Credit rating agency Fitch sheds light on the residential mortgages guaranteeing Westpac's covered bonds

By Gareth Vaughan

A total of 22,218 New Zealand home loans secured by property are being used as collateral against Westpac's imminent 1 billion euros (NZ$1.78 billion) issue of covered bonds to professional, or institutional, European investors.

This total, and additional detail on the residential property loans comprising Westpac's cover pool, is disclosed in a report by credit rating agency Fitch Ratings, which rates Westpac's covered bonds AAA, above of the bank's own AA rating. Moody's Investors Service also rates Westpac's covered bonds AAA.

According to Fitch, the loans in Westpac's cover pool have a total outstanding balance of NZ$2.733 billion, the portfolio is comprised of full documentation loans with a weighted average current loan-to-value ratio of 56.9%. They have a weighted average seasoning, or time they've been running, of 27.3 months. The weighted average remaining term is 281.5 months. Fixed rate loans make up 72.9% of the pool.

"The cover pool is geographically distributed around New Zealand's population centres, with the largest concentrations being in Auckland (31.6%), Canterbury, centred on Christchurch (16%), and Wellington (12.8%)," Fitch said.

Westpac plans to issue 1 billion euros worth of covered bonds next month as the first part of a 5 billion euros covered bonds programme over the next few years.

Covered bonds are senior debt instruments backed by a dedicated group of home loans known as a “cover pool” usually sold 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 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 said in December it would change the law to allow banks to issue covered bonds.

Reserve Bank's 10% limit

The Reserve Bank confirmed last week that it had set an initial covered bond limit of 10% of the total assets of an issuing bank, with this limit calculated on the value of assets encumbered for the benefit of covered bondholders. This confirmation follows consultation initiated by the central bank last October on the introduction of a regulatory framework for covered bond programmes.

In its consultation paper the Reserve Bank said it wanted to see the introduction of legislation that would enshrine the rights of foreign covered bond investors to mortgages written by New Zealand banks ahead of local bank depositors.

In the first covered bond issue by a New Zealand bank, BNZ raised NZ$425 million from domestic institutional investors last June. It then raised 1 billion euros from selling covered bonds to European institutional investors in November through an issue of seven year covered bonds paying out a fixed interest rate of just 3.125% per annum.

BNZ's domestic issue saw NZ$175 million worth of five-year bonds priced at 98 basis points over the swap rate meaning those bonds pay 6% interest per annum. And NZ$250 million worth of seven-year bonds were priced at 112 basis points over the swap rate meaning they pay 6.425%.

BNZ's covered bonds were also rated AAA, ahead of its own AA rating, by Fitch and Moody's. See all New Zealand bank credit ratings here.

"As with all covered bonds, the (Westpac) covered bonds benefit from two layers of protection by having recourse to both the issuer and a collateral pool," says Moody's.  It adds that the AAA rating takes into account the credit strength of Westpac itself and the value of the cover pool.

Aside from being  a source of cheap funding, BNZ and Westpac say they are also issuing covered bonds to help meet the Reserve Bank's core funding ratio (CFR). Introduced on April 1, 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 aims to lift the CFR to 75% during 2012. See Bernard Hickey's comment piece here on covered bonds.

Both ANZ New Zealand and ASB are also considering issuing covered bonds. And before stepping down as Kiwibank CEO last year, Sam Knowles said the state owned bank would look at the possibility of issuing covered bonds over the long-term.