My word is my bond. Risk assessment of the Swedish mortgage portfolio

Abstract

In this thesis, we investigate risks in the Swedish mortgage portfolio, namely Swedish covered bonds, in a housing market decline. We develop a stress-model which estimates mortgages that needs to be withdrawn from the cover pool to honor the covered bond contract. Further, we extend our model to restore the initial market risk profile in the cover pool. Lastly, we use S&P Globals ratings methodology to assess covered bonds’ credit ratings and credit enhancements. Our research suggest significant structural liquidity risk and maturity mismatch within the Swedish mortgage portfolio rather than credit risk. In a worst case scenario, a house price decline of 35%, SEK 446bn of cover assets would be withdrawn in order to honor the covered bond contract, an additional SEK 1380bn to restore the market risk profile and SEK 286bn to keep current ratings. Swedish mortgage institutions could have issues to refinance their covered bonds which typically have maturities of 3-5 years while mortgages have maturities of 25-30 years.