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.

Swedish Covered Bonds: Stable Amid A Challenging Mortgage Market

Sweden remains one of the five-largest covered bond markets, together with Denmark, Germany, France, and Spain, with outstanding issuance totaling Swedish krona (SEK) 2.7 trillion (€238 billion) as of June 2024. The majority of issuance is SEK-denominated, and Swedish issuers benefit from a strong domestic investor market. YTD public euro-denominated benchmark covered bond issuance from Sweden remains subdued compared to the 2023 level, with €3.6 billion issued so far in 2024 (see chart 1). We expect easing interest rates and economic recovery will drive Swedish covered bond issuances.

Covered bonds are a vital funding tool for Swedish financial institutions, constituting approximately 44% of all debt issued by Swedish financial institutions as of July 2024.

Chart 1

Chart 2

Chart 3

The Riksbank Responds To Falling Inflation With Rate Cut

In Sweden, tightening monetary policy and easing supply shocks have contributed to falling inflation, now close to the 2% target. Following the eight consecutive rate hikes that brought the Swedish policy rate to 4% by late 2023, the Swedish Central Bank (Riksbank) lowered the policy rate by 25 basis points in May 2024--for the first time since 2016--amid closer-to-target inflation, weak GDP growth, and poor labor market conditions. The Riksbank anticipates that if the outlook for inflation remains unchanged, the policy rate could be lowered twice in the second half of 2024. In our view, policy rate cut could have a knock-on effect on housing costs, thereby driving the mortgage market (see "Swedish Covered Bonds Withstand Higher Mortgage Rates").

The impact of higher mortgage rates on Swedish households

Since January 2022, the average interest rate on new and renegotiated mortgage agreements to households has risen from about 1.5% to a peak of 4.8% at the end of 2023, then slightly declined to 4.5% following the Riksbank's rate cut in May 2024.

Over the past decade, rapid house price growth fueled by low interest rates has increased household debt, which has recently slowed down but remains relatively high at about 186% of disposable income at the end of 2023. Moreover, Sweden has a shorter interest rate fixation period--with about 65% of mortgages having a remaining fixation period of three months or less--than other jurisdictions. This, along with relatively high indebtedness among households, makes Swedish households particularly sensitive to rising mortgage rates. The Riksbank estimates that almost all of the expected increase in mortgage rates has affected households, resulting in a rapid increase in the interest-to-income ratio--3% higher by the end of 2023 than at the beginning of 2022.

Based on a 2024 sample of over a million mortgage loans backing Swedish covered bond programs, we estimate that the average monthly payment per loan part has increased by more than 68% since early 2022 to December 2024, from SEK1,503 to SEK2,527. Most Swedish borrowers have two loan parts. In our sample, more than 80% of loans are either floating-rate or will be reset to a fixed rate by the end of 2024, having then experienced higher interest rates. The proportion of floating-rate and short-term fixed floating-rate loans has increased, thereby increasing overall borrower interest sensitivity (see "Swedish Covered Bonds Withstand Higher Mortgage Rates").

That said, we believe that high household wealth and savings buffers accumulated during the pandemic, together with a strong labor market, help mitigate the challenges posed by high mortgage rates on borrowers.

Higher interest rate increases tenant-owner association fees

Generally, tenant-owner associations have longer interest rate fixation periods than households, meaning they are not yet fully impacted by the rising policy rate. According to the Riksbank, about 30% of total loans granted to tenant-owner associations are variable rate, and 45% will be renegotiated over the next three years. Despite the expected easing interest rates, the interest rate cost will likely rise upon loans renegotiations, probably resulting in higher association fees. The Riksbank estimates that for a significant portion of housing associations with debts ranging SEK10,000-15,000 per square meter, the fees would increase by SEK1,213 per month, a 2% reduction in the average new tenant's disposable income.

According to our criteria, as tenant-owner-right borrowers often possess a second-ranking right and can be liable for additional payments, all else being equal, these loans may have higher foreclosure frequencies depending on loan seasoning. The exposure to these assets differs among issuers. In 2024, the share of loans secured by tenant-owner rights in our rated programs remained stable versus previous years (see chart 4).

