Areas: Covered bonds, SSAs, Basis swap spreads, FX swaps and fixings, SGB ASW spreads, Fixed income market, Fixed income flows and liquidity, Regulations, Negative rates and Riksbank extraordinary measures

Fixed Income Focus Time to buy 2022-2023 SEK covered

bonds again 2017-09-07 Charlotte Asgermyr

Chief Covered Bond & FI Market Strategist charlotte.asgermyr@seb.se, casgermyr@bloomberg.net +46 8 506 23 166

Time to buy 2022-2023 SEK covered bonds again Wider spreads over past week

SEK 2022-2023 covered bonds widened 5-6bps vs. swaps and government over the past week most likely on back of relatively heavy issuance in the second half of August as the market swallowed a total supply of almost 20bn with DH2212 (12/2022) the latest bond issued at a tight maturity-matched spread level of +32bps.

In the pipeline, we have a new SEK covered bond LFH517 (09/2024) but, worth noting, the issuer is in no hurry for the new bond to reach benchmark status but will only issue on demand at a price it finds reasonable. At present, we see a fair maturity-matched spread for the new bond of +49-50bps. Else, we expect it to be relatively calmer regarding supply of new bonds in the near-term compared to the recent two weeks.

Spread supportives from here:

As a result of the recent underperformance of 2022-2023 SEK covered bonds, SEK 3y/5y SEK CB ASW spread curves have steepened in relation to DKK correspondents. The relative SEK vs. DKK 3y/5y slope has moved from 1.5bps (mid) on Aug 29 to almost 9bps (see page 3 & 4).

Next week on Sep 12, the market will face a +0.13y duration extension of OMRX Mort All index. We expect this index duration change to be supportive for 2022-2023 covered bonds.

Sep 1, the Swedish FSA presented its proposal to government of new regulations for occupational pension funds. The funds have been test reporting over summer using three different confidence levels. Compared to the autumn proposal, in the test-reporting the FSA had clearly taken feedback into account when it came to the treatment of spread risk: Covered bonds were treated as a separate asset class with lower capital requirements than AAA credits. Also, the list of exempted SSAs was widened from only Kommuninvest and capital requirements for unrated bonds were more than halved. In the test-reporting, however, the FSA introduced a new measure - concentration risk - to limit too large exposures to a single company/issuer. That limit was set relatively low and if pursued could have weakened demand from occupational pension funds for covered bonds especially from the larger issuers.

In its final proposal, the FSA acknowledges the importance of occupational pension funds as funding sources for Swedish banks and buyers of Swedish covered bonds. It introduced a special treatment of covered bonds also regarding the concentration risk implying significantly less constraints for the asset class. Also, it lowered the capital requirement for covered bonds further from those used in the test-reporting. To our interpretation the proposed capital requirements are now in line with the present requirements under the current Traffic Light as well as under Solvency II (see page 5 & 6 and more info here).

With today’s (Sep 7) Riksbank repo rate decision a copy-paste of July’s, it maintained its dovish rhetoric. Hence, we see limited risks for steeper 2y/5y SEK yield curves at the moment. Also, ECB delivered no hawkish surprise but proved concerned about the strengthening of the EUR and will monitor the development closely. Draghi carefully hinted that the bulk of decisions regarding the future of the asset purchases will probably come in October.

Risk:

Next week, we will have Swedish CPI for August. As big an upside surprise as to the July CPIF will probably steepen 2y/5y yield curves, something that proved negative for longer-dated SEK covered bond ASW spreads over summer. Olle Holmgren’s inflation forecast for the coming 6 months is close to the Riksbank’s. The big upside surprise to July CPIF was mainly explained by package holidays, a factor that he does not expect to affect Aug CPIF to the same extent.

Recommendation:

We recommend to buy C1586 maturity-matched vs. swaps with a target of 26bps. 3m carry and roll: 2.1bps and 3.6bps, respectively.

