By Gareth Vaughan
Westpac 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.
Speaking before a series of fresh earthquakes struck Christchurch yesterday afternoon, Westpac Treasurer Jim Reardon told interest.co.nz that although the uncertain Middle East situation (notably Libya) was the major initial factor in delaying the 1 billion euro (NZ$1.76 billion) covered bond issue, the February 22 earthquake also caused the bank to reassess things. The five-year issue to overseas institutional investors, which Westpac finally got away late last week, was priced at 75 basis points over the Euro mid-swap rate.
"Once the dust had settled on the Middle East, our biggest issue was where we were left with the Christchurch situation and what it meant for both New Zealand and for Westpac," Reardon said.
"We went back to investors at the time and said we would not be coming again immediately because in our mind we weren't in a position where we could provide investors with full information on the impact of Christchurch."
He said the bank had since done this with its half-year results. Releasing the results last month, Westpac - which has significant Christchurch exposure especially following its 1996 Trust Bank acquisition - said for the six months to March 31 costs associated with the earthquake impacted its cash earnings by about NZ$40 million.
Westpac staff then went through the cover pool and identified the areas of Christchurch hardest hit by the earthquake through their post codes.
"Any collateral in those post codes we withdrew from the cover pool," Reardon said.
"It was about 4% of the pool, or NZ$60 million to NZ$80 million worth in those immediate post codes. That didn't mean they (the homes the loans were secured against) were impacted, it just meant they were in that post code."
Assessing that it would be some time before it became clear to what extent individual homes were damaged, Westpac felt that by eliminating mortgages on a post code basis it was taking away uncertainty for investors. Reardon said Westpac didn't replace the 4% of mortgages removed from the pool because it was still big enough without them.
16% of the cover pool was in Canterbury
In its credit rating report on Westpac's covered bonds, Fitch Ratings noted about 16% of the 22,218 home loans secured by property in Westpac's cover pool were in Canterbury. Fitch rated Westpac's covered bonds AAA, above the AA rating Fitch has on the bank itself.
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.
The Reserve Bank says banks can use up to 10% of their total assets as collateral for covered bonds. As of March 31, Westpac had total assets of NZ$57.695 billion, with 10% of that about NZ$5.76 billion. However, Westpac announced a 5 billion euro (NZ$8.8 billion) covered bond programme late last year (of which the initial 1 billion euro issue is a part) and said it had no plans to go beyond the Reserve Bank's 10% threshold, with the covered bonds programme taking place over several years during which it hopes to grow its total assets.
No more Westpac covered bond issues likely for a while
Meanwhile, Reardon said he'd be "surprised" if Westpac went ahead with any further covered bond issues this year.
"Essentially we are pretty comfortably placed so we will look to see how the New Zealand market grows over the next six months before we lock in any future transactions," said Reardon.
Westpac's half-year results noted cash and liquid assets of about NZ$7 billion against the backdrop of a weak lending market.
"Given the uncertain times we live in, particularly with respect to ongoing issues in Europe, I think we feel that we would like to be more comfortable than less comfortable with respect to both liquidity and funding needs," said Reardon.
BNZ, the only other New Zealand bank to have issued covered bonds, has now reached 60% of its Reserve Bank set capacity having issued about NZ$3.47 billion worth in total. BNZ Treasurer Tim Main said the BNZ hadn't transferred any Christchurch mortgages out of its cover pool.
"We believe our mortgage selection criteria and overall pool structure and management oversight is appropriate," Main said. "With over-collateralisation of 20% in the cover pool, there is ample security to cover for any potential losses."
Aside from being a source of cheap funding, the banks say they are issuing 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 at least 65% of their funding from retail deposits and wholesale sources - such as bonds - 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% on July 1 this year and 75% on July 1 2012.
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