By Gareth Vaughan
After issuing A$700 million (NZ$912 million) of covered bonds in Australia the Bank of New Zealand (BNZ), still the only New Zealand bank to have issued covered bonds, has reached 60% of its Reserve Bank mandated capacity and says it won't be issuing any more until at least next year.
BNZ yesterday issued the five-year covered bonds to Australian institutional investors at 88 basis points over the Australian mid-swap rate. The bank's Treasurer, Tim Main, told interest.co.nz he estimated that was at about 65% of what comparable senior unsecured bonds would have priced at in the Australian market.
It was slightly higher than what the BNZ paid on its NZ$425 million domestic covered bonds issue last June, with Main saying Australian investors saw the issue in their country as a one-off.
"We're getting ahead of all the other Aussie banks who have not yet prepared their (covered bond) programmes," Main said. "So our parent (National Australia Bank) allowed us in there one time only to tap the market. I'm very pleased with the outcome."
Main said the Australian investors would receive interest of about 6.31% per annum.
The Australian issue means BNZ, which has issued covered bonds to domestic institutional investors, European institutional investors, through a private placement and now in Australia, has issued about NZ$3.47 billion worth of covered bonds.
'Step back a bit'
The Reserve Bank says it's comfortable with banks using up to 10% of their total assets as collateral for covered bonds. BNZ had total assets of NZ$68.668 billion at March 31. Main said it had now reached 60% of its covered bond capacity.
"So we think it's prudent to step back a bit, allow a bit of headroom on that limit so that if we do need the funding next year, we can consider another covered bond," said Main.
"Our strategy now is to go back into the senior unsecured bond market to recommence issuance, to maintain a presence in that market which is very important to us, and then we may look to do another covered bond issue next year, depending on how conditions evolve."
Covered bonds are senior debt instruments backed by a dedicated group of home loans assigned to provide security for the debt known as a “cover pool.” Popular in Europe, they are usually issued for terms of between five and 10 years. 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 (APRA) 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, and has introduced legislation to allow banks there to issue covered bonds.
Unlike with residential mortgage backed securities (RMBS), covered bond cashflows are funded by the issuer and not by the cashflows of the mortgage pool. Covered bond investors have dual recourse to the bank and mortgage pool collateral while senior bank bond investors can only claim on the bank, and RMBS investors can only claim on the collateral.
'Good luck to ANZ & Westpac'
Although they haven't yet issued any covered bonds, both ANZ and Westpac are prepared to do so. ANZ is this week conducting a European investor road show ahead of an inaugural covered bond issue after establishing a 5 billion euros programme, And Westpac plans to resurrect the 1 billion euro covered bond issue it delayed in February when the pricing's right. New ASB CEO Barbara Chapman says her bank is also preparing the ground work for a covered bond programme.
Main said he wished the other banks well with what's a "very cost effective" form of funding.
"I wish them luck because really it's not a competitive thing, we're selling New Zealand Inc to the European market so it's in all our best interests if their issues are successful. It means in the future we all have access to a good market and the New Zealand name is very strong," Main said.
Unlike Australia, there has been no specific law preventing banks from issuing covered bonds in New Zealand. However, the Reserve Bank is working on legislation aimed at giving foreign investors greater confidence in buying New Zealand covered bonds. Main said BNZ was relaxed about issuing covered bonds ahead of any legislation.
"They (the Reserve Bank) have said they'll grandfather existing issuances and we're confident that the legislation they come out with will be consistent with what we've been doing."
The latest covered bond issue will further bolster BNZ's strong liquidity position against a backdrop of weak lending growth. Although BNZ was the only one of the big four Australian owned banks to lift its gross lending in the March quarter, chief financial officer Ken Christie told interest.co.nz last month that BNZ was "certainly cashed up," with cash and liquid securities well in excess of NZ$8 billion.
The banks say covered bonds will help them meet the Reserve Bank's core funding ratio (CFR). Established on April 1 last year, the CFR sets out that banks must source at least 65% of their funding from retail sources and wholesale sources like bonds with durations of more than one year. The Reserve Bank plans to lift the CFR to 70% on July 1 and then 75% on July 1 next year.
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