BNZ issues NZ$300 million of covered bonds in private placement after unsolicited investor interest

By Gareth Vaughan

The Bank of New Zealand (BNZ) has issued NZ$300 million worth of covered bonds in a private placement after receiving unsolicited interest in the debt instruments.

Mike Faville, BNZ's newly appointed head of debt capital markets, told interest.co.nz the private placement stemmed from reverse inquiry, or unsolicited interest, from investors in covered bonds. He declined to say who the bonds were sold to or which country the buyers were based in.

However, a Moody's Investors Service ratings report, which assigned an Aaa rating, has the bonds denominated in New Zealand dollars with an eight year maturity, - longer than the five and seven year maturities of the BNZ's previous covered bond issues.

The new NZ$300 million issue means BNZ has now raised NZ$2.57 billion from issuing covered bonds, just over a third of its Reserve Bank imposed limit. The Reserve Bank has confirmed banks can use up to 10% of their total assets as collateral for covered bonds. That compares with an 8% limit set in Australia. As of December 31, BNZ had total assets of NZ$68.6 billion, meaning it could issue covered bonds worth up to about NZ$6.86 billion.

Faville also declined to disclose the interest rate the covered bonds will pay investors. He said there had been ongoing reverse enquiry ever since BNZ's first covered bond issue last June so it was nice to be able to fill some of that demand.

"It's a transaction we're very pleased about," Faville said.

"You don't usually hit reverse enquiry demand unless the deal makes a lot of sense to you."

He wouldn't rule out the possibility of more private placements.

Covered bonds are senior debt instruments backed by a dedicated group of home loans known as a “cover pool” usually issued for five to 10 year terms. The way they're structured means if the issuing bank defaults, the assets in the cover pool are carved off - or ring fenced - from the bank 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 have been banned by the Australian Prudential Regulation Authority as, in the event of a default by the bank issuer, depositors’ claims are diluted. However, the Australian government decided in December to change the law to allow banks to issue covered bonds.

So far BNZ is the only New Zealand bank to have issued covered bonds. It raised NZ$425 million from domestic institutional investors last June and 1 billion euros (NZ$1.85 billion) in Europe in November.

Aside from being a source of cheap funding, the banks say they want to issue covered bonds to help meet the Reserve Bank's core funding ratio (CFR). Introduced on April 1 last year, the CFR sets out that banks must secure 65% of their funding from retail deposits and wholesale sources with maturities of more than one year. The central bank plans to lift the CFR, designed to reduce New Zealand banks reliance on short-term offshore wholesale funding, to 70% this July and 75% in July 2012.

Read Moody's statement below:

Moody's Investors Service has assigned a definitive long-term rating of Aaa to the Series 4 covered bonds issued by the Bank of New Zealand (BNZ) (rated Aa2 and on review for possible downgrade, Prime-1) under the terms of its NZ$7 billion Global Covered Bond Programme. Bank of New Zealand issued NZ$300 million floating-rate Series 4 covered bonds with a 8-year hard-bullet maturity.

Issuer: Bank of New Zealand Covered Bonds Programme Series 4 ....NZ$300M Series 4, Assigned Aaa.

RATINGS RATIONALE

The covered bonds are direct, unconditional and senior obligations of BNZ. In addition, the covered bonds are secured by a pool of residential mortgage loans originated by BNZ and eligible substitution assets (the cover pool). As with all covered bonds, the covered bonds benefit from two layers of protection by having recourse to both the issuer and a collateral pool. T

he rating therefore takes into account the following factors:

1) The credit strength of BNZ, rated Aa2 and on review for possible downgrade.

2) The value of the cover pool. The covered bonds are primarily backed by residential mortgage loans.

Other key factors:

3) Commitment by BNZ to maintain an asset percentage of 97%, which translates into an over-collateralisation of around 3.09%. Moody's considers this over-collateralisation to be "committed".

4) Structure created by the transaction documents. Moody's has assigned a Timely Payment Indicator (TPI) of "Improbable" to the covered bonds. The total value of the assets in the cover pool as at closing date is approximately NZ$2,960,761,456. The cover pool assets are mortgage loans secured by properties in New Zealand. The loans have a weighted-average seasoning of 37 months and a remaining term of 273 months.

The weighted-average loan to value (LTV) ratio is 48.07%. The rating assigned by Moody's addresses the expected loss posed to investors. Moody's ratings address only the credit risks associated with the transaction. Other non-credit risks have not been addressed, but may have a significant effect on yield to investors.

The Aaa rating assigned to the above-referenced covered bonds is expected to be assigned to all subsequent covered bonds issued by the issuer under this programme and any future rating actions are expected to affect all such covered bonds. Should there be any exceptions to this,

Moody's will in each case publish details in a separate press release.

KEY RATING ASSUMPTIONS/FACTORS

Covered bond ratings are determined after applying a two-step process: expected loss analysis and TPI framework analysis. EXPECTED LOSS: Moody's determines a rating based on the expected loss on the bond. The primary model used is Moody's Covered Bond Model (COBOL) which determines expected loss as a function of the issuer's probability of default and the stressed losses on the cover pool assets following issuer default. The Cover Pool Losses for this programme are 16.64%.

This is an estimate of the losses Moody's currently models in the event of issuer default. Cover Pool Losses can be split between Market Risk of 14.47 and Collateral Risk of 3.17%. Market Risk measures losses as a result of refinancing risk and risks related to interest rate and currency mismatches (these losses may also include certain legal risks).

Collateral Risk measures losses resulting directly from the credit quality of the assets in the cover pool. Collateral Risk is derived from the Collateral Score which for this programme is currently 4.15%.

TPI FRAMEWORK:

Moody's assigns a "timely payment indicator" (TPI) which indicates the likelihood that timely payment will be made to covered bondholders following issuer default. The effect of the TPI framework is to limit the covered bond rating to a certain number of notches above the issuer's rating.

SENSITIVITY ANALYSIS

The robustness of a covered bond rating largely depends on the credit strength of the issuer. The number of notches by which the issuer's rating may be downgraded before the covered bonds are downgraded under the TPI framework is measured by the TPI Leeway. Based on the current TPI of Improbable the TPI Leeway for this programme is three notches, meaning the issuer rating would need to be downgraded to A2 before the covered bonds are downgraded, all other things being equal.

A multiple notch downgrade of the covered bonds might occur in certain limited circumstances. Some examples might be (a) a sovereign downgrade negatively affecting both the issuer's senior unsecured rating and the TPI; (b) a multiple notch downgrade of the issuer; or (c) a material reduction of the value of the cover pool. For further details on Cover Pool Losses, Collateral Risk, Market Risk, Collateral Score and TPI Leeway across all covered bond programmes rated by Moody's please refer to "Moody's EMEA Covered Bonds Monitoring Overview", published quarterly.

These figures are based on the most recent cover pool information provided by the issuer and are subject to change over time.

RATING METHODOLOGY

The principal methodology used in this rating was Moody's Rating Approach to Covered Bonds published in March 2010.

Moody's Investors Service did not receive or take into account a third party due diligence reports on the underlying assets or financial instruments in this transaction.

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