BNZ may more than double size of NZ$3 billion covered bonds programme; says depositors' secure

By Gareth Vaughan

The Bank of New Zealand (BNZ) could more than double the size of its NZ$3 billion covered bonds programme after raising a more than expected 1 billion euros (NZ$1.75 billion) from its first foray into the massive European covered bond market.

The issue points to strong demand for Australasian bank debt from European covered bond investors worried about turmoil in their own back yard. The lower pricing helps reduce BNZ's funding costs when compared with other options and helps it meet the Reserve Bank's Core Funding Ratio rules aimed at weaning the big four banks off 'hot' short term foreign funding.

BNZ Treasurer Tim Main told interest.co.nz the bank had been looking to raise 750 million euros but was able to lift the issue to 1 billion euros due to strong investor demand. The seven-year issue was priced at a spread of 62 basis points per annum over the Euro mid swap rate. Main declined to say what the overall pricing – swap plus the 62 basis points - was.

BNZ’s first domestic covered bonds issue, when it raised NZ$425 million in June, 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'll pay 6.425%. However, Main said domestic pricing couldn’t be compared to the very different European market.

Instead the best comparison was with what BNZ would have paid to issue senior, unsecured seven year debt in Europe. And he suggested the covered bond issue was nearly 50% cheaper than the 120 basis points over swap BNZ would’ve paid to issue the vanilla debt. BNZ's euro denominated covered bonds were bought by asset managers, insurance companies, pension funds and central banks from the likes of the Netherlands, Germany, Austria, France, and Britain.

Trillions worth

Europe has the world’s biggest and most developed covered bonds market. The European Covered Bonds Council estimates there were 2.4 trillion euros of covered bonds, from more than 25 countries, on issue at the end of 2008.

“We were very, very happy with the outcome,” said Main.

Credit rating agencies Moody's and Fitch assigned triple A ratings to BNZ’s total NZ$3 billion covered bonds programme, higher than BNZ’s own double A rating. Covered bonds are senior debt instruments backed by a dedicated group of home loans known as a “cover pool.” So if the issuing bank becomes insolvent, the assets in the cover pool are carved off 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 are 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 parents of New Zealand’s ANZ, ASB, BNZ and Westpac are lobbying for the introduction of covered bonds in Australia.

Back here the Reserve Bank wants the Government to pass a law enabling banks to issue covered bonds backed by legislation to help them entice overseas investors. Westpac is expected to be the next New Zealand bank to issue covered bonds,with an issue targeted for the first half of the 2011 calendar year. ANZ and ASB are also eyeing issues.

Debtholder, depositholder protection 'unaffected'

Asked to address deposit holders concerns about covered bonds, Main said the most important thing was there was a limit on the value of covered bonds a bank can issue. The Reserve Bank recently said it’s comfortable with New Zealand banks issuing covered bonds worth the equivalent of up to 10% of their total assets. In BNZ’s case that would be about NZ$6.96 billion based on the bank’s total assets of NZ$69.647 billion as of September 30.

“At that level we think that the credit rating of the bank overall, and therefore the protection for ordinary senior debt holders and deposit holders, is unaffected,” Main said.

“So it’s a matter of issuing up to a level which is not going to threaten the credit rating or the security of other creditors in the bank.”

He said the 10% of total assets level, up from the 5% the Reserve Bank had previously rubber stamped, strikes the right balance between protection for depositors and giving banks the opportunity to source “a good market.” BNZ now aimed to lift the size of its NZ$3 billion programme and expects to issue covered bonds annually.

“It will be our intention, steadily over coming years, to increase the amount of issue to utilize that larger (10%) limit that has been talked about by the Reserve Bank,” Main said. “It would mean that we’d be in the markets probably once a year doing a regular issue into the European market.”

There would also be further domestic issues but no other offshore markets were currently being targeted.

A key reason BNZ was issuing covered bonds was to help it meet the Reserve Bank's core funding ratio (CFR), Main added. 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. When it released its annual results last month, BNZ said its CFR was "well above" 65%.