Market Overview

Both Norway and Finland have well-established covered bond markets, with issuance growing steadily over the past decade. The Norwegian market is the 10th largest market, and the Finnish market is the 14th largest in terms of volume of outstanding covered bonds. Together, the two countries comprise below 6% of the covered bond market, with Norwegian banks issuing approximately double the volume of their Finnish peers. Following a slow start, covered bond supply has normalized in line with last year. Finnish issuers have been comparably active following the update of the Finnish covered bond framework, with recent issuance focusing on longer bond maturities from seven to 10 years rather than the short-to-medium tenor preference in 2022 and 2023. Norwegian issuers have mainly been active in the Norwegian krone market, only recently returning to the euro-denominated market, with a longer maturity preference from five to 10 years.

The cost of covered bond funding in both markets has increased on the back of rising central bank interest rates and more volatility in bank funding costs. Although both mortgage markets are primarily variable-rate markets, banks in Norway use standard variable rates while those in Finland use constant annuity loans. The latter means that the amounts paid by customers will be unchanged if the current paid amount covers increasing interest rates. If mortgage payments do not increase in line with the cost of covered bond funding, the required credit enhancement for the current ratings is likely to increase, all else being equal.

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High mortgage rates constrain mortgage lending

To bring down inflation, Norges Bank increased the policy rate to 4.5% in December 2023. According to Norges Bank, about 90% of the policy rate increase since autumn 2021 has transferred to mortgage rates. At the end of October 2023, the average interest rate for residential mortgages was 5.3%, and it is expected to increase to 5.7% in 2024 before falling. Higher mortgage rates will reduce house prices, in our view.

Since most Norwegian mortgages are floating-rate, higher interest rates combined with high debt burdens have contributed significantly to rising household expenses. According to Norges Bank's analysis on this trend, most households can cope with higher interest expenses. The analysis also shows that below 2% of households may struggle to pay their expenses with available income and assets if the residential mortgage rate rises to 5.7%--the average expected level in 2024.

In response to the European Central Bank hiking interest rates since June 2022, mortgage rates in Finland rose rapidly. Average interest rates on new mortgages increased sharply to 4.26% in September 2023, causing house prices to decline.

Finnish mortgages are generally floating-rate, with more than 95% of new mortgages having a fixed interest rate of less than one year. As a result, debt servicing costs have risen since mid-2022. Furthermore, new regulation has made it easier for lenders to change the mortgage loan condition, including the interest rate, while requiring a notice period and right of termination for the borrower. The interest risk for borrowers is partially mitigated using interest rate hedge products such as a cap or collar structure protecting against higher variable rates. So far higher interest rates have yet to significantly affect mortgage lending activity in both countries.

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Constant annuities may shield Finnish borrowers from rising rates.  Constant annuity loans are a common feature in Finnish cover pools. When interest rates rise the principal payment postponement protects borrowers from a potential mortgage payment increase if the interest payment is still below the mortgage payment.

When interest rates rise the total installment will include a higher interest component. This results in an accumulation of principal, which for most loans leads to the loan maturity extending, while for some loans the accumulated principal becomes due at maturity.

For loans without a maturity extension option, the principal of these loans could accumulate such that it causes a payment shock and increases credit risk. Our global RMBS criteria consider this risk, and the share of constant annuity loans in most of our rated programs' cover pools has slightly decreased since 2023.

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Norway: Focus on debt servicing

Lending regulations were updated in 2023 and maintained the loan-to-value (LTV) limit for residential loans at 85%, the maximum debt-to-income (DTI) ratio at five times the gross annual income, and geographic flexibility ratio at 10% (8% in Oslo). Additionally, lenders now must ensure customers have sufficient funds to cover regular expenses after an interest rate increase of 3%, subject to an interest rate floor of 7%. The previous requirement was to cover regular expenses after an interest rate increase of at least 5%. The purpose of lowering the maximum interest rate sensitivity was to avoid being too restrictive on new origination given higher interest rates. The requirements will be in force until Dec. 31, 2024, when the lending regulations will be evaluated and revised if necessary.

According to Finanstilsynet's 2023 survey, leverage in all borrower age groups taking out new residential mortgages has declined. Additionally, a smaller share of loans is granted to borrowers with a DTI ratio exceeding four times the gross annual income, while a larger share is granted to borrowers with low liquidity, suggesting that debt servicing rather than the DTI cap is now a more prevalent constraint for households.

The amended debt servicing requirement may increase the number of successful mortgage applications and hence, may support the housing market.

Finland: Focus on housing company loans

To curb household indebtedness from mortgages and housing company loans used in new-build construction, a government package of macroprudential enhancements took effect on July 1, 2023. The main changes included a maximum loan maturity of 30 years for housing and housing company loans, a 60% LTV ratio limit on housing company loans for new construction, and an earlier amortization requirement following completion.

