Covered bond spreads at 10-year wides: 2024 will be the third straight year of widening for covered bond spreads, which are c.10bp wider YTD and now touching levels not seen since 1Q14. We started the year at c.32bp at the iBoxx EUR Covered bond index level and have now reached the 43bp mark after the widening trade further accelerated in early November. 2022 and 2023 each saw a widening of c.15bp at the index level.
Despite the relatively reduced covered bond supply from early June, covered bond spreads have been relentlessly widening ever since, due to the combination of: a) high net supply; b) the ECB’s waning support; c) French political headlines and the negative deficit, debt and rating trajectories; d) SSAs under pressure and reaching multi-year wides; and e) the collapse of the Bund-swap spread. With the end of QE, the ASW-Bund spreads pressure on covered bonds is unlikely to subside any time soon, and it is difficult to say how long these price movements will last at the ASW-Bund spreads level.
The widening of covered bond spreads has been generalised. However, looking at the Nordic countries, Norwegian covered bonds have clearly underperformed peers – in fact, their relative performance better resembles the recent trajectory of French covered bonds than that of German Pfandbrief.
The EUR-denominated Norway covered bond index is in fact wider than the overall iBoxx EUR Covered bond index for the first time since late 2022, just before the end of net purchases and reinvestments by the CBPP3 programme in 1H23. The underperformance of Norwegian covered bonds is not linked to the duration of the index, as could be the case for their Dutch counterparts, as the modified duration of the Norwegian covered bond index, at 3.71 years, is indeed shorter than that of the overall iBoxx EUR Covered bond index at 4.18 years.
The widening we are seeing in some specific bonds, such as the DNBNO 3.125 2031, seems excessive at first sight and is difficult to understand, driven by technical factors. In our view, DNBNO covered bonds should trade just a tad (1-2bp) wider than the same-tenor German Pfandbrief, which would imply a level in the low 40s on an ASW basis under current market conditions.
The DNBNO mortgage cover pool consists exclusively of residential mortgages as primary cover assets. Moody's and S&P both attribute top ratings to DNB Boligkreditt's covered bonds (Aaa and AAA, respectively). Moody's collateral score, which is regularly used to assess the quality of the cover assets, was lowered to 4.0% in June 2024 from 4.2% as of March 2024, which is also low by international standards and indicates high credit quality. Moody’s TPI leeway of 6 notches provides substantial support to DNBNO’s Aaa ratings against any potential and rather unlikely issuer and/or sovereign credit quality deterioration.
On an issuer basis, DNBNO continues to be supported by the top ‘high-quality’ line of results, benefitting from Norway’s belated start to the rate-cutting cycle and not by low-quality beats, such as a higher-than-expected provision release, model adjustments or reduced operating expenditure offsetting weaker NII, NIM and fees metrics as we have seen from its Nordic competitors in 3Q24.
Norway’s hawkish central bank and robust debt metrics produce a solid starting point in 2025 amid a backdrop of increasing fiscal concerns. On the whole, the Norwegian economy is expected to rebound from its stagnant trend and achieve mainland GDP continuous growth levels of 1.1% in 2025, 1.43% in 2026 and 1.5% in 2027.
Norway’s fiscal outlook remains stable, with general government debt-to-GDP levels of around 45% in 2023. Moody’s affirmed Norway’s Aaa rating this past June, projecting debt levels to decline to approximately 38% by 2025.
Norway remains one of the few advanced economies that has yet to begin its rate-cutting cycle, with the current rate at 4.5% after the last increase in December 2023. Looking ahead, the first rate cut is expected in March 2025, with the official rate to decline to 3.25% over an 18-24-month horizon, but further depreciation of the NOK, combined with high-capacity utilisation, could slow the disinflation process and may prompt Norges Bank to maintain its current rate levels longer than anticipated. Norway’s central bank projects that the inflation target will be reached by 2027.