Chart 4

New issuances with longer maturities reduce asset-liability maturity mismatch (ALMM)

In 2024, new issuances are shifting toward longer maturities compared to 2023, when the inverted interest rate curve drove covered bond issuance into shorter maturities, with 24% of new issuances falling within the one-to-three-year tenor. However, as of September 2024, all investor-placed benchmark new issuances had a tenor of five years or beyond. This shift could improve the overall weighted-average life of Swedish covered bond issuances, reducing ALMM and refinancing risk. Traditionally, in Sweden, ALMM has been higher than in other countries (see chart 5).

Chart 5

In Sweden, our rated mortgage programs need to cover 'AAA' credit risk to arrive at their respective rating. Consequently, ALMM change does not affect our required credit enhancement commensurate with the rating.

Decreasing Financial Challenges For Property Companies

According to the Riksbank's financial stability report, Swedish financial institutions have significant exposures to the commercial property sector, accounting for about 40% of total debt in the Swedish nonfinancial corporate sector. This poses a specific risk that could threaten overall financial stability. Property companies are being pressurized from higher interest rates because of rising funding costs and falling property value. This development increasingly stresses interest coverage and loan-to-value (LTV) ratios--important indicators while assessing the creditworthiness of commercial real estate (CRE) firms.

Many property companies have started to reduce their loans, either by selling properties to stronger property actors or by injecting equity, to reduce their indebtedness and strengthen financial position. Also, operating profits in the sector have increased, thereby reducing the debt-to-income ratio. According to the Riksbank, among larger property companies, the net debt ratio has fallen to 14% from just over 17% since early 2022.

Financial conditions for property companies have generally improved. Since late 2023, risk premiums for property company bonds have been declining due to expected lower policy rates, enabling property companies to finance their operations via the bond market. According to the Riksbank, property companies have issued over SEK50 billion of bonds since October 2023. However, there will be a large refinancing need in Swedish kronor and foreign currencies. There is a risk that the rental market many continue to weaken, with high interest rates. This could pressure financial ratios as well as property values, which could cause problems for vulnerable property companies, mostly smaller ones.

Although it is unlikely that major Swedish banks will be willing to meet the property companies' entire funding needs on their own, they are likely to maintain credit supply to viable companies in the current situation. This may increase CRE exposure in Swedish covered bonds. The Swedish covered bond law limits CRE exposure, excluding multifamily housing and tenant-owner right associations, to 10% of total assets. We note that CRE assets, including multifamily housing and tenant-owner rights, remain at relatively low levels in our rated covered bonds, and we estimate that they currently comprise 11.7% of total cover pool assets in Sweden.

In our view, covered bond ratings should withstand house price correction and could potentially be a stable funding source for CRE assets (see "Swedish Real Estate: The End Of The Slump Could Soon Be In Sight").

Amortization Requirements Exemptions

Although general amortization requirements introduced in 2016 for borrowers exists, Swedish banks may grant exemption from the amortization requirement given special grounds. Special grounds refer to borrowers experiencing a significant deterioration in their financial circumstances after origination. Further, the exemption must fall within the framework of good lending practices and the bank must perform an individual assessment of the borrower's conditions.

According to the Swedish Financial Supervisory Authority (FSA), between September 2022 and September 2023, approximately 38,500 mortgage borrowers received a temporary exemption from the amortization requirement. The number of granted exemptions peaked during Q1 2023, remained relatively stable during Q2 and Q3 2023, and slightly increased in Q4 2023. In most of the cases, borrowers are granted an exemption of less than one year, and borrowers with high debt and LTV ratios have been granted exemptions to a greater degree.

Chart 6

Based on the issuer's Harmonised Transparency Templates, we observe only a slight increase in the share of interest-only mortgages since 2022. However, the level of interest-only mortgages remains below the pre-pandemic level. In our view, these interest-only loans are more sensitive to rate rises in relative terms, which we adjust for in our analysis (see "Swedish Covered Bonds Withstand Higher Mortgage Rates").