2017-09-07

2

SEK covered bond ASW recently steeper vs. DKK

2017-09-01 | charlotte.asgermyr@seb.se +46 8 506 23 166 3

-15

-10

-5

0

5

10

15

20

Jan-16 May-16 Aug-16 Nov-16 Mar-17 Jun-17 Sep-17

SEK vs. DKK 3y/5y

0

5

10

15

20

25

30

35

Jan-16 May-16 Aug-16 Nov-16 Mar-17 Jun-17 Sep-17

3y/5y ASW spread curve slopes

SEK 3y/5y DKK 3y/5y

-20.0

-10.0

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

Dec-14 Jul-15 Jan-16 Aug-16 Mar-17 Sep-17 Apr-18

5y domestic spreads vs. swaps

DKK 5Y (Flex) vs 3M Cibor SEK 5y SHBASS

-45.0

-40.0

-35.0

-30.0

-25.0

-20.0

-15.0

-10.0

-5.0

0.0

-10.0

0.0

10.0

20.0

30.0

40.0

50.0

60.0

Dec-14 Jul-15 Jan-16 Aug-16 Mar-17 Sep-17 Apr-18

5y covered bond ASW spread difference: Denmark vs. Sweden

Diff Danish vs. Swedish bsw to 6m euribor Domestic 5y DKK vs. SEK, rhs

5y SEK covered bonds back at cheap levels vs. Danish

2017-09-01 | charlotte.asgermyr@seb.se +46 8 506 23 166 4

-40.0

-35.0

-30.0

-25.0

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

-10.0

0.0

10.0

20.0

30.0

40.0

50.0

Dec-14 Jul-15 Jan-16 Aug-16 Mar-17 Sep-17 Apr-18

3y covered bond ASW spread difference: Denmark vs. Sweden

Diff Danish vs. Swedish bsw to 6m euribor Domestic 3y DKK vs. SEK, rhs

-30.0

-20.0

-10.0

0.0

10.0

20.0

30.0

40.0

50.0

Dec-14 Jul-15 Jan-16 Aug-16 Mar-17 Sep-17 Apr-18

3y domestic spreads vs. swaps

DKK 3Y (Flex) vs 3M Cibor SEK 3y SHBASS

FSA proposal of capital requirement regulation for occupational pensions (new Traffic Light):

Spread risk Current Traffic Light System Spreads are stressed by max (25 bps, 100% of the current credit spread)*

modified duration

Test reporting The FSA clearly took feedback into account as regards the spread risk module: Covered bonds was treated as a separate asset class with lower capital

requirements than AAA credits. The list of exempted SSAs was widened from only Kommuninvest to include

supranationals provided the issuing state has a credit rating equivalent to AA or higher.

In line with the previous proposal, bonds issued by Swedish government, Swedish municipalities and counties are exempted.

This also applies to government bonds from other countries conditioned on that the government has a credit rating of AA or above.

Also, bonds issued by municipalities or regions that lack credit rating but whose country has credit ratings AA or higher may also be exempted.

Capital requirements for unrated bonds have been more than halved.

Final proposal Capital requirements on covered bonds have been lowered further. Duration limit of max. 10y introduced for spread risk to handle convexity of long

bonds. Else, no changes compared to the test-reporting.

5

The classification of credit ratings is based on the grade scale applied by, among others, Standard & Poor's, Fitch or corresponding credit rating agencies. Capital requirements for covered bonds in the test-reporting in parenthesis.

Capital requirements are calculated as:

stress*modified duration*holding MV

where max. modified duration 10y

Spread riskAutumn 2016 proposal

Rating VaR 99.5% VaR 98% VaR 95% VaR 99.5% (our interpretation)Covered bonds 0.9% (1.2%) 0.8% (1%) 0.7% (0.8%) 2.00%AAA 1.80% 1.60% 1.40% 2.00%AA 2.30% 1.80% 1.50% 2.50%A 2.75% 2.25% 1.85% 3.00%BBB 3.50% 2.90% 2.37% 4.00%BB 4.75% 4.20% 3.35% 5.00%B or lower 4.75% 4.20% 3.35% 7.50%No rating 4.75% 4.20% 3.35% 10.00%

Confidence levels: New proposal

-8.0%-6.0%-4.0%-2.0%0.0%2.0%4.0%6.0%8.0%

10.0%12.0%

Oct-06 Jul-09 Apr-12 Dec-14 Sep-17

5y c

over

ed b

ond

cap

req

Current and new proposed TLS stresses vs. actual 5y covered bond performance vs. government

Current TLSAutumn 2016 proposed TLSActual 12m govt spread chg*durationSolvency II adj to govt spread (credit margin)Final Sep-17 proposed TLS

FSA proposal of capital requirement regulation for occupational pensions (new Traffic Light):

New feature: Concentration risk Current Traffic Light System: Does not exist in the current Traffic Light System (but exists in Solvency II). Concentration risk penalizes a company which does not have a highly diversified

portfolio.

