Two key mitigants typical of New Zealand covered bond programmes are sufficient to protect investors from the negative credit impacts of any house price correction in the country, according to Moody’s, which nevertheless noted that one of these is absent from Bank of New Zealand’s covered bonds.

New Zealand house prices have roughly doubled in the decade to Q1 2013 and are now at record highs, noted Moody’s in a report today (Friday). However, the rating agency said that investors are protected from any negative credit impacts that could arise from a correction by two factors: use of indexed property values when applying asset coverage tests (ACT); and low weighted average loan-to-value (LTV) ratios evident for cover pools.

“The use of indexed property values in ACT significantly mitigates the risk to which covered bond investors are exposed when house prices fall because it requires the issuer to add additional mortgage loans to the cover pool in such a scenario,” said Moody’s.

“The indexing of property values – when performing an ACT – means that more mortgage loans must be added to the cover pool when house prices fall to a point where the Indexed LTV exceeds a certain LTV threshold. This is because the ACT gives no benefit to the portion of a loan above the LTV threshold.”

But while ANZ National, ASB, Kiwibank and Westpac NZ use indexation in their ACTs, Bank of New Zealand does not, “therefore investors do not benefit from additional mortgage loans being added to the cover pool when house prices decline”, said Moody’s.

Bank of New Zealand was the first bank in the country to issue covered bonds. When Australian banks began approaching the covered bond market in late 2011, some issuers, including Bank of New Zealand parent National Australia Bank, initially proceeded without using indexation, but following feedback from investors added it to their programmes.

Moody’s noted that Westpac NZ and ASB have the lowest and hence most conservative LTV thresholds, of 75%, with the others having 80%. The rating agency calculated that, assuming committed overcollateralisation of 21%, New Zealand issuers using indexation would have to add on average about 18% in additional mortgages to cover pools, based on current LTV distributions, if house prices were to fall by 40%. With the highest proportion of loans with LTVs above 75%, Kiwibank would have to add the highest amount of additional mortgage loans if house prices were to fall by more than 30%, added Moody’s.

Estimated additional assets required to meet ACT based on current LTV

Source: Covered bond investor reports, Moody’s calculations

The other key mitigant, low weighted average current LTVs, reduce the need for banks to add additional mortgage loans to cover pools, said Moody’s.

“The lower the WA Current LTV, the more house prices can fall before the mortgage loans exceed the LTV threshold, and therefore the less likely it is that additional mortgage loans need to be added to the cover pool,” it said. “This reduces investors’ reliance on the issuers performing their obligations.”

WA current LTV for New Zealand and Australian cover pools

Source: Covered bond investor reports, Moody’s

Moody’s said earlier this month that a Reserve Bank of New Zealand plan to restrict high LTV lending is credit positive for covered bonds. (See article here.)