Chart 7

Sweden's Covered Bond Framework

Swedish covered bonds are issued based on the Swedish covered Bonds Issuance Act ("Lag 2003:1223 om utgivning av sakerstallda obligationer") and complementary regulation. The Act came into force in 2004 and was amended by SFS 222:803 to align to the EU directive.

Table 1

All issuing institutions must have a specific license to issue covered bonds. Most Swedish mortgage assets are originated, and covered bonds issued, by separate mortgage bank entities, like Swedbank Hypotek AB and Länsförsäkringar Hypotek AB, for example. However, covered bonds can also be issued directly from a bank's balance sheet, as is the case with Landshypotek Bank AB. For those covered bonds issued directly from the balance sheet, legislation protects and segregates the cover pool post issuer insolvency.

The Swedish FSA 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.

Overcollateralization, liquidity buffer, and maturity extension

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, LTV ratios above the regulatory limits will be ineligible for the cover pool. CRE remains limited to 10% of the cover pool and overcollateralization remains at a minimum nominal 2%.

The issuer must ensure that the cover pool contains a liquidity buffer that covers the highest daily liquidity outflow for the next 180 days. Covered bond issued after July 8, 2022, with extensions may consider the extended maturity date in the liquidity calculation.

We understand that the extensions are permitted to avoid the issuer's default, but are not available in an issuer's insolvency. Further, we expect Swedish covered bond issuers to enter into resolution before the insolvency of the issuer, which may not require an extension. In our view, the resolution may limit the use of extensions in Sweden and further clarification could help market participants better understand when maturity extensions can occur.

Commingling risk

Commingling risk refers to the risk that cash collected from the cover assets (mortgage loans, for example) could be trapped in the issuer's insolvent estate or temporarily restricted from servicing the covered bonds. Generally, we consider commingling risk as a secondary order risk in covered bonds.

The 2022 change to the Swedish covered bond law removed certain clear requirements relating to the maintenance of separate cover pool accounts. These requirements provided important support for our analytical consideration that a counterparty insolvency would not necessarily result in losses of cash collections. We continue to consider the risk covered by law post issuer insolvency, but we have not been able to identify similar support from other sources for collections made prior to the issuer's insolvency. In the absence of structural mitigants we size for this risk in our overcollateralization calculation.

Mortgage Market Overview: Lower Inflation And Easing Monetary Policy To Support Swedish Economy

We expect the Swedish economy will expand marginally by 0.3% this year, following a 0.2% full-year contraction in 2023. During 2025-2027, we anticipate that declining inflation and easing financing conditions will support Sweden's stronger growth of 2% on average.

Consistent with the global trends, inflation in Sweden has been declining. We project full-year inflation growth at 2.5%, declining to 2% in 2025. We have not observed significant inflationary pressure from wage growth. In our view, inflation will gradually decline and stabilize close to the Riksbank's target of 2% in 2025, but the weaker krona could present upside risks.

We estimate unemployment rate will reach its peak of 8.3% in 2024, gradually decreasing to 7.7% in 2027.

Table 2

Chart 9

Property market outlook: Higher interest rates spell the end of house price growth

High household indebtedness and very short interest rate fixation period make Swedish households highly sensitive to mortgage rates. Due to a sharp rise in mortgage rates, a high portion of variable rate financing, and a still elevated price-to-income ratio, house prices corrected significantly last year (see chart 10).

Chart 10

Higher interest rates, together with more stringent credit assessment, have curtailed household credit growth, with fewer households taking out new mortgages, and with smaller loans than before. According to FSA, in 2023, fewer households (about 5%) had housing loans exceeding 4.5x their annual income before tax (9% in 2022). Both the average debt-to-income ratio and the share of households with a debt-to-income ratio above 450% were back at about the same level as in 2018.

