NZ banks buy into covered bonds

Bankers say the main benefit of covered bonds is that they open up a big funding channel. Photo / Herald On Sunday

New Zealand banks have been raising billions of dollars in recent weeks by doing something their Australian parent companies can not yet legally do - issue covered bonds.

Three of the big four banks announced last week they had raised, or were in the throes of raising large amounts of money from a market which in Australia is - for the time being at least - illegal.

Bankers say the main benefit of covered bonds is that they open up a big funding channel for the banks and have become an important part of the fund-raising landscape, particularly after the global financial crisis.

Covered bonds can make bank depositors nervous because in the event of a bank failing, investors in this instrument take precedence over them.

They've been illegal in Australia since 1959 but are a familiar sight in many other countries.

Covered bonds are debt securities backed by the cash flows from a specific pool of mortgages or other loans. They differ from standard bonds as investors have specific recourse to the assets that secure, or cover, the bonds in the event of default, and retain a claim on the bank's residual assets.

But every covered bond issued by a bank effectively subordinates the claims of senior and subordinate unsecured debt holders, leaving fewer assets available to settle their claims in the event of a bank failure.

Some countries have chosen to limit them, so that they are seen to be a reasonable proportion of the assets still available to depositors if the bank goes under.

In New Zealand's case, the Reserve Bank in January announced that a regulatory limit would be applied to the issuing of covered bonds by New Zealand banks - initially 10 per cent of the bank's total assets. The central bank said it would review the appropriateness of this limit within the next two years.

It's been a source of irritation to Australia's big four banks - National Australia Bank, ANZ Bank, Commonwealth Bank of Australia, and Westpac - that they haven't been able to raise funds from this market, which they say puts them at a competitive disadvantage in the international market place.

Australian Prime Minister Julia Gillard announced in December that Australian banks could issue covered bonds but the legislation allowing them to do so has yet to become law.

The Bank of New Zealand last week announced its first Australian dollar-denominated A$700 million bond issue.

"We had an opportunity to go into the Australian market before the Australian banks started issuing, so the timing issue was critical and we had a great reception," the BNZs' head of balance sheet management, Mahes Hettige, told the Herald.

Late last week, Westpac NZ said it had raised €1 billion from its first covered bond issue, attracting investors from Asia, the Middle East, Europe, Scandinavia and Britain. ANZ New Zealand is conducting a European investors roadshow for its first euro-denominated covered bond transaction and ASB Bank, a unit of Commonwealth Bank of Australia, is understood to be planning its own issue.

Funds raised from these issues will go towards strengthening the banks' New Zealand balance sheets.

New Zealand banks have not been constrained in their ability to raise funds through covered bonds, but they are a relatively new instrument on the domestic scene. The BNZ has been something of a pioneer in this area over the last year.

Internationally, covered bond markets are performing strongly as people seek out conservative investments in the aftermath of the global financial crisis and of the sovereign debt problems of some European Community members.

Reserve Bank deputy governor Grant Spencer said covered bond programmes would benefit the New Zealand banking system through a broadening of international funding sources, particularly for the issuing of long-term debt.

WHO HAS RAISED WHAT

* The Bank of New Zealand has successfully completed its inaugural Australian Dollar-denominated covered bond transaction, issuing A$700 million for a 5-year term.
* Westpac New Zealand launched its first covered bond transaction, raising €1 billion. Westpac said the ongoing strength of the New Zealand mortgage market and banking sector contributed to a successful transaction.
* ANZ New Zealand is conducting a European investor roadshow around its inaugural Euro-denominated covered bond transaction.