In December 2023, FIN-FSA restored the non-first home buyers' housing loan cap to its pre-2021 level of 90%. According to FIN-FSA, household indebtedness has declined due to sluggish credit demand, contracting housing loan stock, and faster growth of nominal income. FIN-FSA expects this trend to continue in 2024, which could help to reduce financial system vulnerabilities.

Sustainable Covered Bonds

Norwegian banks are very active in green bond issuance for unsecured as well as covered bonds. DNB Boligkreditt AS and SpareBank 1 Boligkreditt helped pave the way for green covered bonds, followed by several savings banks and associated issuers, including SR-Boligkreditt AS, Sparebanken Vest Boligkreditt, Møre Boligkreditt AS, Sparebanken Sør Boligkreditt AS, Eika Boligkreditt AS, and Nordea Eiendomskreditt AS. Programs are generally established in line with the green bond principles and aligned with the EU taxonomy to some degree. Most programs publish taxonomy assessments and second party opinions. One of the main challenges faced by issuers remains the availability of EPC labels.

Issuers have identified significant volumes of assets based on Norwegian building codes. They provide favorable pricing and terms for eligible customers and offer dedicated lending programs for energy efficiency investments. Although, this increases the potential for green covered bond issuance, issuers prefer unsecured senior debt.

OP mortgage bank issued the first Finnish green covered bond framework, with a total volume of EUR€1.75 billion since 2021, while Nordea Mortgage Bank followed suit with €2 billion of green covered bond issuances.

According to the European Covered Bond Council (ECBC), green covered bond issuance has been lower in Finland than in other Nordic countries, which is largely due to focus on data collection and reporting. Most Finnish issuers are looking to issue green covered bonds. The focus remains on green unsecured bonds and a common framework is being developed in the Finance Finland committee for ESG.

Legal Framework

Norwegian covered bonds legislation was adopted in June 2007 and updated in June 2022 to reflect the EU covered bond harmonization directive. Cover pools are primarily secured by Norwegian residential mortgages and mortgages backed by tenant-owner rights. A few issuers specialize in commercial real estate or public sector loans (below 2% of the volume outstanding). Most loans are floating-rate and are NOK-denominated.

Finland first adopted its legal framework for covered bonds in 1999. Several amendments have followed, most recently, the legislative framework adopting the harmonized EU legal framework took effect on July 8, 2022. Cover pools are generally secured by Finnish residential mortgages and, to a lesser extent, housing cooperative loans. All loans are euro-denominated and mainly floating-rate.

Mortgage Market Overview

Norway

Norwegian real GDP growth decelerated to 1.2% in 2023, after strong growth of 3.3% in 2022, and we expect a slight rebound to 1.4% in 2024. This stems from falling household consumption following high inflation and interest rates. For 2024-2026, we expect real GDP growth will average 1.6% annually, supported by recovering private consumption as inflation declines, and rising mainland investment.

The labor market remains tight, with record low unemployment, at 3.6% in 2023, and labor supply constraints in many sectors. However, due to weaker economic activity and more jobseekers, we expect unemployment to increase to 3.8% in 2024 and peak at 4.0% in 2025.

Norwegian household debt to disposable income, at 238% as of Q1 2023, is one of the highest among OECD countries, and we expect it to remain near this level over the next two years. Despite rising interest rates, house prices remained broadly stable in 2023 following a temporary cooling during autumn 2022. Over the next two years, we project house price growth will slow down due to higher interest rates. However, given housing construction has slowed and labor markets are supporting wage growth over the medium term, any fall in house prices will likely be short-lived.

We view the housing market as being overvalued by approximately 22%. As a result, we think measures aimed at preventing overheating in the housing market will likely be tightened and remain.

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Growth in building stock and new construction of houses has historically been significantly below the general population growth. This has likely contributed to strong demand and price growth in the housing market.

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Finland

Finland's real economy did not expand in 2023, because inflation and high interest rates weigh on domestic demand, while external demand from Finland's main trading partners has been particularly weak. That said, we expect a moderate recovery from 2024 with real growth averaging 1.4% between 2024-2026 as the impact of these effects wanes.

Although employment has improved recently, we expect a slight deceleration as a skills mismatch in the labor market become more evident and the labor market tightens. Unemployment is likely to remain at 6.5%-7.0% over the next few years despite government reforms to fill gaps by investing in infrastructure and research and development.

Rising interest rates and high inflation caused the housing market to slow considerably and house prices to decline by about 7.3% year-on-year in Q3 2023. We anticipate the market to recover during 2024 once interest rates stabilize. Urbanization will continue to increase house prices in Helsinki and other growth cities, compared to relative smaller cities and non-urban areas.

We assess the Finnish housing market as being slightly undervalued, by 2.0%. Therefore, we expect authorities to continue considering measures supporting house prices, especially in those regions where prices are under pressure.

Residential construction growth has historically exceeded the general population growth. This has likely kept house price increases lower than Scandinavian peers.

