Rivals likely to be salivating at cheap funding provided by BNZ's 1 billion euros worth of covered bonds

By Gareth Vaughan

The Bank of New Zealand will pay out a fixed interest rate of just 3.125% per annum to investors' in last month's 1 billion euros (NZ$1.76 billion) seven-year covered bond issue, BNZ's September quarter General Disclosure Statement (GDS) reveals.

Although BNZ will face additional costs from the euro denominated covered bond issue when it swaps the money back into New Zealand dollars, the confirmation of BNZ's cheap new funding source will have its rival banks licking their lips ahead of their own covered bond issues.

Westpac New Zealand chief financial officer Richard Jamieson recently told interest.co.nz that his bank planned the first issue in a 5 billion euros covered bond programme in the first quarter of 2011 and BNZ's issue had "priced reasonably well." ANZ and ASB are also contemplating issuing covered bonds.

BNZ Treasurer Tim Main told interest.co.nz last month the seven-year issue covered bond issue was priced at a spread of 62 basis points per annum over the Euro mid swap rate. But Main had declined to say what the overall pricing – swap plus the 62 basis points - was.

The interest BNZ will pay on the European covered bonds is just over half what it's paying on its first domestic covered bonds issue, when it raised NZ$425 million selling covered bonds to institutional investors in June. The bank is paying 6% on a five-year tranche of that offer and 6.425% on a seven-year tranche. And Main suggested it would've cost BNZ about twice the 62 basis points price to issue standard senior, unsecured seven year debt in Europe.

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.

Covered bonds 'ring fence' a group of mortgages

Covered bonds are senior debt instruments backed by a dedicated group of home loans known as a “cover pool.” If the issuing bank defaults, 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 have been banned by the Australian Prudential Regulation Authority as, in the event of a default by the bank issuer, depositors’ claims are diluted. However, as part of major banking sector reforms the Australian government has announced Aussie banks will now be allowed to issue covered bonds.

BNZ's GDS shows the bank established the Covered Bond Trust to hold housing loans and provide guarantees to its covered bond investors on June 2 when it issued the NZ$425 million worth of covered bonds to local institutional investors. BNZ notes guarantees provided by the Covered Bond Trust have a prior claim over the Trust's assets. As of September 30, the Trust held housing loans valued at NZ$489 million.  BNZ adds that it retains the risk and rewards of ownership related to these loans, meaning they haven't been "derecognised" from its financial statements.

The underlying collateral for the guarantees provided by the Trust comprised housing loans and other assets valued at NZ$493 million at September 30.

Meanwhile, the Reserve Bank of New Zealand wants the Government here to pass a law enabling banks to issue covered bonds backed by legislation to help them entice overseas investors.

The Reserve Bank says 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 NZ$6.96 billion worth, based on the bank's total assets of NZ$69.647 billion at September 30.

BNZ's Main said a reason his bank was issuing covered bonds was to help it meet the Reserve Bank's core funding ratio (CFR). 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.