Covered bonds appear to be fulfilling their expected role of providing funding diversification for Australian banks, a Reserve Bank official said today (Monday), adding that large onshore deals earlier this year were somewhat surprising, with Moody’s noting that banks have significant unused issuance capacity.

Guy Debelle, RBA

Speaking to the Australia Securitisation Forum (ASF) in Sydney, Guy Debelle, assistant governor, financial markets at the Reserve Bank of Australia (RBA), said that covered bond issuance by Australian banks earlier this year did not quite conform to his expectations of how the asset class would be used, but that this has since changed.

“At this forum last year, I said that I thought covered bonds were likely to be used to access funding offshore, while RMBS would continue to be the main vehicle used to raise asset-backed funding onshore,” he said. “That wasn’t quite how it panned out earlier this year, when there were a few very large covered bonds issued domestically.”

Commonwealth Bank of Australia (CBA) in January sold a A$3.5bn (Eu2.77bn/US$3.61bn) dual tranche five year issue that is the largest bank bond ever sold in Australia, with Westpac Banking Corporation shortly thereafter launching a dual tranche five year of its own – for A$3.1bn – and ANZ Banking Group in the middle of March tapping the domestic market for A$3bn via a dual tranche four year issue.

Debelle said that price was the driver of the onshore transactions, with local investors finding it hard to resist the yield on offer, and the wide spreads on the covered bonds also repricing primary RMBS spreads to uneconomic levels for bank and non-bank issuers.

However, since then pricing levels on covered bonds have tightened considerably, said Debelle, with issuance patterns more in line with his expectations. The bulk of recent covered issuance has been offshore, he said, and of much longer tenors.

“At the same time, we have seen RMBS issuance pick up in the domestic market, with only a few issues into the offshore market,” he said. “Twelve months after their inception, banks have issued, on average, around a quarter of their covered bond issuance caps.

“Covered bonds seem to be performing their expected role of attracting a different investor base and providing an important source of funding diversification for financial institutions.”

Debelle’s comments were made on the occasion of the Australian central bank introducing new information disclosure requirements for RMBS in its operations, and come around one year after the country’s banking act was modified to allow for covered bond issuance, with royal assent being given to legislation on 17 October 2011.

Moody’s said today that the Australian covered bond market has developed rapidly since it came into existence in late 2011, and that Australian banks’ ability to issue covered bonds continues to be a credit positive for them.

“The market is approaching a steady state, with transaction structures bedded down, over A$40bn of issuance, and a gradually expanding investor base”, said Ilya Serov, Moody’s vice president and senior officer. “We continue to view covered bonds as a positive, because they provide the banks with funding opportunities when unsecured debt markets experience severe tightening.”

Covered bonds provide Australian banks with funding opportunities at times when unsecured debt markets experience severe tightening, said the rating agency, with issuance uninterrupted even when unsecured debt markets experience a severe tightening.

Covered bonds represent a ready source of funding for banks to refinance government-guaranteed securities raised in 2008, added the rating agency, with significant spare issuance capacity of around A$104bn (72%) comfortably in excess of government-guaranteed debt maturities (A$58bn in 2013-2014). [See table below]

“Covered bonds also provide valuable funding diversification,” said Serov. “We estimate that major Australian banks met about 35% of their 2012 funding tasks by issuing covered bonds.

A similar pattern is likely to continue through 2013, said Moody’s, with issuance slowly falling to a 25% level over the course of next year and 2014.

“Covered bond issuance has served to broaden the banks’ investor bases,” said the rating agency. “As previously canvassed in our research, the major banks’ relatively high reliance on senior unsecured funding in offshore markets is a key vulnerability.

“To that end, a moderate degree of substitution of unsecured issuance by covered bonds helps mitigate concerns regarding such exposure to confidence-sensitive types of funding.”

It noted that even if the issuance levels of covered bonds approach a regulatory cap of 8% of Australian assets, the aggregate percentage of funding attributable to secured sources will remain at around 10% of total funding, a relatively low level. As a result, covered bond issuance is unlikely to materially affect the credit position of unsecured creditors, said Moody’s.

Source: Moody’s