Chart 11

As inflation and interest rates are expected to fall, house prices, along with household demand for mortgages, will likely rise in the coming years. According to Statistics Sweden, mortgage growth rate increased for the first time since March 2022 to 0.7% annually in May 2024 (from 0.5% in April 2024), increasing slightly to 0.8% in July 2024.

Housing loans recovered faster than previous cycles, driven by strong labor market, in our view. We expect that Swedish house price growth will start to recover by 0.6% in 2024, increasing to 2.7% over 2026-2027 (see "European Housing Markets: Better Days Ahead").

We currently view the Swedish housing market as being overvalued by 33%, which we adjust for in our credit analysis. In our view, Swedish house price correction may lower our overvaluation assumptions, thereby lowering our assessment of Swedish mortgage credit risk.

House price declines and cover pool LTVs

Despite house price correction and stable amortizing loan share (approximately 75% of our rated cover pools), we do not observe a significant increase in LTV ratios in our rated Swedish covered bond programs. Therefore, our view of credit quality remains relatively stable.

Chart 12

Lack of new builds supports house prices

Although rising interest rates and declining house prices have led to a decrease in overall housing demand, low home supply remains a supportive factor for house prices. This is mainly due to limited new construction, given rising construction and funding costs. Statistics Sweden shows that newly started construction of houses during first half of 2024 is about 58% lower than the same period in 2022.

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Features Of Swedish Covered Bond Programs

While relatively homogeneous, the Swedish covered bond market comprises covered bonds backed by a mix of assets. Most Swedish covered bonds are backed by residential and multifamily housing, while commercial, agriculture mortgage loans, and public sector debt comprise a smaller part.

Table 3

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.

Comparison Of Swedish Covered Bond Programs

In 2024, the indexed weighted-average LTV ratio in most of our rated programs has slightly increased compared to 2023, therefore, the credit coverage (foreclosure frequency and loss severity) has increased.

Table 4

Chart 14

Rating Outlook: Unused Notches Insulate Bonds From The Risk Of Bank Downgrades

Most Swedish covered bond issuers have very high issuer credit ratings (ICRs). These allow all rated issuers to reach the 'AAA' rating for their covered bonds based on jurisdictional support alone. On average, our rated Swedish programs benefit from 2.4 unused notches, by which the ICR can be lowered, without resulting in any effect on the covered bond program's rating level, all else being equal. The rating uplift assigned to our rated Danish covered bond programs can be accessed here (under "Country Focus- Sweden")

On average, Swedish covered bond programs have slightly lower credit risk than peer countries but higher market risk, reflecting ALMM. The available credit enhancement is slightly lower relative to peer countries, see here (under "Country Focus- Sweden").

The available and target credit enhancement by country can be found here (under "Ratings Distribution and outlook/Ratings Outlook").

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

• Economic Outlook Eurozone Q4 2024: Consumer Spending To The Rescue, Sept. 24, 2024
• Global Covered Bond Insights Q4 2024: On Course For A Strong Year, Sept. 18, 2024
• European Covered Bonds Resist Commercial Real Estate Jitters, Aug. 27, 2024
• European Housing Markets: Better Days Ahead, July 17, 2024
• Covered Bonds Outlook Midyear 2024: Growth And Rates Support Performance, July 11, 2024
• Swedish Covered Bonds Withstand Higher Mortgage Rates, June 20, 2024
• Swedish Real Estate: The End Of The Slump Could Soon Be In Sight, Feb. 29, 2024
• European Covered Bonds Reach Harmonization Milestone As The Journey Continues, July 12, 2022
• Swedish Covered Bonds: Harmonization Plan Paves Way For Further Rating Uplift, Feb. 4, 2021
• 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

• Sparbanken Skane (Mortgage Covered Bond Program), Sept. 16, 2024
• Lansforsakringar Hypotek (Mortgage Covered Bond Program), March 22, 2024
• Swedbank Mortgage AB Covered Bond Program, Feb. 5, 2024
• Danske Hypotek AB (Mortgage Covered Bond Program), Jan. 3, 2024
• Landshypotek Bank AB (Mortgage Covered Bonds), Nov. 14, 2023