Fitch rates NZ$300 mln inaugural ASB covered bond issue AAA

ASB has become the last of New Zealand's big four banks to issue covered bonds, with a NZ$300 million private placement.

Via a spokeswoman, ASB chief financial officer Shayne Bryant confirmed the bank had completed a NZ$300 million private placement of covered bonds. However, Bryant refused to disclose further details, including the interest rate the bonds will pay and who the investors are, saying these were confidential and couldn't be released.

Earlier, credit rating agencies Fitch and Moody's issued press releases giving the ASB issue their highest possible AAA and Aaa credit ratings. Denominated in New Zealand dollars, the issue is presumably to domestic retail investors and appears to mature in six-years given a maturity date in December 2017.

Fitch says ASB's cover pool - or security - consists of 26,040 loans secured by first-ranking mortgages over New Zealand residential properties with a total outstanding balance of NZ$3.86 billion. The portfolio is wholly comprised of full documentation loans which have a weighted average current loan-to-value ratio of 49.8%, and a weighted average seasoning, or term they've been running, of 3.3 years. Fixed-rate loans represent 51.1% of the cover pool.

ASB's first covered bond issue is part of a €7 billion (NZ$12 billion) covered bond programme the bank registered earlier this year.

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 were 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 the Australian parents of New Zealand's big four banks are now issuing 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.

The Reserve Bank this month confirmed plans for covered bond legislation 18 months after the first covered bond issue by a local bank and with more than NZ$6 billion worth of covered bonds already on issue from BNZ, Westpac and ANZ.

See Fitch's statement below:

Fitch Ratings has assigned ASB Bank Limited's (ASB, 'AA'/Stable Outlook/'F1+') Series 2011-1 NZD300m inaugural residential mortgage covered bonds a 'AAA' rating.

The hard bullet bonds due in December 2017 are guaranteed by ASB Covered Bond Trustee Limited. ASB, under its covered bond programme, can periodically issue covered bonds up to EUR7.0bn, secured on a dynamic pool of first-ranking New Zealand residential mortgage loans.

The rating is based on ASB's 'AA' Long-Term Issuer Default Rating (IDR) and a Discontinuity Factor (D-Factor) of 29.9%, the combination of which enables the covered bonds to reach a 'AAA' rating on a probability of default basis. The minimum overcollateralisation (OC) the issuer commits to in the programme documentation is sufficient to sustain the 'AAA' level of stress.

The programme's contractual asset percentage (AP) of 83.3% (equivalent to 20.0% OC) is equal to the AP supporting the 'AAA' rating. The level of AP supporting the rating will be affected, among other things, by the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuances, and it cannot be assumed that it will remain stable over time.

"With ASB's first covered bond issuance, all four major New Zealand banks have now activated their covered bond programmes. This issuance has allowed ASB to access longer tenor debt," said David Carroll, Director in Fitch's Structured Finance team.

Fitch's D-Factors measure the likelihood of an interruption of payments on the covered bonds at the time of a default by their issuer, on a scale between 0%-100%; 0% reflects a perfect continuity, and 100% is equivalent to a simultaneous default of the issuer and its covered bonds.

The D-Factor of 29.9% reflects the: strength of the asset segregation through a bankruptcy remote SPV, which will act as guarantor of the covered bonds; the mitigant-to-liquidity gap risk in the form of a pre-maturity test, triggering the cash collateralisation of payments due over the next 12 months upon a downgrade of the issuer below 'F1+', or for future soft bullet issues, a 12-month maturity extension and a cash reserve covering three months of payments due on the covered bonds; the provision for the guarantor to take decisions after issuer default, aided by the adequate quality of the issuer's IT systems; and the lack of a covered bond regulatory regime in New Zealand.

All else being equal, the rating of ASB's residential mortgage covered bonds could still be maintained at 'AAA' if the issuer was rated at least 'A'. As of 31 October 2011, the cover pool consisted of 26,040 loans secured by first-ranking mortgages over New Zealand residential properties with a total outstanding balance of NZD3.86bn.

The portfolio is wholly made up of full documentation loans which have a weighted average current loan-to-value ratio of 49.8%, and a weighted average seasoning of 3.3 years. Fixed-rate loans represent 51.1% of the cover pool. In a 'AAA' scenario, Fitch has calculated a weighted average frequency of foreclosure for the cover assets of 10.8%, and a weighted average recovery rate of 51.1%.

The cover pool is geographically distributed across New Zealand, with the largest concentrations being in Auckland (65.7%) and Wellington (8.8%).

The agency's mortgage default analysis is based on the Australian mortgage default model criteria updated with a New Zealand-specific default probability, market value declines, and other risk adjustments that relate to the New Zealand mortgage market.

