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 this report, we review the Swedish covered bond market.

Overview: Sweden, A Nordic Benchmark

2020 was a challenging year for covered bond issuance in Sweden. For the first time in years, the market experienced a decrease in outstanding covered bonds. Sweden remains one of the five-largest covered bond markets, together with Denmark, Germany, France, and Spain, with outstanding issuance totaling €248 billion at end-2020. Further, public euro-denominated benchmark covered bond issuance from Sweden remains subdued, with only €1 billion issued so far in 2021 (chart 1).

The Swedish covered bond market is relatively new 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 48% of all debt issued by Swedish monetary financial institutions.

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Covered Bonds Face Competition From Deposits And The Central Bank

In 2021, we expect Swedish investor-placed benchmark covered bond issuance to be lower than in 2020, similar to that of other European issuers. This is due to significant growth in bank deposits due to reduced consumer spending. Further, the Swedish central bank (Riksbank) started its purchase of covered bonds in March 2020. The holdings of covered bonds increased to SEK362 in August 2021. Despite the lower issuance, Sweden's banks continue to rely on domestic and foreign wholesale funding to a large extent, relative to customer deposits, so we expect issuance to eventually recover in covered bonds.

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

Following the pandemic, the government has announced several support packages. 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 unprecedented government support has cushioned the pandemic's impact on the economy and labor market, contributing to Sweden's comparably mild economic contraction relative to European peers'. Measures include committed guarantees and tax deferral, as well as increased spending to support the labor market, business, and local and regional governments (LRGs). The government has announced additional support packages totaling more than SEK400 billion (8% of GDP), while guarantee commitments and liquidity support exceed SEK600 billion (12% of GDP), although we do not expect these will be fully utilized. That said, we do not exclude the possibility of further support packages or adjustments to current measures if recovery stalls.

We expect Riksbank's monetary policy will remain loose until at least 2023, and anticipate covered bond yields will remain at historically low levels.

COVID-19 Has Delayed The Harmonization Transposition Into National Law

Despite a generous transposition period, the pandemic delayed work on covered bond legislation in most EU countries. Sweden and a number of countries have not met the deadline to transpose the EU directive, leaving harmonization as work in progress.

On Nov. 4, 2020, the Swedish government published a detailed draft proposal and request for comments to amend the Swedish covered bond law. The main proposed amendments to the existing law relate to loan-to-value (LTV) requirements, overcollateralization, the introduction of 180 days' liquidity coverage, and clarification of rules for extensions.

We understand the work is ongoing and that a final law is expected toward the end of 2021. We still believe coverage of 180 days' liquidity will be positive for credit enhancement for some Swedish covered bonds. We expect the amendments to the law will enter into force on or before the July 8, 2022 deadline.

The Swedish Property Market Maintains Momentum Despite COVID-19

The pandemic did not cause a correction in the Swedish real estate sector as house prices continued to rise. House prices increased over 10% in 2020 (fourth-quarter year-on-year estimate), the largest increase from European countries. This demand is driven by low interest rates, tax incentives, limited housing supply, growth in income, and increasing household debt. In second-quarter 2020, average house price rose 6% year on year in Stockholm, which was accompanied by a 4.6% rise in the number of houses sold.

Spending most of their time at home, people placed more value on owning a home. Price-to-rent and price-to-income ratios rose further in 2020 and are close to their all-time highs in most European markets. The Swedish price-to-income ratio also increased sharply, surging by 6.2% in second-quarter 2020. We forecast a further 4.5% expansion in the housing market for 2021 and a slightly less pronounced 2.7% in 2022 (see "Europe's Housing Market Will Chill In 2021 As Pent-Up Pandemic Demand Eases," published on Feb. 22, 2021).

