Standard & Poor’s assigned Australia to Category 2 under its covered bond rating methodology today (Thursday) after reviewing the country’s framework and wider funding options, meaning that authorised-deposit taking institutions (ADIs) with ratings of A- or higher could achieve a triple-A rating from it.

The rating agency also assigned Australian prime residential mortgage loans to Bucket 1 for its target asset spreads.

S&P said that its classification of the country in Category 2 came after a review of Australian covered bond legislation, which came into effect in October with an amendment to the Banking Act 1959, and the range of funding options and strength of funding sources in Australia.

“We believe that the Act, which provided legal certainty to Australian covered bond programmes, coupled with our view of the systemic importance of covered bonds in Australia and the availability and strength of the refinance funding sources, is commensurate with a Category 2 programme categorisation,” said S&P.

This means that Australian covered bonds can be rated four to six notches above an issuing bank’s rating, depending on the programme’s asset-liability mismatch (ALMM) risk classification.

S&P does not rate the covered bond programmes of the big four Australian banks that have established covered bond programmes so far. However, the CEO of Suncorp Bank, which is reported to be working on a programme, last month cited the bank’s A+ rating from S&P when discussing how the bank was planning covered bond issuance, noting that this would allow it to achieve a triple-A rating, and the classification of Australia in Category 2 confirms this, even if it were to have a “high” ALMM risk score from the rating agency.

The Category 2 classification puts Australia on a par with Canada, Finland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal and the UK.

Expanding upon its rationale for the classification, S&P noted evidence of banks providing funding for the acquisition of residential mortgage portfolios, repurchase agreements with the Reserve Bank of Australia, and the Australian government being highly supportive of the country’s financial system.

“Prior to the Act, the issuance of covered bonds was prohibited,” said S&P. “We believe the Act demonstrates the importance of covered bonds as an alternative funding option that broadens the investor base, thereby supporting financial stability in Australia.”

S&P assigned Australian prime residential mortgage loans to Bucket 1 for its target asset spreads, meaning that a target asset spread of 425bp will apply.

“We analysed the secondary market trading margins of Australian AAA rated prime RMBS as a proxy for residential mortgage loan sales in Australia,” said the rating agency. “We have included only prime RMBS in our analysis as this is in line with the eligibility requirement to be included as cover pool assets.

“We also considered the extent offshore markets affect the Australian market because Australia has a level of reliance on offshore funding. While Australian RMBS have performed well to date, the Australian funding market tends to be influenced by key global capital markets.”