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Westpac, NAB Seek Cheap Debt With N.Z. Covered Bonds

A Bank of New Zealand branch in Auckland
A Bank of New Zealand branch in downtown Auckland. Photographer: Staton R. Winter/Bloomberg

Bank of New Zealand’s sale of the country’s first covered bonds is spurring others to follow as Australian banks seek to cut borrowing costs through local units with securities forbidden by their own regulator.

BNZ, the Auckland-based subsidiary of National Australia Bank Ltd., sold NZ$425 million ($296 million) of top-rated bonds backed by mortgage payments on June 14 at a 38 percent discount to what New Zealand banks would pay without cover, according to Moody’s Investors Service. Westpac Banking Corp.’s New Zealand unit said yesterday that it’s planning a similar sale this year.

While Australia’s regulator prohibits banks from selling covered notes, the Reserve Bank of New Zealand said last month that it supports the securities as a cost-effective way for lenders to meet tougher capital requirements. Australia’s four-biggest banks, which control New Zealand’s largest lenders, need to refinance $129 billion of debt at home and overseas before the end of 2011, according to data compiled by Bloomberg.

“Australian banks can access cheaper debt, target new investors and diversify their funding by selling covered bonds through their New Zealand subsidiaries,” said Leef Dierks, an analyst for Barclays Capital in Frankfurt who specializes in the securities. “Covered bonds offer a sound alternative, especially at a time when issuing senior unsecured debt is a challenge for lenders.”

European Sales

Covered bonds, mostly sold by European banks, typically attract higher credit ratings than regular notes because they’re backed by assets such as mortgages that stay on the lender’s balance sheet and that can be sold in a default.

Korea Housing Finance Corp., the state-run residential funding provider, is planning Asia’s second sale of covered bonds, a spokeswoman said today. Kookmin Bank, South Korea’s largest lender, raised $1 billion from the first such sale in May 2009, pricing five-year, 7.25 percent notes to yield 550 basis points more than Treasuries, according to data compiled by Bloomberg.

Sales of the securities in Europe jumped 72 percent to 161.5 billion euros ($198 billion) this year from 93.9 billion euros in the same period of 2009 as total European bond issuance dropped and the continent’s fiscal crisis spurred demand for the safest debt, Bloomberg data show.

Extra Yield

The extra yield investors demand to hold Australian financial company debt instead of government bonds has jumped 24 basis points since the start of May, a Bank of America Merrill Lynch index shows. A basis point is 0.01 percentage point.

National Australia Bank, Commonwealth Bank of Australia, Westpac and Australia & New Zealand Banking Group Ltd. sold no bonds in May after issuing a combined average A$2 billion of notes in each of the first four months of this year, according to Bloomberg data.

Introducing covered bond legislation in Australia may be a way for the government to assist banks if global credit markets freeze as they did after the collapse of Lehman Brothers Holdings Inc., Nomura Holdings Inc. analysts said in a report this month.

“Concerns about the reliance of the major banks on external borrowings remains a key risk for the sector should we face an extended period of financial risk aversion on the back of European sovereign debt concerns,” Nomura said.

Banking Act

The Australian Prudential Regulation Authority, or APRA, bans covered notes because they are not “consistent with depositor preference provisions set out in the Banking Act,” according to its website. The Treasury is considering a proposal to allow the bonds “to enhance the stability of the country’s financial system,” Moody’s said in a report today.

Treasury spokesman Conan Elphicke declined to comment and APRA spokesman Andrew McCutcheon said the regulator’s position hasn’t changed.

BNZ’s covered bond sale included NZ$175 million of five-year notes priced to yield 98 basis points more than the swap rate, it said in an e-mailed term sheet. The bank’s NZ$315 million of 8.675 percent notes due in 2015 are trading at 131 basis points more than the benchmark, ANZ prices show.

BNZ is rated Aa2 by Moody’s, two steps below the Aaa grade the risk assessor gave its covered bonds. The bank and its Australian-owned peers -- ASB Bank Ltd., Westpac and ANZ National Bank Ltd. -- control 92 percent of New Zealand home loans, according to Fitch Ratings.

‘Funding Source’

Westpac’s Auckland-based unit sees covered bonds as a “good alternative funding source” and is preparing for its first sale, public relations manager Liz MacIntyre said in an e-mailed response to questions from Bloomberg News. ASB is considering “covered bonds as a funding option, but no decision has been made,” Steve Carritt, acting general manager for treasury, said in an e-mail.

Sydney-based Commonwealth Bank along with National Australia and ANZ, both based in Melbourne, declined to comment on the potential for covered bonds in Australia or New Zealand.

Credit-default swaps on National Australia fell 5 basis points to 130 basis points today, the lowest since June 4, according to Nomura and CMA DataVision in New York.

While New Zealand has no framework for covered bonds, the Reserve Bank of New Zealand said in a report last month that there are no regulatory impediments to banks in the country selling the securities and that it “supports the development of this instrument.”

Until an official policy is published, the central bank has set an informal guideline that banks may sell covered bonds equivalent to 5 percent of assets, spokesman Mike Hannah said in a telephone interview. That would allow BNZ, ASB, Westpac and ANZ to raise about NZ$15 billion from the securities, based on regulatory filings showing their assets.

New Avenue

“Managing their reliance on offshore wholesale funding will continue to be a key challenge for Australian and New Zealand banks,” said David Carroll, a director at Fitch. Covered bonds “provide another avenue for banks to source long-dated funds that may be attractive to the New Zealand major bank subsidiaries, which in the past have derived funding from their Australian parents.”

Covered bonds may also enable issuers to attract investors who bought government-guaranteed bank debt under programs introduced after Lehman’s collapse, according to Patrick Winsbury, a Sydney-based senior vice president at Moody’s.

“It taps into an AAA investor base and therefore in effect continues the relationships that were set up with the government-guaranteed funding during the crisis,” he said.

State-Backed Bonds

Australia’s banks sold more than A$120 billion of state-backed bonds last year, according to Deutsche Bank AG. The government removed the guarantee in March, a month before New Zealand lawmakers did the same.

New Zealand lenders sold NZ$10.3 billion of debt under their country’s guarantee program, according to the Treasury.

Covered bonds may damage a bank’s ratings if it sells too many as they reduce the value of assets that are available to other bondholders in a default, Moody’s said in its report. As long as BNZ keeps its program small as a percentage of overall funding, it will remain in a credit “sweet spot,” the ratings company said.

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