The housing market in Sweden has been stabilizing since late 2017, despite continually increasing household debt. In our view, the Swedish Financial Supervisory Authority's (SFSA's) measures, aimed at faster amortization and lower LTV mortgages, will gradually strengthened household balance sheets. However, the progress in reducing household indebtedness is exclusively thanks to the use of macroprudential measures. Since the start of the pandemic, we have observed a temporary relaxation on amortization, 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 population of Sweden has continued to rise through this period (chart 4)--driven mainly by positive net migration. Simultaneously, construction of new dwellings has been at historic low levels, and only recently picked up to meet pending demand (chart 5). Growth has been particularly strong in urban areas, which we expect to continue to support demand for housing, despite the pandemic.

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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 LTV ratios for loans in the cover pool decide 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 SFSA can extend the limit to 30% on "special grounds".

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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 match 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.

Amortization Requirements Reintroduced

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.

Due to the spread of the coronavirus and its effects on the Swedish economy, on April 14, 2020, Finansinspektionen decided that banks were given the possibility of granting temporary exemption from amortization requirements to all new and existing mortgagors. Around 12% of Sweden's mortgagors used the exemption--essentially switching full or partly to an interest-only mortgage. For new lending, Finansinspektionen's evaluation indicates that the temporary exemption resulted in new mortgagors taking slightly larger mortgages and buying slightly more expensive homes. The exemption resulted in new mortgagors borrowing around 4% more and buying homes that were approximately 1% more expensive. The exemption expired on Aug. 31, 2021.

Due to the amortization requirement only applicable to new mortgages and the introduction of amortization exemption during the pandemic, we have so far not observed significant changes to weighted-average maturities of mortgage loans in the cover pool (chart 7).

Chart 7

We expect the ongoing focus on formal amortization requirements will be positive for asset and liability mismatch management in Swedish covered bonds, and will reduce the volume of interest-only loans. Currently, interest-only mortgages remain elevated following the pandemic. We expect the reactivation of the amortization requirements to help stabilize Swedish house prices.

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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 within the law.

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Mortgage Market Overview: The Economic Rebound Supports The Swedish Housing Market

We estimate that the Swedish economy contracted by 2.8% in 2020 because of the pandemic. The decrease in GDP growth is expected to be less pronounced in Sweden than in the eurozone (-6.7%). Milder recession can be attributed to the fact that Sweden left a greater share of its economy open during the pandemic as opposed to a series of regional lockdowns introduced across Europe. We forecast the economy will rebound by 3.0% in 2021 and further by 2.8% in 2022. The recovery is being supported by the SEK105 billion stimulus package dedicated to fostering the economy and mitigating the impact of the pandemic.

The Next Generation EU plan could add 0.5% to Swedish GDP (cumulative by 2026) under our low-impact scenario over the next five years and 1.2% under a high-impact scenario. With its €750 billion Next Generation plan, the EU aims to repair the damage that COVID-19 wrought and reset economic growth onto a higher and more sustainable path.

Unemployment reached 8.3% in 2020 and remains above the eurozone average of 8.0%. However, Sweden's robust benefit system as well as the unprecedented support from the Swedish government to LRGs should help to limit negative effects on the economy. We estimate the unemployment rate will increase further to 9.0% in 2021 and decrease to about 8.0% in 2022. In our view, the labor market recovery will be supported by the COVID-19 stimulus package.

Table 3

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In 2020, house prices increased over 10%--the largest increase from European countries, despite the pandemic. We note that house price growth has outpaced income growth, and we continue to follow the development of household indebtedness in the Swedish mortgage market. We expect house price growth to be more tempered in 2022 as the economy starts to normalize and amortization requirements are reintroduced in fourth-quarter 2021.

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; 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 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. In addition 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. In 2021, the share of loans secured by tenant-owner rights in our rated programs remains stable versus previous years (chart 11).

Chart 11

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 LRGs, 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 pandemic.

Green covered bonds and ESG considerations  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.

Environmental and social credit factors are typically credit neutral in our analysis of Swedish mortgage covered bonds. Certain features of the Swedish tax system and market have incentivized the origination of a relatively high proportion of interest-only loans, which we consider as credit negative in our analysis. However, the share of this type of loans declined since 2016, with the introduction of mandatory amortization requirements.

In terms of governance, the Swedish covered bond framework does not require issuers to maintain liquid assets to cover at least six months of liquidity needs. This leads to a reduction of the achievable ratings or the number of unused notches available in all our rated programs due to the lack of liquidity coverage.

