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
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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
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Moody's Investors Service Pty. Ltd.
Level 10
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Sydney NSW 2000
Australia
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SUBSCRIBERS: (612) 9270-8100
Moody's: Australian Covered Bonds Leads to Credit Negative Issues in RMBS Collateral