About 11.4% of NZ home loans, and 12.1% by value, are now providing security for covered bonds issued by NZ banks to predominantly overseas institutional investors

By Gareth Vaughan

About 11.4% of New Zealand home loans are now being used to provide security for covered bonds issued by New Zealand banks.

A controversial form of debt security, the Reserve Bank gave NZ banks the greenlight to start issuing covered bonds in 2010. They are touted as a secure, long-term and comparatively cheap source of funding for banks in an uncertain world. Popular in Europe, covered bonds came through the 2008-09 height of the Global Financial Crisis intact.

Covered bondholders have both an unsecured claim over the issuing bank and hold a secured interest over a specific pool of assets set aside by the issuing bank known as the cover pool. NZ banks' cover pools consist of residential mortgages. Should a bank issuer fail, covered bondholders, in the form of institutional investors predominantly located overseas, would be at the front of the queue to be repaid ahead of depositors and holders of other secured bonds.

That's because if the issuing bank becomes insolvent, the assets in the cover pool are carved off from the issuer’s other assets solely for the benefit of the covered bondholders. This ring fencing of a chunk of a bank’s balance sheet is why covered bonds were banned by the Australian Prudential Regulation Authority (APRA) until shortly after NZ allowed them as, in the event of a default by the bank issuer, depositors’ claims are diluted. It's also why covered bonds typically attract the highest possible credit rating, higher even than their bank issuer's rating.

As of February, New Zealanders had $276.125 billion deposited with local banks.

Some 12.1% of mortgages by value in cover pools

According to credit ratings agencies Moody's and Fitch, there were 176,437 loans in the cover pools of NZ banks as of December 31, 2016. Reserve Bank figures show that, as of January, there were 1,548,506 residential mortgages on issue in NZ. That means 11.4% of them are assigned to cover pools.

According to Moody's, the aggregate value of loans in NZ banks' cover pools was $28.5 billion as of December 31. And as of April 11, Moody's says the total value of covered bonds on issue was $18.5 billion with 25 covered bonds outstanding for periods of five to 17 years.

Reserve Bank figures show $234.914 billion worth of residential mortgages on issue as of January, meaning 12.1% by value are providing security for covered bonds. 

The Reserve Bank has decreed that banks may use up to 10% of their total assets as security for the benefit of covered bondholders. Based on December 31 figures, NZ's big five banks have $454.7 billion worth of total assets, and thus could in theory use up to $45.47 billion worth of assets as security for covered bonds. As of December 31, the big five banks had a combined $219 billion of residential mortgages on issue.

Although NZ banks have plenty of covered bond capacity left, the four Australian owned banks must factor APRA rules affecting funding from their parents into their covered bond planning.  APRA says only covered bonds meet its criteria for contingent funding arrangements provided by the Australian parents to their Kiwi subsidiaries during times of financial stress.

To date, only the big five NZ banks have issued covered bonds. However, other NZ banks are allowed to do so, should they choose to.

 Bank  Covered  bonds
on issue
 Total  assets  Covered bonds
on issue as a
% of total assets
 Value of total assets
available for covered
bond security
 ANZ NZ  $5.1 bln  $163.2  bln  3.1%  $16.32 bln
 ASB  $3.2 bln  $87  bln  3.7%  $8.7 bln
 BNZ  $4.2 bln  $94.1  bln  4.5%  $9.41 bln
 Kiwibank  $191.3 mln  $20  bln  0.95%  $2 bln
 Westpac  NZ  $5.1 bln  $90.4  bln  5.6%  $9.04 bln
 Total  $17.8 bln*  $454.7  bln  3.9%  $45.47 bln

*This figure is based on the Reserve Bank's register of covered bond programmes, and differs from the figure provided by Moody's that's in the article above.

RBNZ touts benefits of covered bonds for bank depositors

The Reserve Bank says although the priority claim covered bondholders have over a portion of the issuing bank’s assets would reduce the value of the assets available to meet the claims of other creditors and depositors in the event of a bank failure, covered bond issuance may also benefit depositors.

