator has a legal right to request full amortization on the loan at market conditions, after the default of the issuing bank. We expect the maturity for an amortization post issuer default to be in line with the maximum offered in the market.

Historically, mortgage loans have much shorter observed maturity dates due to Sweden's high prepayment rates secured by the consumer protection act. In line with our covered bonds criteria guidance, we consider the constant prepayment rates (CPR), an input in our asset-liability mismatch analysis, at 5% for mortgage loans in Sweden (see "Guidance: Covered Bonds Criteria," published on May 2, 2018). We will continue to monitor the market and adjust CPR levels considering market trends.

Bostadsrat:  Historically, the preferred form of ownership of apartments in Sweden has been "Bostadsrat" (tenant-owner right). Supply has grown significantly compared with the only other alternative--rental apartments. Bostadsrat are mainly found in the larger Swedish cities but the ownership format is found throughout Sweden. Buyers obtain a "right to live" in an apartment as part of a cooperative housing association. Additional to own mortgage payments, the borrower has an obligation to pay a monthly service fee to the association, which helps maintain the association and pay off the first ranking mortgage loan to the association. Since tenant-owner-right borrowers often have a second-ranking right and can be liable for additional payments (for example, if other owners do not pay), we consider these loans may have higher foreclosure frequencies depending on loan seasoning.

Chart 9

Commercial real estate loans:   Commercial properties eligible for Swedish cover pools vary but consist mainly of office space, retail facilities, and to a lesser extent, industrial space. However, the largest segment is often housing associations and multifamily housing, which from a regulatory standpoint is not considered commercial real estate exposure. The loans are normally variable-rate linked to the Swedish interbank offered rate (STIBOR) and have shorter maturities and interest-only characteristics.

Public sector loans:   Public sector loans are relatively diverse, ranging from loans to Swedish local and regional governments, public utility companies, export credit agencies, and supranationals. However, the market share of local and regional government funding has decreased, because banks have struggled to find assets with attractive margins for covered bond funding. Funding cost for the public sector remains very low, but the funding demand may increase on the back of the COVID-19 outbreak.

Green covered bonds   A potential new source for issuance growth is green and social covered bonds. Landshypotek helped pave the way for green covered bonds, while SBAB Bank and its subsidiary the Swedish Covered Bond Corporation have both considered following suit (see Are Covered Bonds Becoming More Sustainable?,", published Sept. 6, 2019). This is in part due to the perceived advantageous funding conditions for green and social covered bonds but, more importantly, issuers state that there's interest from investors who normally do not invest in the covered bond market. The green and social market remains limited in size, but with increasing local covered bond investor interest, we expect Swedish covered bond issuers will be at the forefront of developments within this expanding segment.

Comparison Of Swedish Covered Bond Programs:

The strong Swedish economy and low interest rates have been very supportive of the mortgage market's performance. Due to the relatively high level of perceived property overvaluation in Sweden, the credit risk of the residential component of Swedish cover pools is slightly higher than credit risk in cover pools in strictly residential-based jurisdictions with more stable house prices. However, the very low mortgage LTV ratios in Sweden reduce expected losses when defaults occur, which compares positively with other jurisdictions with higher LTV ratios.

Table 4

Chart 10

Rating Outlook: Bonds Are Well Insulated From The Risk Of Bank Downgrades

Chart 11 shows the very high issuer credit ratings (ICRs) assigned to the majority of the Swedish covered bond issuers. These allow all rated issuers to reach the 'AAA' rating for their covered bonds based on jurisdictional support alone.

Chart 11

Table 5

Chart 12 shows the breakdown of the average target credit enhancement levels compared with available credit enhancement across countries. Swedish programs on average have slightly lower credit risk compared to peer countries, but higher market risk, reflecting asset liability mismatch. The available credit enhancement is currently higher relative to other peer countries.

Chart 12

Scenario Analysis

We recently published our guidance for analyzing residential mortgage loans in Sweden. We do not expect the new guidance will impact our covered bond ratings (see "Guidance: Global Methodology And Assumptions: Assessing Pools Of Residential Loans," published Jan. 25, 2019.) In our last Covered Bond Market Insight on Sweden we performed a scenario analysis in which we applied considerable drops in house prices (35% and 55% lower), and saw no rating impact (see "Swedish Covered Bond Market Insights 2019," published on April 29, 2019). We expect no ratings impact if we were to model similar declines in house prices when applying the new guidance.

Related Criteria

• Global Methodology And Assumptions: Assessing Pools Of Residential Loans, Jan. 25, 2019
• Covered Bond Ratings Framework: Methodology And Assumptions, June 30, 2015
• Methodology And Assumptions: Analyzing European Commercial Real Estate Collateral In European Covered Bonds, March 31, 2015
• Methodology And Assumptions For Assessing Portfolios Of International Public Sector And Other Debt Obligations Backing Covered Bonds And Structured Finance Securities, Dec. 9, 2014
• Covered Bonds Criteria, Dec. 9, 2014

Related Research

• Sweden 'AAA/A-1+' Ratings Affirmed; Outlook Stable, Aug. 14, 2020
• German Covered Bond Market Insights, July 20, 2020
• How COVID-19 Will Change Covered Bonds, July 8, 2020
• Credit Conditions Europe: Curve Flattens, Recovery Unlocks, June 30, 2020
• Global Covered Bond Characteristics And Rating Summary Q2 2020, June 30, 2020
• Global Covered Bond Insights Q2 2020, June 30, 2020
• Government Job Support Will Stem European Housing Market Price Falls, May 15, 2020
• European Economic Snapshots: Larger Risks To Growth Loom Ahead, May 5, 2020
• French Covered Bond Market Insights, Feb. 18, 2020
• Spanish Covered Bond Market Insights, Jan. 29, 2020
• Dutch Covered Bond Market Insights, Nov. 21, 2019
• Are Covered Bonds Becoming More Sustainable?, Sept. 6, 2019
• Harmonization Accomplished: A New European Covered Bond Framework, April 18, 2019
• Can A Housing Market Crash Cripple Sweden's Economy?, June 26, 2018
• Glossary Of Covered Bond Terms, April 27, 2018
• New Swedish Mortgage Amortization Law Will Likely Benefit Swedish Covered Bonds By Reducing Asset-Liability Mismatch, June 3, 2016

Related Transaction Updates

• Transaction Update: Lansforsakringar Hypotek (Mortgage Covered Bond Program), March 19, 2020
• Transaction Update: Swedbank Mortgage AB Covered Bond Program, March 17, 2020
• Transaction Update: Landshypotek Bank AB (Mortgage Covered Bonds), Dec. 13, 2019
• Transaction Update: Sparbanken Skane (Mortgage Covered Bond Program), Dec. 3, 2019
• Transaction Update: Danske Hypotek AB (Mortgage Covered Bond Program), Sept. 3, 2019