Westpac puts 1 billion euro covered bond issue on ice blaming Middle East turmoil

By Gareth Vaughan

Westpac New Zealand has called a halt, for now, to its plans to issue 1 billion euros (NZ$1.8 billion) worth of covered bonds to European institutional investors.

Westpac Treasurer Jim Reardon told interest.co.nz the bank was postponing its maiden covered bond issue due to the uncertain "geo-political" situation in the Middle East. With protests against governments from Morocco to Bahrain, Reardon said there had been a "fairly significant" pushing out of credit spreads in Europe and "pull away" by investors.

He said Westpac had sought expressions of interest on Monday morning, but by lunch time the same day it was clear the Middle East, with bloodshed in Libya dominating the news, was "out of hand."

"We're better to wait for market conditions to settle down," Reardon said. "It's the Middle East so it could be two weeks or two months."

The bank's funding position was "very comfortable" he added, meaning it could afford to wait.

"We're in good nick, so we didn't have to rush anything."

Reardon, who in his previous role spent four years as head of derivatives trading at the Bank of Scotland in London, said Westpac had been looking at a five year term for the covered bond issue but this could change when it comes back to market. However, it was still likely to aim for a full 1 billion euros issue because the bank was keen to do a benchmark transaction.

Covered bonds are senior debt instruments backed by a dedicated group of home loans known as a “cover pool” usually sold for five to 10 year terms. The way they're structured means if the issuing bank defaults, the assets in the cover pool are carved off - or ring fenced - on the issuer’s balance sheet solely for the benefit of the covered bondholders.

This ring fencing 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, The Australian government said in December it would change the law to allow banks to issue covered bonds.

Westpac's issue is designed as the first part of a 5 billion euros covered bonds programme over the next few years.

Here, the Reserve Bank has set an initial covered bond limit of 10% of the total assets of an issuing bank, with this limit calculated on the value of assets encumbered for the benefit of covered bondholders. This confirmation from the central bank last month, follows consultation last October on the introduction of a regulatory framework for covered bond programmes.

In its consultation paper the Reserve Bank said it wanted to see the introduction of legislation that would enshrine the rights of foreign covered bond investors to mortgages written by New Zealand banks ahead of local bank depositors.

BNZ issue

In the first covered bond issue by a New Zealand bank, BNZ raised NZ$425 million from domestic institutional investors last June. It then raised 1 billion euros from selling covered bonds to European institutional investors in November through an issue of seven year covered bonds paying out a fixed interest rate of just 3.125% per annum. The money raised does, however, have to be converted from euros to US dollars and then New Zealand dollars.

Reardon said Westpac wasn't looking to issue covered bonds to domestic investors because it wanted to diversify its investor base.

BNZ's domestic issue 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 pay 6.425%.

BNZ's covered bonds and Westpac's proposed covered bonds, have both been rated Aaa and AAA by credit ratings agencies Moody's Investors Service and Fitch Ratings, higher than the banks own Aa2 and AA ratings.

"As with all covered bonds, the (Westpac) covered bonds benefit from two layers of protection by having recourse to both the issuer and a collateral pool," says Moody's.  It adds that the AAA rating takes into account the credit strength of Westpac itself and the value of the cover pool of  22,218 home loans secured by property.

Aside from being  a source of cheap funding, BNZ and Westpac say they are also issuing covered bonds to help 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. See Bernard Hickey's comment piece here on covered bonds.

Both ANZ New Zealand and ASB are also considering issuing covered bonds. And before stepping down as Kiwibank CEO last year, Sam Knowles said the state owned bank would look at the possibility of issuing covered bonds over the long-term.

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