RBNZ happy for banks to launch covered bond programmes well in excess of the central bank imposed 10% cap on assets

By Gareth Vaughan

The Reserve Bank is unconcerned that banks are launching covered bond programmes whose size is well in excess of the mandated limit, saying it's more efficient for them to do this to allow for potential regulatory changes and future asset growth.

The regulator has set a cap that lets banks use up to 10% of their total assets as collateral for covered bonds. However, two banks - ASB and Westpac - have launched covered bond programmes with values well in excess of 10% of their assets.

A Reserve Bank spokeswoman told interest.co.nz that the central bank is not concerned about this.

"The limit imposed by the Reserve Bank effectively restricts the value of assets, that a bank may encumber in favour of a covered bond programme, to 10%. (But) a bank may register a prospectus for a programme with a value that may be above that limit, as long as it does not actually encumber more than 10% of its total assets in favour of the covered bond programme," the spokeswoman said.

"It is more efficient to register a single prospectus for one programme that has sufficient headroom to allow for any regulatory changes, changes in exchange rates, balance sheet growth, etc., than to constantly register and re-register as circumstances change."

ASB has established a 7 billion euro (NZ$12.2 billion) covered bond programme and has total assets of NZ$63.1 billion. That means its programme is nearly twice the size of its NZ$6.31 billion 10% limit. Westpac has a 5 billion euro (NZ$8.7 billion) programme and total assets of NZ$56.8 billion, meaning its programme is also well in excess of its NZ$5.68 billion 10% cap.

Both banks say the programmes, with numerous actual issues of covered bonds planned over a period of several years, allow for them to grow their asset bases.

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 Western Europe, they are usually issued for terms of five to 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 as, in the event of a default by the bank issuer, depositors’ claims are diluted. However, the Australian government decided last December to change the law, and has introduced legislation that will allow Australian banks 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. Therefore covered bonds typically carry AAA credit ratings.

ASB hasn't yet issued any covered bonds although Westpac raised 1 billion euros (NZ$1.7 billion) from overseas institutional investors in its first covered bond issue in June. Westpac subsequently pulled between NZ$60 million and NZ$80 million worth of Christchurch residential mortgages out of the pool used as collateral against its inaugural covered bond issue after the devastating February 22 earthquake.

ANZ, which has total assets of NZ$125.3 billion meaning it could issue covered bonds worth NZ$12.53 billion, has put a 5 billion euro (NZ$8.7 billion) covered bond programme in place but hasn't yet issued any covered bonds. And in four covered bond issues so far BNZ has raised about NZ$3.47  billion, reaching 60% of its Reserve Bank mandated capacity.

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