"...at low levels of [covered bond] issuance, increasing funding diversity, by developing a covered bond programme, can potentially reduce the probability of a failure occurring," the Reserve Bank says.

"In deciding to allow covered bond issuance, the Reserve Bank considered the benefits of reducing the probability that an issuing bank may fail, and the cost of potentially increasing the losses that may be suffered by the other creditors and depositors in the event of failure. These considerations have been balanced by the imposition of a limit on covered bond issuance. This limit is 10% of the total assets of an issuing bank, calculated on the value of assets encumbered for the benefit of covered bondholders."

"Depositors may also benefit from banks’ covered bond issuance, as it gives banks access to cheaper funding. This may translate into cheaper loans for New Zealand borrowers or higher interest payments for New Zealand savers, depending on the competitive forces in the market. In principle, accessing cheaper funding should allow banks to compete more aggressively for retail customers," the Reserve Bank says.

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21 Comments

"...at low levels of [covered bond] issuance, increasing funding diversity, by developing a covered bond programme, can potentially reduce the probability of a failure occurring," the Reserve Bank says.
Hahaha. If the reserve bank really believed this, it would allow 20%, 30% or 50% of covered bonds.
Another factor not mentioned above is that the covered bond pool is fluid. After the Chch earthquake, the banks quickly took the good mortgaged houses that had been most damaged out of the covered bond pool. So if there was ever a REALLY big earthquake, this will make the remaining risky non covered bond pool even weaker.

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The RBNZ remains unique in the banking world by allowing prime NZ residential mortgages to be ring fenced for overseas investors while imposing the OBR scheme on NZ depositors to ensure that their deposits will not be returned should there be financial instability in one or more banks. APRA and the RBA are far more protective of Australian depositors.

Is it possible to find out if your mortgage/house is part of a covered bond pool of assets? Can you find out?

Nice question. I'm not an expert on this. But I'm wondering why it would matter? If you find that you are in the elite covered pool, are you proposing to stop paying your mortgage just to teach them a lesson!! Haha.

JT, I addressed that here in 2012;

http://www.interest.co.nz/bonds/59429/what-anyone-home-loan-andor-bank-deposit-needs-know-about-bank-bonds-compared-drugs-and

What the banks have to say: Can you find out if your mortgage is in a cover pool? And what does it mean if it is?

The banks are under no legal obligation to tell a customer if his or her mortgage has been placed in a covered bond cover pool. However, interest.co.nz asked the big four if they would be prepared to do so if asked by a customer. ANZ and BNZ said yes, they would.

We further asked the banks if a customer requested their mortgage not be placed in a cover bond cover pool, or asked for it to be removed if it was in one, would they be prepared to do this?

To this ANZ replied: "Once a loan is in the covered bond cover pool, there are very limited circumstances under which ANZ can remove loans from the cover pool."

BNZ said: "No. What’s important to clarify here is that what is sold to the covered bond guarantor are the bank's rights in the mortgage loan, eg the right to receive repayment of the amounts the bank has lent to the customer. These rights are assets of the bank and the bank is legally entitled to deal with those rights, including by transferring them to a covered bond guarantor. Any obligations that the bank has in relation to the customer, such as to provide an additional loan, all queries regarding servicing of the mortgages remain with the bank ensuring we maintain a strong relationship with our customers."

Meanwhile, ASB's response to the two questions was: "There would be no practical impact on customers if their mortgage was part of a covered bond cover pool, as we continue to offer the same service to all of our mortgage customers. Should a customer contact us we would be happy to discuss this with them."

And Westpac said: "A customer can expect no changes to the manner in which a loan is managed as part of a covered bond pool as the loan servicing is still managed by Westpac, and it is only the beneficial ownership which has changed. There is no impact on the terms and conditions of the loan. Under our standard documentation Westpac has the right to transfer or assign the loan to someone else, including for the purpose of securitisation. It is not a requirement of the loan agreement that Westpac notify the borrower (or our normal practise) of a transfer."

a question here; this information states "the bank's rights in the mortgage loan, eg the right to receive repayment of the amounts the bank has lent to the customer. These rights are assets of the bank and the bank is legally entitled to deal with those rights, including by transferring them to a covered bond guarantor." I read this as saying the bank as effectively "sold" it;s rights re the mortgage to a third party, the "Bond holder", does that mean then that the Bond holder can then call in the mortgage? Or does the Bond document mean that that responsibility remains with the Bank?