Fitch has formed assumptions about the default probability and losses of the cover pools under a 'AAA' stress scenario, as well as tested maturity mismatches between the cover pools and possible covered bond issuances in a wind-down scenario under the management of a third party.

And here's Moody's statement:

Moody's Investors Service has assigned a definitive long-term rating of Aaa to the Series 2011-1 covered bonds issued under the terms of a €7.0 billion covered bond programme established by ASB Bank Limited ("ASB" or the "Issuer").

Under the programme, either ASB or its wholly owned subsidiary, ASB Finance Limited, London Branch may issue covered bonds. ASB issued NZ$300 million fixed-rate Series 2011-1 covered bonds with a 6-year hard-bullet maturity. This issuance is the first Series issued under the covered bond programme established by ASB.

Issuer:

ASB Bank Limited ....NZ$300M Series 2011-1, Definitive Rating Assigned Aaa

RATINGS RATIONALE

The covered bonds are direct, unconditional and senior obligations of ASB. The payments of all amounts due in respect of the covered bonds are unconditionally guaranteed by ASB Covered Bond Trustee Limited (the "CB Guarantor"). In addition, the covered bonds are secured by eligible assets primarily being a pool of residential mortgage loans originated by ASB and eligible substitution assets (the cover pool).

As with all covered bonds, the covered bonds benefit from two layers of protection by having recourse to both the issuer and a collateral pool (or cover pool).

The definitive rating therefore takes into account the following factors:

1) The credit strength of ASB, rated Aa3/P-1/C+.

2) The credit quality of the Cover Pool securing the payment obligations under the Covered Bonds. All the loans in the Cover Pool are residential mortgage loans originated by ASB in New Zealand.

Other key factors:

3) Requirement on ASB to maintain a maximum asset percentage of 90%, which translates into a minimum over-collateralisation of around 11.11%. Moody's considers this over-collateralisation to be "committed".

4) The use of structuring techniques designed to mitigate the rating linkage between the Issuer and the Covered Bonds..

Moody's has assigned a Timely Payment Indicator (TPI) of "Improbable" to the covered bonds. The total value of the pool of residential mortgage loans within the cover pool as at cut-off date is approximately NZ$3,861,129,889.71. The cover pool assets are mortgage loans secured by properties in New Zealand.  The loans have a weighted-average seasoning of 37.3 months and a weighted-average remaining term of 257.6 months. The weighted-average loan to value (LTV) ratio is 49.8%.

The rating assigned by Moody's addresses the expected loss posed to investors. Moody's ratings address only the credit risks associated with the transaction. Other non-credit risks have not been addressed, but may have a significant effect on yield to investors. The Aaa rating assigned to the above-referenced covered bonds is expected to be assigned to all subsequent covered bonds issued by the issuer under this programme and any future rating actions are expected to affect all such covered bonds.

Should there be any exceptions to this, Moody's will in each case publish details in a separate press release.

KEY RATING ASSUMPTIONS/FACTORS

Covered bond ratings are determined after applying a two-step process: expected loss analysis and TPI framework analysis.

EXPECTED LOSS:

Moody's determines a rating based on the expected loss on the bond. The primary model used is Moody's Covered Bond Model (COBOL) which determines expected loss as a function of the issuer's probability of default and the stressed losses on the cover pool assets following issuer default. The Cover Pool Losses for this programme are 23.0%. This is an estimate of the losses Moody's currently models in the event of issuer default.

Cover Pool Losses can be split between Market Risk of 17.3% and Collateral Risk of 5.7%. Market Risk measures losses as a result of refinancing risk and risks related to interest rate and currency mismatches (these losses may also include certain legal risks). Collateral Risk measures losses resulting directly from the credit quality of the assets in the cover pool. Collateral Risk is derived from the Collateral Score which for this programme is currently 6.50%.

TPI FRAMEWORK:

Moody's assigns a "timely payment indicator" (TPI) which indicates the likelihood that timely payment will be made to covered bondholders following issuer default. The effect of the TPI framework is to limit the covered bond rating to a certain number of notches above the issuer's rating.

SENSITIVITY ANALYSIS

The robustness of a covered bond rating largely depends on the credit strength of the issuer. The number of notches by which the issuer's rating may be downgraded before the covered bonds are downgraded under the TPI framework is measured by the TPI Leeway. Based on the current TPI of Improbable the TPI Leeway for this programme is three notches, meaning the issuer rating would need to be downgraded to A2 before the covered bonds are downgraded, all other things being equal.

A multiple notch downgrade of the covered bonds might occur in certain limited circumstances. Some examples might be (a) a sovereign downgrade negatively affecting both the issuer's senior unsecured rating and the TPI; (b) a multiple notch downgrade of the issuer; or (c) a material reduction of the value of the cover pool.

(Updates add ASB private placement comments and Moody's statement).