BNZ seeking at least €500 mln through European covered bond issue in market that 'has become a little less frozen'

By Gareth Vaughan

The Bank of New Zealand (BNZ) hopes to raise at least €500 million (NZ$797 million) from Western European institutional investors this week through an issue of covered bonds secured by New Zealand residential mortgages written by the bank.

BNZ Treasurer Tim Main told interest.co.nz the bank hoped to take advantage of a window of opportunity in turbulent global funding markets and place some debt to help pre-fund its needs for the year. The BNZ's European fund raising efforts come hot on the heels of downgrades by Standard & Poor's of its credit ratings on nine euro-zone countries including France as the European sovereign debt crisis rumbles on.

BNZ's latest covered bond issue, its fifth overall assuming it goes ahead, also closely follows covered bond issues by its parent National Australia Bank (NAB), ASB's parent Commonwealth Bank of Australia (CBA), and the ANZ Banking Group over the holiday season where the big Australian banks have had to pay investors higher interest rates than their New Zealand subsidiaries paid in earlier covered bond issues.

Main said the BNZ had factored this into its plans.

"The important thing is the market has become a little less frozen at the start of 2012, which is a good thing," said Main. "Investors are back in the market buying bank debt. So we're looking to take an opportunity, with the slightly improved sentiment out there, to make an issue and the price simply reflects current market conditions."

BNZ's move to issue covered bonds comes after the ANZ Banking Group last week priced a €1 billion, ten-and-a-half year covered bond issue at 130 basis points over the swap rate. That's up from the 95 basis points over swap its NZ subsidiary, ANZ New Zealand, got as recently as October last year when it sold €500 million worth of covered bonds in a five-year issue and compares with just 62 basis points over swap in BNZ's €1 billion seven-year issue back in November 2010.

According to Bloomberg, earlier in January CBA and NAB paid about 100 basis points more than premiums on senior unsecured debt issued in the middle of last year when they sold a combined €2.5 billion worth of five-year covered bonds. The Australian Financial Review reported that, after hedging the proceeds, CBA and NAB's costs all up were between 210 and 220 basis points over the Australian bank bill rate, or 6.6%. ANZ's were 240 basis points over the bank bill rate, or 6.85%.

'Jump when investor appetite is there'

Asked whether he thought fund raising would get more difficult, Main said it was hard to tell.

"I think 2012 is going to be similar to the second-half of 2011 where you have underlying negative investor sentiment but there may be periods of positive activity and developments," said Main. "So whenever the markets improve, I think the thing for banks will be to take advantage of those windows and jump in while investor appetite is there, place some debt in the market to meet our funding requirements and then step back and reassess things."

Asked how much BNZ was seeking to raise Main said €500 million was the minimum benchmark issue size in Europe and this is BNZ's "primary" target. Subject to market conditions, he hopes to get a deal done this week.

It's BNZ's first covered bond issue since last June with the bank having previously raised NZ$3.47 billion from covered bonds.The Reserve Bank has set a cap that lets banks use up to 10% of their total assets as collateral for covered bonds. BNZ has total assets of NZ$74 billion, meaning it can issue close to NZ$7.4 billion worth of covered bonds.

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 has now changed the law, meaning the Australian parents of New Zealand's big four banks have started issuing covered bonds.

AAA credit ratings better than those on the bank issuers' themselves

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. Standard & Poor's rates the big four New Zealand banks themselves, who have all issued AAA rated covered bonds, AA-. Moody's Investors Service rates the banks Aa3.

Covered bonds are viewed as a cheap source of funding for the banks - investors' in the ANZ issue are receiving 3% interest per annum and in BNZ's inaugural euro issue, 3.125%, although as noted above the banks also have to pay to convert money raised overseas back into New Zealand dollars.

The Reserve Bank currently has a consultation paper open on its plans for covered bond legislation.

Meanwhile, Main said at the moment investors have a strong preference for securitised forms of bank debt, such as covered bonds, over standard senior bank debt, so they can get the stronger credit rating.

"We're hopeful if markets improve further this year, then there may be increased appetite for senior unsecured (debt) but right now the interest is in covered bonds," said Main.

BNZ has hired DZ Bank, JPMorgan Chase & Co., NAB, Natixis, Royal Bank of Scotland and the German arm of Italy's UniCredit to manage the offer, with Main saying BNZ is targeting institutional investors in Britain, Germany and France.

If BNZ successfully raises €500 million, or more, this should prove a significant slice of its 2012 funding requirements. Main said the bank was looking to raise less money this year than the more than NZ$4 billion it raised during 2011.

'Ahead of plans'

 BNZ is well funded, Main added, given deposit growth had been "wonderful" and asset growth less than planned.

"We're well ahead of our plans and this term funding we're looking to do through covered bonds is simply to pre-fund the needs we project over the coming year."

BNZ's last General Disclosure Statement (GDS) shows it had NZ$6.29 billion worth of liquid assets as of September 30 last year. That's less than the NZ$9.47 billion, NZ$11.12 billion and NZ$12 billion held at the same date, respectively, by ASB, Westpac NZ and ANZ NZ. Liquid assets include the likes of cash, Treasury bills, call deposits with central banks, bank bills and residential mortgage backed securities with the idea they can be quickly converted to cash if and when needed by the bank.

The BNZ GDS shows the bank grew business loans by NZ$496 million to NZ$26.13 billion in the September quarter and housing lending by NZ$305 million to NZ$27.38 billion. The business lending outpaced its rivals and BNZ's housing lending, which rose NZ$305 million and trailed only Westpac's NZ$335 million and Kiwibank's NZ$318 million in the quarter.

BNZ's total assets rose NZ$4.6 billion in the September quarter to NZ$74 billion. Term deposits rose NZ$172 million to NZ$18.9 billion and total deposits increased NZ$496 million to NZ$31.4 billion.