Murray, my understanding is the bank is in charge unless it defaults on the covered bond. Only if the bank defaults do covered bondholders' rights come into play.

The Reserve Bank says although the priority claim covered bondholders have over a portion of the issuing bank’s assets would reduce the value of the assets available to meet the claims of other creditors and depositors in the event of a bank failure, covered bond issuance may also benefit depositors.

Unelected government apparatchiks picking winners? Dear oh dear, when will government officials learn they have no influence over these matters, including CPI inflation movements. Best to err on the side of caution when other people's money has been placed at risk by an indefensible capital recovery rort (OBR) that distinctly walks and talks like a socialising private sector losses racket.

Yes, depositors have indeed been placed at risk by OBR. See in 2012 the RBNZ saying that OBR reduces the risk of government bailout so reduces the optimal capital that banks need hold. (see para 44 in here )

"Taking account of the possible effects of crisis bailout costs on government funding costs would also increase the optimal capital ratio. This does not lead us to require ever increasing levels of capital however, as the introduction of the Open Bank Resolution policy will reduce the probability of a bailout and reduce this effect."

Obviously, because the RBNZ can dump risk on depositors with OBR, it can allow banks to have a lower level of capital.

"...there is no obligation on the part of Government to use OBR in the event of the failure of a registered bank",
which could be even worse?
http://www.rbnz.govt.nz/-/media/ReserveBank/Files/regulation-and-supervi...

Why doesn't one of the opposition parties promise to scrap the iniquitous OBR system and force banks to raise their capital ratios to protect the depositors. The Australian Reserve Bank required extra capital from their banks for this, so they used the profits that they made in NZ to help while the NZ Government sat back and did nothing.

Because no one can operate without a bank these days. It is a captive market.

Appreciate the idea, but try going down to the local shop to buy a packet of ciggies with crypto currency?
Not really going to work.

it's coming,

REPORTING CASH PRICES WITH A BLOCKCHAIN

The solution to the reporting problem exists and can be quickly implemented. It is called a block chain and takes each transaction for cattle either fed, feeder or stocker and creates a block transaction, confirmed by buyer and seller, then linked to a chain in time order. Transactions would be posted in a linear time line and would include the delivery period, by week for the first 30 days then by two weeks, up to 60 days then by month. Industry participants could view the blockchain but not individual transactions or names. They could review transactions by region, by delivery period, or nationally. The block chain would serve as a cash settlement tool for the CME live cattle contract that is struggling. Industry leaders say it is a good idea but needs to be studied and will take years to implement.

A group of Aussie wheat farmers didn't agree. They were unable to find prices offered by grain terminals in different geographic locations. They were forced to simple accept the local bid. Furthermore, once they accepted bids for their wheat, the settlement and clearing of the transaction took 45 days. In six months they put in place a blockchain that now allows them to view bids from locations all over their area and has decreased the settlement and payment to two business days.

Still doesn't explain why the tax payer has to guarantee the business practices of a bunch of private business's that have been able to influence law and policy to the degree that they have. To describe depositors as a "captive market" on exemplifies the need to properly regulate the banks.

The choice is whether to let normal market bankruptcy procedures apply to banks or to allow government intervention at the point of bankruptcy.

Letting banks 'hit the wall' in a normal market bankruptcy fashion is a pretty stressful outcome to any depositor / voter.

would it be correct to observe that not only does Kiwibank have an implicit government guarantee, but the covered bond issuance is the lowest of all the the banks, both in nominal and percentage terms. That looks pretty good.

True, its not the covered bonds that Kiwibank has trouble with at the moment!

Apart from the fact that 85% of Kiwibank's loan book is in residential mortgages, it does look great. That must be the govts idea of productive investment. I wouldn't be rushing to put my money in with them, unless of course you trust in govt...good luck with that.