Statement on Monetary Policy – February 2012
Box D: Covered Bond Issuance by Australian Banks
Covered bonds are on-balance sheet asset-backed securities issued by financial institutions. Investors in covered bonds have a preferential claim on a pool of assets (called the cover pool) in the event that the issuing institution fails to make the scheduled payments on the covered bond. If the cover pool is insufficient to meet the issuer's obligations to investors, they have an unsecured claim on the issuer for any residual amount.[1]
Covered bonds typically have a higher credit rating than that of the issuer because the cover pools are usually comprised of high-quality assets such as prime mortgages, covered bond holders rank above unsecured creditors, and extra collateral is held in the cover pool.
There is a well-developed global market for covered bonds, particularly in Europe. In Australia, however, authorised deposit-taking institutions (ADIs) have only recently been permitted to issue these bonds, following the passing of legislation – the Banking Amendment (Covered Bonds) Act 2011 – in October 2011. Under the new legislation, there is a cap on covered bond issuance by ADIs to limit the subordination of depositors to covered bond investors. An ADI must limit the value of its cover pools to a maximum of 8 per cent of its assets in Australia. Given that Australian ADIs have set their cover pools at close to 120 per cent of the value of covered bonds – with some variation of this ‘over-collateralisation’ across banks – this implies that covered bonds could provide up to around 6¾ per cent of total on-balance sheet funding for Australian assets. This is equivalent to about $140 billion for the major banks, based on the current level of their assets in Australia. The covered bond programs of the four major banks have all received a AAA credit rating, which is higher