Test reporting The capital requirement for concentration risk is based on the size of the exposure to one issuer

and this exposure’s size in relation to total exposures. Assets exempted from concentration risk are those mentioned as exempt when calculating capital requirement in spread risk (see page 4).

If the issuer is part of a group, all companies within the group should be considered as one issuer. If the reporting company has mutual funds that is not transparent, the value of the holding is assumed to be attributed to the fund manager which in those cases replaces the issuer.

Issue exposure above threshold 3.5% must be stressed by 20%. No special treatment for covered bonds.

Final proposal Threshold raised: Issue exposure above threshold 5% must be stressed by 20%. Special treatment of covered bonds: Covered bond exposures should be included but

assigned a risk weight of 25%.

6

Disclaimer (continues on next page) Authors' statement of independence (Analyst Certification)

We, the authors of this report, hereby confirm that notwithstanding the existence of any potential conflicts of interest referred to herein, the views expressed in this report accurately reflect our personal views about the companies and instruments covered. We further confirm that we have not been, nor are or will be, receiving direct or indirect compensation in exchange for expressing any of the views or the specific recommendation contained in the report. We are not registered or qualified as research analysts, representatives or associated persons under the rules of any US exchange, regulatory organization or State.

This statement affects your rights

This report is confidential and may not be reproduced, redistributed or republished by any recipient for any purpose or to any person.

Recipients

SEB Research is approved and issued by Skandinaviska Enskilda Banken AB (publ) (“SEB”), a bank organized under the laws of the Kingdom of Sweden, on behalf of itself and its affiliates for institutional investors. SEB is not a registered Broker-Dealer under the US Securities and Exchange Act of 1934. This report must not be distributed to retail clients except those of SEB Oslo Branch and, in case of research distributed via SEB Helsinki Branch, to its retail clients located in Finland.

Use This research report is produced for the private information of recipients - if you are not a client of ours, you are not entitled to this research report, and should destroy it. The document is not, and should not be construed as, an offer to sell or solicitation of an offer to buy any securities. Opinions contained in the report represent the author's present opinion only and may be subject to change. In the event that the author's opinion should change or a new analyst with a different opinion becomes responsible for our coverage of the company concerned, we shall endeavour (but do not undertake) to disseminate any such change, within the constraints of any regulations, applicable laws, internal procedures within SEB, or other circumstances.

Good faith and limitations

All information, including statements of fact, contained in this research report have been obtained from SEB, Bloomberg or Macrobond and compiled in good faith from sources believed to be reliable. However, no representation or warranty, express or implied, is made by SEB with respect to the completeness or accuracy of its contents, and it is not to be relied upon as authoritative and should not be taken in substitution for the exercise of reasoned, independent judgement by you. Recipients are urged to base their investment decisions upon such investigations as they deem necessary. To the extent permitted by applicable law, no liability whatsoever is accepted by SEB for any direct or consequential loss arising from the use of this document or its contents.

Distribution

This research report has been prepared by SEB or its affiliates and is being distributed by SEB offices in Stockholm, Copenhagen, Oslo, Helsinki, Frankfurt, London, Tallinn, Vilnius, Singapore and Hong Kong. Research reports are prepared and distributed in Lithuania by AB SEB bankas and in Estonia by AS SEB Pank in accordance with the requirements of the local laws and Financial Supervision Authority’s conduct of business rules. It is being distributed in the United States by SEB Securities Inc. ('SEBSI'), a wholly owned subsidiary of SEB organized under the laws of the State of Delaware, USA. Any United States institutional investor receiving the report, who wishes to obtain further information or to effect a transaction in any security discussed in the report, should do so only through SEBSI and not its affiliates.

