Bloomberg News

Covered Bond Market Swells Before Law Change: Australia Credit

June 08, 2011

June 8 (Bloomberg) -- National Australia Bank Ltd.’s New Zealand unit sold its first covered bonds in Australia, cutting funding costs as the market for the asset-backed securities grows to a record.

Bank of New Zealand’s funding arm priced A$700 million ($747 million) of five-year notes to yield 88 basis points more than the swap rate, according to an e-mailed statement today. The last domestic sale of five-year senior unsecured bonds by one of Australia’s four biggest banks priced at a 113 basis- point spread, data compiled by Bloomberg show.

While offshore banks are allowed to sell covered notes in Australia, domestic lenders are barred from offering the debt under laws the government plans to change this year. BNZ’s sale adds to A$2.3 billion of securities sold in Australia in 2011 by Canadian Imperial Bank of Commerce, DnB NOR Boligkreditt AS and Bank of Nova Scotia, already the busiest year on record, showing demand for top-rated bonds in a nation set to have the second- lowest sovereign debt burden in the developed world by 2015.

“The covered bond market is likely to continue to develop as banks seek to diversify their funding sources once the laws are changed,” said Mark Mitchell, head of credit at Sydney- based Kapstream Capital, which manages about A$3.9 billion. “As the sales so far this year have demonstrated, there will likely be buyers because the securities offer a pick up to other AAA assets.”

Global Sales

Demand for the securities, first sold in Prussia in the 18th century, has seen worldwide sales surge 38 percent to 212.5 billion euros ($311 billion) this year, Bloomberg data show.

In Europe, the debt yields an average 160 basis points more than government bonds, according to Bank of America Merrill Lynch’s EMU Covered Bonds Index. That compares with a 191 basis- point spread on financial notes, Merrill Lynch data show.

Toronto-based Canadian Imperial Bank raised A$700 million by selling five-year, 6.25 percent notes on March 11 priced to yield 74 basis points more than the swap rate, Bloomberg data show. The spread on the notes, rated AAA by Standard & Poor’s, has narrowed to 73 basis points, Australia & New Zealand Banking Group Ltd. prices show.

Covered bonds, which typically have the highest credit rating, are backed by assets that stay on the bank’s balance sheet and can be sold in a default. Australian lenders are banned from offering the securities at home under laws that favor depositors over creditors.

Cheaper Funding

The government released draft legislation in March to lift the ban and give local banks access to cheaper funding in a nation with the highest interest rates in the developed world.

“There is a very large global buyer base for AAA-rated” securities, said Robert Mead, Sydney-based head of portfolio management at Pacific Investment Management Co. “That means there will be demand for Australian banks’ covered bonds from around the world.”

The Reserve Bank of Australia increased borrowing costs seven times between October 2009 and November in an effort to prevent the nation’s biggest mining boom in a century from quickening inflation. It left rates unchanged yesterday at 4.75 percent. The U.S. Federal Reserve has kept its main interest rate in a range of zero to 0.25 percent since December 2008.

Interest rates and demand for commodities helped spur a 29 percent advance in the nation’s currency in the past 12 months against the U.S. dollar. The so-called Aussie reached $1.1012 on May 2, the highest since exchange controls were scrapped in 1983, and traded at $1.0666 at 2:53 p.m. in Sydney today.

Consumer Prices

Consumer prices in Australia may rise an annual 2.95 percent in the next five years, based on the gap between yields on government bonds and inflation-indexed notes.

Yields on Australia’s benchmark 10-year bonds fell 28 basis points since Dec. 31 to 5.27 percent at 2:56 p.m. in Sydney today. Similar-maturity Treasuries declined to 2.99 percent from 3.29 percent.

The International Monetary Fund forecasts Australia’s sovereign debt burden will shrink to 21.8 percent of gross domestic product in 2015 from 22.3 percent last year, taking it to the smallest among developed nations after Estonia’s 5.2 percent.

Under government proposals, local banks wishing to sell covered bonds in Australia will be allowed to use 8 percent of assets as collateral.

The threshold means Westpac Banking Corp., Commonwealth Bank of Australia, National Australia Bank and ANZ Bank will be able to sell a total of A$150 billion of the securities, according to Westpac.

Diversify Funding

BNZ’s sale of covered bonds is the first in Australia by one of New Zealand’s four largest banks, which are all units of Australia’s biggest lenders, Bloomberg data show.

“Our strategy was to diversify our funding sources,” said Mahes Hettige, head of balance sheet management at BNZ, in a phone interview from Wellington yesterday. The sale received a “great reception” from Australian investors during meetings held last month, he said.

The Auckland-based lender sold 1 billion euros of covered bonds in November, in the first issue of the debt in the currency by a bank outside Europe in more than two years.

It sold NZ$425 million ($348 million) of top-rated bonds backed by mortgage payments last June at a 38 percent discount to what New Zealand banks would pay without cover, according to Moody’s Investors Service.

--Editors: Edward Johnson, Iain Wilson

To contact the reporter on this story: Sarah McDonald in Sydney at smcdonald23@bloomberg.net

To contact the editors responsible for this story: Iain Wilson at iwilson2@bloomberg.net; Shelley Smith at ssmith118@bloomberg.net


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