Moody's: Australian Covered Bonds Leads to Credit Negative Issues in RMBS Collateral
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Moody's: Australian Covered Bonds Leads to Credit Negative Issues in RMBS Collateral

Global Credit Research - 22 Nov 2011

Sydney, November 22, 2011 -- Moody's Investors Service says that higher-rated banks in Australia (Aa range) will likely prefer issuing in the covered bonds market rather than the RMBS one, but most lower-rated banks (below Aa range) will continue issuing RMBS.

"These lower-rated banks, which have pools with less diversity and usually higher arrears when compared to those of the higher rated banks, will accordingly make up a larger proportion of the RMBS market, resulting in more risk for collateral pools," says Richard Lorenzo, a Moody's Vice President and Senior Credit Officer.

Lorenzo's remarks follow the release on Nov 16 of a discussion paper by the Australian Prudential Regulation Authority (APRA) on Basel III liquidity reforms, and which also provided reasons for banks to buy covered bonds -- issuance of which only started this year in Australia -- over RMBS.

"Higher-rated banks will favor issuing covered bonds over RMBS because they will help solve funding needs and will be cheaper to fund in the capital markets. The banks will also buy covered bonds over RMBS because they provide better liquidity management, and will be cheaper in a repurchase agreement with the Reserve bank of Australia," says Lorenzo.

The covered bond market is essentially an Aaa-rated market. Although it is possible for A-rated banks to issue Aaa-rated covered bonds, it may be uneconomical for those lower rated institutions because of the amount of support needed to achieve an Aaa-rated covered bond would exceed what is for an Aaa-rated RMBS.

In terms of specifics, Moody's lists the reasons for buying covered bonds as:

Liquidity management. Even though BASEL III defines covered bonds as High Quality Liquid Asset 2 (HQLA2), APRA does not count covered bonds towards a bank's BASEL III Liquidity Coverage Ratio. However, once Australian covered bonds prove themselves a liquid asset in Australia, we anticipate APRA will deem them as HQLA2 eligible and a valid tool for liquidity management under BASEL III.

Conversely, RMBS bonds are not HQLA2 eligible under BASEL III definitions.

Cheaper to repo. Because there are no HQLA2-eligible assets in Australia currently, the central bank established a committed liquidity facility to help banks meet their liquidity-coverage-ratio needs using repos. New margins were released on 16 November and covered bonds were cheaper to repo versus RMBS in all cases except for tenors longer than 10 years.

Reasons to issue covered bonds

Helping solve funding needs. There is a deep market for covered bonds in Europe, a developing one in US, and at times of weak market confidence, covered bonds will interest fund managers that would have traditionally bought banks' senior unsecured debt. Because of demand, banks would not be able to issue similar amounts of RMBS versus covered bonds.

Cheaper to issue. Covered bonds are generally cheaper to issue to the capital markets versus RMBS. In Europe, where covered bond and RMBS markets are mature, covered bonds trade inside RMBS for all jurisdictions except for Portugal.

Lower-rated banks continue with RMBS. Because higher-rated banks will replace some of their RMBS funding with covered bond funding, while other banks will continue with RMBS funding, the RMBS market will become less diversified and exhibit higher arrears.

This is because lower-rated banks tend to be regionally focused with geographic concentrations in their lending. Therefore, as the more geographically diverse, higher-rated banks, issue fewer RMBS, and lower-rated banks continue issuing RMBS, the overall Australian market will have less diversified pools. This is credit negative as it leaves the RMBS market more vulnerable to geographic risks such as floods.

Lower-rated banks have higher arrears. As seen from the exhibit below, lower-rated banks have higher arrears versus higher-rated banks. As higher-rated banks issue less RMBS, we expect RMBS market arrears to increase, leading to higher default rates.

The report is entitled Covered Bonds Leads to Credit Negative Issues in RMBS Collateral. It can be found at www.moodys.com

NOTE TO JOURNALISTS ONLY: For more information, please call one of our global press information hotlines: New York +1-212-553-0376, London +44-20-7772-5456, Tokyo +813-5408-4110, Hong Kong +852-3758-1350, Sydney +61-2-9270-8141, Mexico City 001-888-779-5833, São Paulo 0800-891-2518, or Buenos Aires 0800-666-3506. You can also email us at mediarelations@moodys.com or visit our web site at www.moodys.com.

Richard Lorenzo
VP - Senior Credit Officer
Structured Finance Group
Moody's Investors Service Pty. Ltd.
Level 10
1 O'Connell Street
Sydney NSW 2000
Australia
JOURNALISTS: (612) 9270-8102
SUBSCRIBERS: (612) 9270-8100

Jennifer Wu
VP - Senior Credit Officer
Structured Finance Group
JOURNALISTS: (612) 9270-8102
SUBSCRIBERS: (612) 9270-8100

Releasing Office:
Moody's Investors Service Pty. Ltd.
Level 10
1 O'Connell Street
Sydney NSW 2000
Australia
JOURNALISTS: (612) 9270-8102
SUBSCRIBERS: (612) 9270-8100

Moody's: Australian Covered Bonds Leads to Credit Negative Issues in RMBS Collateral
No Related Data.

© 2012 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved.


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