We also consider governance factors as being relatively less supportive in Swedish programs where there is no commitment to maintain a minimum level of overcollateralization. This introduces the risk that the available credit enhancement could decrease in the future to levels that are not commensurate with the current rating, and it reduces the achievable ratings or the number of unused notches available to the covered bond program.

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.

In 2021, the indexed weighted average loan to value ratio in our rated programs has decreased thanks to Swedish house-price increase. The credit coverage (Foreclosure Frequency and Loss Severity) has improved mainly due to the application of revised guidance for the criteria for assessing pools of residential loans. The improvement in WAFF is driven by the application of the new LTV curve, which considers effective loan to value (ELTV) ratios (based on 80% OLTV/20% CLTV). In the previous criteria, only the original LTV was considered for WAFF calculation. Furthermore, under the new guidance, tenant-owner-right loans originated with affordability test and seasoning higher than 18 months are not penalized, which also has positive impact on WAFF calculation. The decrease in WALS is majorly driven by the updated higher threshold for jumbo valuation and the removal of penalty on tenant-owner-right loans being applied on adjusted market value decline previously.

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

The majority of the Swedish covered bond issuers have very high issuer credit ratings (ICRs) (chart 13). These allow all rated issuers to reach the 'AAA' rating for their covered bonds based on jurisdictional support alone. The programs benefit from different numbers of unused notches. These are notches by which the ICR can be lowered, without resulting in any effect on the covered bond program's jurisdiction-supported rating level (JRL), all else being equal

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Table 5

Swedish programs on average have slightly lower credit risk compared with peer countries, but higher market risk, reflecting asset liability mismatch. The available credit enhancement is slightly higher relative to other peer countries (chart 12).

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Scenario Analysis: Swedish Covered Bonds Ratings Can Withstand House-Price Corrections

Despite a stable outlook for the housing sector, we have carried out scenario analysis with large drops in house prices to gauge whether these would affect the overcollateralization that is commensurate with our rating. In our current credit model, we consider that the Swedish house price reflects an overvaluation of 29.8%. We have tested this scenario analysis for house-price drops of 20% and 50%, which is in line with what occurred in the early 1990s, where single family house prices decreased by 20% from their 1989 peak.

The overcollateralization in line with our current rating does not increase significantly in the worst scenario (table 6). These hypothetical price drops do not affect the achievable rating on any of the programs either.

Table 6

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

• Global Covered Bond Insights Q3 2021, Sept. 9, 2021
• Covered Bonds Outlook Midyear 2021: Credit Stable Despite Waning Support, July 23, 2021
• Covered Bond Harmonization In The EU Remains A Work in Progress, July 13, 2021
• European Economic Snapshots - The Economy Is Responding Quickly To The Grand Reopening, July 9, 2021
• French Covered Bond Market Insights 2021, June 16, 2021
• Global Covered Bond Insights Q2 2021, June 30, 2021
• Europe's Housing Market Will Chill In 2021 As Pent-Up Pandemic Demand Eases, Feb. 20, 2021
• Swedish Covered Bonds: Harmonization Plan Paves Way For Further Rating Uplift, Feb. 4, 2021
• Norwegian And Finnish Covered Bond Market Insights 2021, Jan. 19, 2021
• ESG Industry Report Card: Covered Bonds, Nov. 9, 2020
• Sweden 'AAA/A-1+' Ratings Affirmed; Outlook Stable, Aug. 14, 2020
• 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: Danske Hypotek AB (Mortgage Covered Bond Program, Aug. 19, 2021
• Transaction Update: Swedbank Mortgage AB Covered Bond Program, March 17, 2020
• Transaction Update: Landshypotek Bank AB (Mortgage Covered Bonds), Dec. 22, 2020
• Transaction Update: Sparbanken Skane (Mortgage Covered Bond Program), Oct. 7, 2020
• Transaction Update: Lansforsakringar Hypotek (Mortgage Covered Bond Program), April 14, 2021