2017-09-06 7

The SEB Group: members, memberships and regulators SEB is a member of, inter alia, Nasdaq OMX Nordic, Oslo Stock Exchange, the London Stock Exchange, NYSE Euronext, Frankfurt Stock Exchange, Tallinn Stock Exchange as well as certain European MTF’s such as BATS-Chi-X, Turquoise, Burgundy, XUBS, POSIT and Sigma-X. SEB is regulated by Finansinspektionen in Sweden and, for the conduct of investment services business, in (i) Denmark by Finanstilsynet, (ii) Norway by Finanstilsynet, (iii) Finland by Finanssivalvonta, (iv) Germany by Bundesanstalt für Finanzdienstleistungsaufsicht, (v) the UK by the Financial Conduct Authority and Prudential Regulation Authority (details about the extent of our regulation by the Financial Conduct Authority and Prudential Regulation Authority are available from us on request), (vi) Estonia by the Estonian Financial Supervision Authority, (vii) Lithuania by the Bank of Lithuania, (viii) Singapore by the Monetary Authority of Singapore, and (ix) Hong Kong by Securities and Futures Commission. SEBSI is a U.S. broker-dealer, registered with the Financial Industry Regulatory Authority (FINRA). SEBSI is a subsidiary of SEB. SEBSI is authorized to engage in the underwriting of securities but does not make markets or otherwise engage in any proprietary trading in any securities. SEB’s research reports are prepared in accordance with the industry standards and codes of conduct applicable to financial analysts in the countries where they are based. In Denmark, Finland, Norway and Sweden, analysts act in accordance with the rules of ethics of each country’s Society of Financial Analysts. Analysts comply with the recommendations and industry standards of the Danish, Norwegian and the Swedish Securities Dealers Associations and with those of the Federation of Finnish Financial Services. Analysts certified by the CFA Institute also comply with the Code of Ethics of the CFA Institute. Prevention and avoidance of conflicts of interest All research reports are produced by SEB’s Research department, which is separated from the rest of its activities by an Information Barrier; as such, research reports are independent and based solely on publicly available information. Following standard practice, recommendations and target share prices are removed from research on companies which are the subject of public offers on which SEB is advising. The remuneration of staff within the Research department is determined exclusively by research management and senior management and may include discretionary awards based on the firm’s total earnings, including investment banking income; however, no such staff receive remuneration based upon specific investment banking transactions. SEB’s Compliance department monitors the production of research and the observance of the group's procedures designed to prevent any potential conflicts of interest from affecting the content of research. Your attention is also drawn to the fact that: The current market price of the instruments shown in this report is the price prevailing at the close of the business day preceding the date of publication or when applicable a more recent price than that. Unless explicitly stated otherwise in this report, SEB expects (but does not undertake) to issue updates to this report following the publication of material new figures or forecasts relevant to the instruments covered, or upon the occurrence of other events which could potentially have a material effect on it. The instruments discussed in this research report may not be eligible for sale in all countries, and such instruments may not be suitable for all types of investors. Offers and sales of instruments discussed in this research report, and the distribution of this report, may be made only in countries where such instruments are exempt from registration or qualification or have been so registered or qualified for offer and sale, and in accordance with applicable broker-dealer and agent/salesman registration or licensing requirements. Additional recommendation history for the instrument is available at http://www.seb.se/research Methodology SEB Research & Strategy determines the global economic backdrop and outlook for fixed income, FX and commodity markets using; 1) own analysis and aggregation tools, including proprietary models and indicators and amended by publicly available data providers (free and fee-based) such as Macrobond, Bloomberg and others; 2) input from other research units within SEB; 3) Various research reports (free and fee-based). The various sources being integrated must fulfil the principles of consistency, plausibility and must be backed by fact. Final consideration as to any valuations, projections and forecasts contained in this report are based on a number of assumptions and estimates and are subject to contingencies and uncertainties, and their inclusion in this report should not be regarded as a representation or warranty by or on behalf of the Group or any person or entity within the Group that they or their underlying assumptions and estimates will be met or realized. Different assumptions could result in materially different results. Past performance is not a reliable indicator of future performance. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in securities, such as ADRs, whose values are influenced by the currency of the underlying security, effectively assume currency risk.

2017-09-06 8