RBNZ wants to let banks use commercial, development and agricultural property loans, as well as residential mortgages, as security for covered bonds

RBNZ wants to let banks use commercial, development and agricultural property loans, as well as residential mortgages, as security for covered bonds

By Gareth Vaughan

A draft Reserve Bank document on incoming covered bonds legislation says that, aside from the standard use of residential mortgages as security for the bonds, banks can also use loans secured by commercial, development or agricultural property.

This detail is include in a Reserve Bank consultation document on the covered bonds application process and information requirements. It comes after the Reserve Bank of New Zealand (Covered bonds) Amendment Bill was rubber stamped by Parliament's Finance and Expenditure Committee in September with very minor amendments, although the Bill has yet to be passed into law.

As interest.co.nz reported in May, the Bill sets out that  banks could issue covered bonds secured by assets other than the residential mortgages used to date, such as farm loans, and the legislation also opens the door for entities other than registered banks to issue covered bonds in the future.

The Reserve Bank is proposing two categories of asset class designation for covered bond programmes. The first is residential mortgages and the second is property.

The country's big four banks - ANZ NZ, ASB, BNZ and Westpac NZ - have thus far borrowed more than NZ$11 billion through issuing covered bonds with the Reserve Bank's approval, since BNZ became the first to do so in 2010. The select committee recommends existing covered bond programmes be registered with the Reserve Bank within nine months of the Bill passing into law. State owned Kiwibank has also been developing a covered bond programme, with the assistance of Barclays Capital and Chapman Tripp.

To date the banks have used residential mortgages as security for their covered bonds. Under the residential mortgage category of asset class designation, the Reserve Bank says the value of loans secured by a first ranking mortgage, charge, or other security interest over residential property must exceed 75% of the value of the cover pool assets securing the covered bond.

However, other assets that may be used in this category include;

(a) an at call deposit held with a New Zealand registered bank and convertible into cash within 2 business days;

(b) a bank-accepted bill or certificate of deposit that: (i) matures within 100 days; and (ii) was not issued by the registered bank that issued or guarantees the covered bonds secured by the assets in the cover pool;

(c) a bond, note, debenture or other instrument issued or guaranteed by the New Zealand Government or a foreign Government with a foreign currency credit rating of AA (or its equivalent) or above;

(d) a loan secured by a first-ranking mortgage, charge or other security interest over residential property in New Zealand;

(e) a mortgage insurance policy or other assets related to the loan referred to in (d);

(f) a contractual right relating to the holding or management of another asset in the cover pool;

(g) a derivative held for one or more of the following purposes: (i) to protect the value of another asset in the cover pool; (ii) to hedge risks in relation to another asset in the cover pool; (iii) to hedge risks in relation to liabilities secured by the assets in the cover pool.

In the property category, to qualify as a property covered bond programme, the value of loans secured by a mortgage, charge, or other security interest over commercial, residential, development or agricultural property must exceed 75% of the value of the cover pool assets securing the covered bond.

The same other assets can also be used as security as in the residential mortgage category except for (d), which in the case of the property category is  a loan secured by a first-ranking mortgage, charge or other security interest over residential, commercial, development or agricultural property in New Zealand.

What are they?

Covered bonds are dual-recourse securities, issued for anywhere from three to 10 years, through which bondholders have both an unsecured claim on the issuing bank (should it default on the bonds) and hold a secured interest over a specific pool of assets - generally residential mortgages - called the cover pool.

Covered bonds are different to senior unsecured debt instruments issued by banks, where the bondholder is simply an unsecured creditor of the bank, and also from mortgage-backed securities, where the bondholder has a secured interest in the cover pool but has no claim on the issuing bank.

Due to their dual recourse security, covered bonds generally attract the highest possible AAA credit rating (which is higher than the New Zealand bank issuer's own AA- ratings) and are therefore a cheaper form of funding for banks than standard bank bonds. The Reserve Bank has imposed a 10% limit on the proportion of a bank’s assets that may be encumbered in favour of covered bonds as a condition of banks’ registration.

Critics argue covered bond legislation will effectively enshrine the rights of investors, mostly European institutional ones, to some of the residential mortgages written by New Zealand banks ahead of local bank depositors, who currently have about NZ$108 billion in term deposits in New Zealand's banks.

See all interest.co.nz's stories on covered bonds here.

The Reserve Bank is seeking submissions on its consultation document by November 16. The consultation document assumes no material changes are made to the Bill from how it was reported back by the Select Committee.

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If you ever needed clearer evidence that the RBNZ has been captured by the banks (in terms of its regulatory role) then here it is.

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