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Despite house price corrections, LTV ratios for our rated Norwegian and Finnish programs have not increased significantly. Therefore, our view of credit quality remains relatively stable.

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Increased risks associated with commercial real estate exposure

Norway.  According to Norges Bank, real estate exposures represent the largest financial stability risk, particularly the commercial real estate (CRE) sector, because banks' exposures to these firms are highest (45% of total bank loans to Norwegian non-financial corporates in 2022), and they are most affected by higher interest rates. This is because CRE firms' debt-to-earnings ratios are high, therefore they are more vulnerable to higher financing costs. If both rental income and property prices should fall markedly, many firms will struggle to service their debt.

Norges Bank's analyses highlight that because high employment supports office space demand, rental income should rise, and most firms are still able to cover higher interest expenses. On the other hand, rising financing costs and lower equity ratios due to lower CRE prices mean CRE firms may struggle to refinance, which may force fire sales, and could ultimately lead to a fall in property prices.

Finland.  Households' shares of housing company loans account for an increased portion of household debt in Finland (about 15% of as of February 2023). According to the Bank of Finland, rising interest rates and financing costs have exacerbated financial stability risks associated with housing company loans. Given the large share of variable-rate loans and limited use of interest rate hedges, interest-only period expirations on these loans may result in debt servicing costs rising substantially. Together with uncertain economic outlook and weakening housing demand, this could cause further house price declines.

In Norway, Eiendomskreditt AS's cover pool comprises Norwegian commercial real estate mortgage loans, while in Finland the exposure to housing companies is limited. While we believe that CRE asset performance may deteriorate, we do not anticipate it to significantly impair the credit quality of the covered bonds we rate (see "Covered Bonds Could Ease The Pain In European Commercial Real Estate," published May 16, 2023).

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Norwegian And Finnish Covered Bond Program Comparison

In 2024, the credit coverage (foreclosure frequency and loss severity) in our rated Norwegian programs has remained stable compared with 2023.

In most rated Finnish programs, the credit coverage has slightly increased, mainly due to higher current LTV ratios.

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Access our Global Covered Bond Insights dashboard to view the the rating uplifts assigned to our rated Norwegian and Finnish covered bond programs.

Rating Outlooks

Both Norwegian and Finnish covered bonds benefit from investment-grade rated issuers, the first recourse for bondholders. Most of our rated programs benefit from at least one unused notch of uplift, which would protect the rating on the covered bonds in the event of an issuer downgrade.

Norway and Finland are comparable in terms of average target credit enhancement, which is the overcollateralization commensurate with the maximum collateral-based uplift. Where we register a difference between the two is the gap between available credit enhancement and target credit enhancement, which is generally tighter in Finland (access our Global Covered Bond Insights dashboard to view the target credit enhancement levels by country).

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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 Q1 2024: Issuance Still Strong As Market Exits Central Bank Funding, Dec. 15, 2023
• Covered Bonds Outlook 2024: Stability Amid Turbulence, Dec. 11, 2023
• Banking Industry Country Risk Assessment: Finland, Nov. 28, 2023
• Economic Outlook Eurozone Q1 2024: Headed For A Soft Landing, Nov. 27, 2023
• Banking Industry Country Risk Assessment: Norway, Nov. 27, 2023
• Finland ‘AA+/A-1+’ Ratings Affirmed; Outlook Stable, Oct. 27, 2023
• Norway, Sept. 11, 2023
• Covered Bonds Could Ease The Pain In European Commercial Real Estate, May 16, 2023
• European Covered Bonds Reach Harmonization Milestone As The Journey Continues, July 12, 2022
• Glossary Of Covered Bond Terms, April 27, 2018

Related Transaction Updates

• Transaction Update: Eiendomskreditt AS (Commercial Mortgage Covered Bonds Program), Jan. 31, 2024
• Transaction Update: Oma Savings Bank PLC (Mortgage Covered Bond Program), Jan. 24, 2024
• Transaction Update: The Mortgage Society Of Finland CBA Covered Bond Program, Dec. 13, 2023
• Transaction Update: The Mortgage Society Of Finland CBA Covered Bond Program, Dec. 13, 2023
• Transaction Update: Sp Mortgage Bank PLC CBA Mortgage Covered Bond Program, Dec. 6, 2023
• Transaction Update: POP Mortgage Bank PLC Covered Bond Program, Oct. 13, 2023
• Transaction Update: Sp Mortgage Bank PLC (Mortgage Covered Bond Program), Aug. 3, 2023
• Transaction Update: Storebrand Boligkreditt Mortgage Covered Bond Program, June 19, 2023
• Transaction Update: The Mortgage Society of Finland (Mortgage Covered Bond Program), June 1, 2023
• Transaction Update: DNB Boligkreditt AS (Legislation-Enabled Mortgage Covered Bonds), May 31, 2023
• Transaction Update: OP Mortgage Bank, May 17, 2023