by Robin Nordblad, Dittmar & Indrenius

Transcription

1 Finnish covered bonds an overview by Robin Nordblad, Dittmar & Indrenius This chapter provides a brief overview of the Finnish covered bond market, the Finnish covered bond legislation and the special insolvency rules regarding covered bonds. Finland currently has five covered bonds issuers. Two of the issuers are specialised mortgage bank subsidiaries of credit institutions and three are credit institutions that also have other operations than mortgage banking. The issuers covered bond ratings range from AA to AAA Standard & Poor s (S&P) and Aa1 to Aaa (Moody s). After the financial crisis, Finnish banks have increasingly relied on the covered bond market for their financing. The recent proliferation of issuances (see Exhibit 2) has no doubt in part taken place because of a substantial revision of the Finnish Covered Bonds Act (CBA) in August 2010, which, among other things, meant that also credit institutions other than specialised mortgage banks can issue covered bonds. Previously, only specialised mortgage banks could do so. Due in part to this change, the Finnish market has seen two new entrants, Nordea and Ålandsbanken, that had not previously formed mortgage bank subsidiaries. While Finnish banks increasingly rely on the covered bond market, Finnish covered bond origination still pales in comparison to that of Sweden and Denmark, which both in absolute terms and adjusted for size have much deeper covered bond markets. In 2011, Swedish banks had over 200bn in outstanding covered bonds and Danish banks over 350bn in outstanding covered bonds, whereas Finnish 83 The Finnish covered bonds market Exhibit 1 Credit Institution Source: Issuers public documents Specialised mortgage bank? Aktia Real Estate Mortgage Bank plc Yes* Nordea Bank Finland plc No OP Mortgage Bank Yes Sampo Bank plc No** Bank of Åland plc No *Aktia stated on September 12, 2012 that it will seek a covered bond license for its parent bank. **Sampo Bank previously ran a specialised mortgage bank subsidiary but it was merged into Sampo Bank plc on December 31, Robin Nordblad, Partner Dittmar & Indrenius tel: fax: robin.nordblad@dittmar.fi

2 Finnish covered bonds since 2004 ( m)* Exhibit ,250 1,500 1,500 1,250 2,125 5,250 9,883 7,433 Source: 2004 to 2011: European Covered Bonds Council website; source for 2011 to date: public offering documents. 84 banks had less than 20bn in outstanding covered bonds. The entire residential mortgage stock in Finland is currently approximately 85bn. With the outstanding issues currently at around 20bn, banks are expected to further deploy their mortgage stocks towards the relatively cheap covered bond funding, in keeping with the post-financial-crisis trend. Investors are expected to show continued interest in Finnish covered bonds due to the relatively solid financial condition of Finnish banks and economy in general. Finland along with the rest of the Nordic countries provides a stable market with legal certainty. Collateral rules more flexible The new CBA introduced a more flexible set of rules, the primary objective of which was to make the covered bond legislation more competitive. In addition to broadening the scope of eligible issuers to credit institutions, the new CBA introduced more flexibility regarding the type of collateral that can be used to secure the bonds. Previously, publicsector debt (such as municipal and government bonds) and mortgages could not be included in the same cover pool - if public-sector debt was to be used, separate bonds backed by only public-sector debt had to be issued. In practice this meant that public-sector debt was not used as collateral. The new CBA allows issuers to include both public-sector debt and mortgages in the same cover pool. The CBA also permits non-finnish collateral, such as EU mortgages and public-sector debt as well as bonds of certain supranational institutions, to be included in the cover pool. Moreover, the CBA facilitates the creation of several cover pools for one issuer, thus enabling issuers to create different risk exposures for different investors. The cover pool statistics of Finnish issuers show, however, that the currently outstanding Finnish covered bonds are in practice backed almost solely by Finnish residential mortgages. Only one issuer reports having a cover pool allocation of approximately 1.5% in public-sector debt. Issuers can now also include cash and bonds issued by other credit institutions in the cover pool as substitute collateral on a temporary basis if, for example, mortgages are quickly replaced because they have been repaid prematurely. The flexibility brought by the changes in the CBA should be welcomed by both issuers and credit rating agencies. For example, the ability to use cash as temporary collateral has added an effective tool to issuers liquidity management. In the absence of appropriate mortgage stocks, issuers can also add more permanent liquidity to the pool by using short-term public-sector debt. The new CBA also allows specialised mortgage banks to act as conduits to the covered bond market for credit institutions that, although eligible for a license to issue covered bonds, have decided not obtain one. In this structure, the conduit mortgage bank on-lends the proceeds from the covered bonds to the piggy-backing credit institution which then posts collateral to the conduit bank. The collateral is recorded in mortgage bank s cover pool and secures the covered bonds.

