Covered bonds can provide a viable funding option for financial institutions in South Asia and the ASEAN region, according to Moody’s, with the rating agency seeing potential in India, Thailand, Malaysia and Indonesia in particular and a lack of legal frameworks not necessarily an impediment.

In a report published yesterday (Monday), Moody’s noted that loan growth in many parts of South Asia and in countries that form the Association of Southeast Asian Nations (ASEAN) has outpaced deposit inflows over the past five years, with many leading financial institutions using most of their stock of deposits to fund loans.

Moody’s expects a slowdown in loan growth across the ASEAN region given slowing economic and credit growth in these countries, and noted that although economic growth in India is expected to remain strong, corporate lending has fallen. The rating agency therefore expects that deposit growth will more broadly match loan growth in many of these countries, limiting funding pressure on banks.

“Nonetheless, the structurally high loan-to-deposit ratios that banks in some markets are facing means that even a modest mismatch between deposit growth and loan growth could turn into a meaningful incentive for financial institutions to tap the wholesale funding markets over the coming years,” Moody’s said.

“In this context, covered bonds could add to the funding tools of financial institutions in South Asia and the ASEAN region.”

Moody’s said that the potential role of covered bonds varies from country to country, depending on the specific situations of financial institutions.

In India, the rating agency said, covered bonds could be particularly attractive to non-bank finance companies (NBFCs), including specialist housing finance companies. Amid a significant uptick in retail lending, NBFCs have been diversifying funding sources to reduce their dependence on financing from banks, and are actively engaged in securitisation.

Moody’s said that, specifically, covered bonds can assist Indian housing finance companies in managing the interest margins between their lending and funding.

“The cost of funding for housing finance companies in India is significantly higher than the costs that banks face, because such companies do not have access to retail deposits, which means they are lending at thin margins,” the rating agency said. “Moreover, the majority of funding for such companies is on fixed interest rates, whereas lending by banks is on a floating rate basis, which poses an interest rate risk in a declining interest rate scenario.

Moody’s noted that yields on Asian and global covered bonds tend to be lower than those of senior unsecured bonds.

“If this spread differential were to be replicated for Indian covered bond issuers, it could help housing finance companies that issue covered bonds to better manage interest rate risk,” it said.

In Thailand, Moody’s said, covered bonds could help diversify the foreign currency funding needs of banks, which are a result of their financing of Thai companies’ international expansion. Moody’s said that, in this respect, the foreign currency position of Thai banks appears stretched, with foreign currency loan-to-deposit ratios averaging 192% as of 31 March.

“Thai banks typically hedge their foreign currency exposures by entering into swaps in the domestic market,” said the rating agency. “Diversifying their funding needs away from the volatile swap market could provide some stability and covered bonds could potentially assist in this regard.

“That said, foreign currency assets account for only about 11% of the total assets of Thai banks, while foreign currency loans are equivalent to only 8% of their total loans.”

In Malaysia, Moody’s said, covered bonds could play a role in the funding mix of banks and non-bank financial institutions over the longer term, helping to reduce the cost of longer term funding used to match long dated assets. It noted that some financial institutions in Malaysia have sizeable asset portfolios such as residential mortgages, which could be used as assets for covered bonds.

In Indonesia, covered bonds could be a viable option for mortgage-focused banks, according to the rating agency. It said funding costs for Indonesian banks – which are primarily deposit-funded – have become increasingly volatile owing to multiple interest rate increases over the past few years.

“In that context, covered bonds could provide fixed rate funding for Indonesian banks at longer maturities than that provided by deposits,” Moody’s said.

It said the mortgage portfolios of mortgage-focused banks in Indonesia – such as Bank Tabungan Negara, which it rates Baa3 stable, with a baseline credit assessment of ba2 – could potentially support covered bond issuance. BTN has already issued RMBS.

The rating agency noted that the only nation within the regions of South Asia and ASEAN to have a specific covered bond regulatory framework in place is Singapore. However, it said this is not an impediment to issuance, as long as existing legal frameworks can support the key credit protections required for covered bonds.

Moody’s suggested that in common law countries such as India and Malaysia, the segregation of the cover pool can be achieved through a legal transfer of the cover pool assets to a bankruptcy-remote special purpose vehicle (SPV) – a structure employed in the UK, Australia and Singapore, for example.

It added that depending on the availability and details of securitisation laws, civil law countries may also be able to support asset segregation, and therefore dual recourse. It cited South Korea as an example, noting that before a covered bond framework was introduced in the country, asset segregation in the first covered bond issuance was achieved via a securitisation law.

In May, VakıfBank sold the first and to date only emerging market covered bond, a Eu500m issue. Moody’s said the deal, which attracted some Eu3.2bn of orders, showed that there is demand for non-triple-A or double-A rated covered bonds from emerging markets.

The rating agency said covered bonds from South Asian and ASEAN countries – except Singapore – would be in this category, given that the local currency country ceilings for bonds in these countries are currently at or below single-A.

Photo credit: ASEAN