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

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.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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16 Comments

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I wonder. Are Westpac's mortgage customers aware that a European customer now has some ownership rights over their mortgage?

And are term depositers being compensated for being shunted down the priority queue?

cheers

Bernard

A: (1) Don't be silly....and A: (2) Don't be sillier...

Oh come on Bernard.  You of all people should get your facts right!

There are no 'ownership rights' as the banks that issue covered bonds are not selling the loans to anyone - they remain 100% owned by the bank...  

What is happening is that there are certain creditor rights being attached to blocks of loans that form the covered bond pools...  And creditor rights are absolutely not the same thing as ownership rights!!

Are term depositors being compenstated...  well that rather depends on whether term depositors demand compensation or not.  Westpac is under no obligation to give them any... so it is rather up to the customers to ask for it.....

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.

A question. If my mortgage is part of this bond and in 2 years time - say after i come off the current fixed rate deal - I decide to move to a different lender,  then what happens? Surely Westpac can't prevent me from leaving on the spurious grounds that they have already sold my mortgage to someone else on a five year term?

I'm genuinely interested in the answer to this Gareth...please advise.

Chris, we expect there would be substitution clauses in the documentation - replacing your mortgage with another of the required "quality."

This one Ostrich? - a weighted average current loan-to-value ratio of 56.9%. It's the one both Fitch and Moodys have.

Yes, it seems a bit odd. I don't have the data Fitch & Moodys used though.

Hey no worries CB...as one of the chosen you can expect invitations to the bank BBQs and no trouble getting cheap credit ever again...the last thing the banks wants, is to see you pay up and depart.

Interesting, thanks Gareth. Can't help but feel such a clause could be open to abuse by the banks should the sh*t hit the fan further down the line... Maybe these things aren't quite such a cast-iron bet for foreign investors after all.....

In one of the links in the article above

"The securities typically get higher credit ratings and pay less interest because they are backed by assets such as mortgages that stay on the lenders balance sheets and that can be sold in the event of default"

Question do the home loan borrowers get told they have been repackaged and on sold?

Do they have a choice? Do they get to take advantage of the lower interst rate. What happens if they want to pay of debt?

I understand that the "package" can be on sold so what happens to the home owner " if the assets can be sold in the event of default" Why do I think this is just an accident waiting to happen?

The value of the banks assets are  based on mortgages on a whole lot of overvalued property. This is what happened overseas when so many banks failed. The property values dropped below the value of the mortgages but the covered bonds still had to be paid back and the banks depositors  lost their money. 

For the Govt to allow the banks to issue covered bonds is a sign of last resort along with selling SOEs.

 

Ssssshhhhh!

You're not allowed to say such things.

Well you are forgetting of course that banks have to mark their loans to market each reporting period, which means that changes in the value of the properties will be taken account at each reporting period.  

This won't be done individually, but in aggergate and under the watchful eye of the auditors, Securities Commission and Reserve Bank.  IFRS has provisions for pooling of securities (loans) for such valuation purposes.

I don't figure how issuing covered bonds is a sign of last resort...  care to elucidate?

Depositors should avoid BNZ and Westpac like the plague.
 

Unless those banks re apply for a Government Guarantee aye Malarkey:)

Yes and those Banks,still shuffle the group mortguages around to each other at the price they were back in 07...The reality is that these empty houses have a negative value because of state Taxes and insurance. As long as they remain empty and unsold they can do this.But the moment that the asset is realised,they have a loss.....So the Banking system is in LALA Land.When the crunch comes the dollar will be worthless..even Ben has talked of going back to the Gold standard.

It does seem strange that around the world Basel III is bringing in tougher capital requirements and yet the NZ banks are now diluting their capital in this manner. 

When you consider the unrealised losses that banks are "holding" in their commercial property portfolios (and even in areas of their rural and residential books in the current market), it makes you think twice about where best to protect your cash deposits. 

To date the NZ and Australian banks have performed well by maintaining solid capital bases and not getting too exposed to the complex instruments that caused chaos in Europe and the US.  Let's hope this trend continues.