3 83-87_DCM_ /9/12 16:04 Page 85 Basics of the CBA s matching requirements temporary substitute collateral (e.g., cash) and publicsector debt, the maximum bond-to-value ratio is 100% based on the book value of the assets. The CBA provides for the following collateral matching 3. The present value of the cash flows from the collateral requirements that are intended to protect covered bond must at all times exceed 102% of the present value of holders in the insolvency of the issuer: the covered bonds liabilities. In respect of residential Loan-to-value (LTV) ratio mortgages, only 70% (and 60% for commercial real 1. Only mortgages that have a LTV ratio of 100% or lower estate mortgages) of the cash flows can be taken into are eligible for inclusion in the cover pool. account when calculating the present value. 2. The aggregate value of the collateral must at all times Liquidity test exceed the aggregate outstanding amount of the The weighted average maturity of the covered bonds must covered bonds. In respect of residential mortgages, the not be longer than the weighted average maturity of the maximum covered bond-to-value ratio is 70% of the collateral. value of the collateral underlying the mortgages (i.e., real estate and shares in housing companies). In Interest cover test respect of commercial real estate mortgages, the The 12-month rolling interest cover (collateral cash flow vs. maximum bond-to-value ratio is 60%. In respect of covered bond interest payments) must be at least 1:1. 85 Your Independent Partner in Finance & Capital Markets Selected recent Finance & Capital Markets transactions: D&I acted as Finnish counsel to Nordic Mines in connection with its SEK 236 million rights offering. D&I advised Russian Railways in the EUR 120 million financing and procurement of high-speed trains by Karelian Trains. D&I advised Rexel Group, in the Finnish aspects of EUR 1.7 billion refinancing of the group. D&I regularly acts for Westdeutsche ImmobilienBank in Finnish commercial real estate financing transactions. D&I advised Ålandsbanken in the establishment of its EUR 1 billion Medium Term Note and Covered Bond Programme. D&I advised Ratos, the Swedish listed private equity house, in the financing of its acquisition of Finnkino. Mergers & Acquisitions, Finance & Capital Markets, Dispute Resolution, Corporate & Commercial Pohjoisesplanadi 25 A, FI Helsinki, Finland

4 86 An issuer is required on a quarterly basis to monitor the value of the real estate assets underlying mortgages recorded as collateral in the cover pool. With a few exceptions, statistical valuation methods can be used. If a certain value-reduction threshold set by the issuer is breached, the value of the relevant collateral must be adjusted in the cover pool, which may mean that additional collateral must be added. Until the occurrence of an insolvency event, the cash flows from the collateral will not be recorded in the cover pool upon payment, unless the cash flows are temporarily recorded as substitute collateral. Mortgages and publicsector debt therefore need to be replaced with new collateral as and when they are repaid. While only one Finnish covered bond issuer currently commits to a certain overcollateralisation level in its public prospectus, it appears based on the issuers reports that, on average, Finnish covered bonds de facto are overcollateralised. Based on our experience, this is driven by a variety of factors including credit rating agencies OC requirements, average LTV ratios of mortgages actually being lower than 70%/60% and the operational practicality of a liquidity buffer. Insolvency rules Upon bankruptcy of an issuer the financial regulator will appoint a supervisor whose mandate is to protect the interests of covered bonds holders. The courts will appoint a bankruptcy administrator to administer the bankruptcy estate. The cover pool will be run by the bankruptcy administrator who is monitored by the supervisor. The administrator and the supervisor have certain specific powers such as the right to hedge any risks with derivatives, taking up liquidity loans and with the permission of the financial regulator, transferring the bonds and the entire cover pool to another licensed credit institution. The CBA affords covered bond holders a statutory security interest in a certain portion of the assets in the cover pool (i.e., the collateral) which is tantamount to that of a secured lender. Counterparties to derivative instruments that hedge interest rate or currency risks relating to the cover pool and the bonds as well as providers of postbankruptcy liquidity loans enjoy the same status as covered bond holders on a pari passu basis. This is only true, however, to the extent that the collateral, the bonds, the derivatives and liquidity loans are actually recorded in the cover pool. The bankruptcy of the issuer generally will not accelerate the bonds. Rather, the bonds will be repaid in accordance with their original payment schedule from the collateral which is ring-fenced from the bankruptcy estate and therefore beyond the reach of the general creditors of the issuer. In essence, the security interest therefore entitles the covered bond holders to a portion of the cash flows derived from the collateral. However, if the covered bonds are rendered a misnomer by virtue of insufficient collateral, the bankruptcy administrator may accelerate the bonds and liquidate the collateral. In the case of mortgages, the actual mortgages would have to be sold and not the collateral underlying the mortgages (unless the underlying mortgage debtor has defaulted on the mortgage and it has become enforceable). Any covered bond claims exceeding the value of the collateral will be unsecured and therefore likely subject to a significant haircut in bankruptcy. Limitations on the coverage of the cover pool The CBA includes certain limitations on the covered bond holders security interest 1. The security interest is limited to 70% of the value, as recorded in the cover pool, of the collateral underlying the residential mortgages in the pool, at the time the bankruptcy commenced. The limitation for commercial real estate mortgages is 60%. In effect, the minimum statutory bond-to-value ratio in insolvency is therefore 100%.

5 2. The covered bond holders take the risk of any deterioration in the value of the collateral following the bankruptcy, although, as regards mortgages, the primary credit risk faced by bond holders relates to the mortgage debtors ability to pay their mortgages. 3. If there is any de facto overcollateralisation which is not legally committed to by the issuer, the bankruptcy administrator may in certain circumstances transfer assets from the cover pool to the bankruptcy estate. The administrator can only do so, however, if it is evident at the time that the collateral that is to be transferred is not necessary in order for the issuer to discharge the covered bond liabilities as they fall due. Conclusion The new CBA has been a welcome development to the Finnish covered bond market. It has laid the foundation for future growth of the Finnish market - a prospect for which the potential is great. Contact us: Dittmar & Indrenius Pohjoisesplanadi 25 A, FI Helsinki, Finland tel: office@dittmar.fi web: 87