From Banking Day:
The Australian Government will set the cap on the percentage of assets that can be used to support covered bonds at eight per cent, the Financial Review reports – up from the cap of five per cent suggested by the Government back in December.
For some weeks, talk in banking and government circles has indicated a higher cap was likely. The corresponding cap in New Zealand will be 10 per cent of assets.
The Government will introduce the bill to enable banks to sell covered bonds into Parliament today. This requires an amendment to the Banking Act to override the existing depositor preference provisions.
Covered bonds, which involve banks pledging pools of assets as security to investors in wholesale debt, are widely used by banks in Europe as a wholesale funding option. Banks in Australia are anxious to make use of this option. They are a more flexible instrument than another alternative – the securitisation of asset pools – which requires a clean sale of assets to a separate trust.
Assets eligible for use in covered bonds will be residential mortgages, government bonds and cash.
And according to Bloomberg:
The plan is higher than the 5 percent originally proposed by the government and means the nation’s four biggest lenders will be able to sell as much as A$150 billion ($152 billion) of the notes, according to Westpac Banking Corp. (WBC)
Well, that’s splendid. Indeed it is, says Deutsche in a client note:
Scenario analysis shows reduced funding costs could add ~2% to earnings
We estimate the cost of issuing covered bonds will be 60-100bps lower than existing wholesale debt. Assuming: covered bonds are issued up to the limit; wholesale debt is displaced; and that the cost of the wholesale debt that does remain increases by 10bps, then the net reduction in funding costs would add ~2% to cash earnings. This benefit would likely play out over a number of years (as covered bonds are issued and other funding rolls off over time).
Hmmm…that is if the wholesale funding is displaced, as opposed to built upon, and the newly minted borrowings aren’t poured into new mortgages via the falling credit standards that the RBA warned against yesterday. Which hopefully won’t happen because of just such vigilance.
Deutsche could also be wrong if we recall that Gail Kelly recently declared on the ABC’s 7.30 that she would cut interest rates when her cost of funds began to fall. Surely we can expect an imminent unilateral rate cut for mortgage holders!
Not likely.
But the issuance of covered bonds does present a related problem for the banks. If they issue a bunch of them and displace wholesale debt, it will be that much harder to make the case for more unilateral rate rises, even if swap rates are rising, as Deep T. argued yesterday.
Finally, if you’re wondering whether covered bonds will hold up better than other wholesale debt in a crisis then the answer you are after is ‘a bit’, according to the RBA:
Covered bonds were not immune from the effects of the financial crisis but did prove more resilient to severe market stress and, with European Central Bank (ECB) support, have recovered faster than other wholesale funding instruments, such as asset backed securities and unsecured bank debt. The relative resilience of covered bonds is to be expected: the dual recourse and cover pool replacement provisions put covered bond investors in a better position than those holding asset-backed securities and unsecured debt. The European mortgages that typically back covered bonds also became less distressed than the US mortgages that backed many US residential mortgage-backed securities (RMBS). Nonetheless, despite providing more safety to investors, covered bond issuers’ access to debt markets became seriously disrupted during the crisis, suggesting that the robustness of covered bonds should not be overstated.
