Fitch Affirms New Zealand Covered Bond Ratings on New Criteria - Reuters News

Fitch Ratings has affirmed the ratings of five New Zealand mortgage covered bond programmes following the implementation of the agency's new Covered Bonds Rating Criteria published on 26 October 2016. The Outlooks are Stable. The agency has also assigned a Payment Continuity Uplift (PCU) to each programme.

The ratings of the New Zealand mortgage covered bond programmes affirmed at 'AAA' with a Stable Outlook correspond to the following issuers. The programmes have been assigned a corresponding PCU:

• ANZ Bank New Zealand Limited (ANZNZ, AA-/Stable/F1+); PCU of six notches
• ASB Bank Limited (ASB, AA-/Stable/F1+); PCU of three notches
• Bank of New Zealand (BNZ, AA-/Stable/F1+); PCU of six notches
• Kiwibank Limited (Kiwibank, AA/Rating Watch Negative/F1+); PCU of six notches
• Westpac New Zealand Limited (WNZL, AA-/Stable/F1+); PCU of six notches

Issuer Default Rating Uplift

An Issuer Default Rating (IDR) uplift of zero-notches has been assigned to the programmes of the above-mentioned issuers, as New Zealand does not explicitly exempt the issued covered bonds from bail-in under the Open Bank Resolution regime and there is a risk of cover pool enforcement. Therefore, the IDR remains the floor of the covered bond rating.

Payment Continuity Uplift

Four New Zealand programmes were assigned a PCU of six notches, as they were assessed as having at least 12 months liquidity protection for principal payments and sufficient protection for interest payments for the timely payment of the covered bonds. Where programmes have a combination of both hard and soft bullet issuance types, which can cross default, Fitch looks at the materiality of liquidity protection for each issuance type in the programme and assigns the PCU based on the mechanism that provides the least protection. The remaining programme's liquidity provisions are commensurate with a PCU of three notches as a result of the limited cure period under the 12 month pre-maturity test for the outstanding hard bullet covered bonds.

Recovery Uplift

All New Zealand programmes are considered to have significant foreign-exchange (FX) exposure in the recovery given default scenario, as cover assets are denominated in New Zealand dollars and the majority of issuance is denominated in other currencies. Fitch expects the covered bond swaps hedging this risk would be terminated in a covered bond event of default scenario. Fitch has capped the recovery given default uplift for these programmes to one-notch, as the FX exposure presents significant downside risk to the programme. The one-notch uplift for recoveries is supported with sufficient overcollateralisation (OC), which Fitch relies on to cover credit loss on the cover assets when assigning the bond rating.

Breakeven Asset Percentage for the Ratings

Fitch has revised the breakeven asset percentage (AP) for the ratings of the covered bond programmes following the update of its refinancing spread levels and fire-sale discount assumptions. The 'AAA' breakeven AP's for ANZNZ, Kiwibank and WNZL have been capped at the maximum contractual AP documented in the programme.

In its analysis, Fitch gives credit to the highest level of nominal AP observed in the past 12 months for four out of five programmes in New Zealand. Even though these programmes' excess over-collateralisation is funded through a demand loan, repayments under the demand loan rank subordinate to covered bondholders. For WNZL's programme, Fitch only gives credit to the over-collateralisation defined via the asset coverage test (ACT) calculated by WNZL and published in its investor reports. This is because the repayment of its demand loan in the programme ranks in priority over payments to covered bondholders.

Detailed information on the programmes mentioned in this commentary can be found in the Excel file, New Zealand Covered Bond Programmes - Rating Action Report, dated 8 November 2016, which can be accessed by the link above.

Variation from Criteria

Fitch has applied a variation from its cover asset Refinancing Spread Level (RSL) assumptions for New Zealand, which provide for refinancing stress on standard mortgage cover assets simulating their sale to meet covered bond payments. Only ANZNZ and ASB have cover assets indirectly linked to an at-call line-of-credit product that is not included in the cover pool. These products are linked to the same secured property as the cover assets and, in the event of the cover assets being sold, the line-of-credit loans would also need to be sold. Fitch believes the additional line-of-credit loans increase the refinancing cost for these programmes, as they could be more difficult to sell to a third-party as the line-of-credit product is not standard across New Zealand. It also increases the amount of loans needed to be sold, potentially affecting the sale price of the cover assets.

Fitch considered an additional stressed refinancing rate differential of 100bp above New Zealand's base mortgage refinance stresses for cover assets linked to at-call line-of-credit loans. The agency applied the adjusted refinancing stress on the pro-rata value of the cover assets linked. The revised mortgage refinance stresses on the 'AA+' tested rating on a probability of default basis was 334bps. ANZNZ's refinance spreads at 'AA+' were adjusted to 268bp and ASB's to 292bps from the base rate of 234bp, based on the pro-rata value of these linked line-of-credit loans to the cover pools. There was no ratings impact to the covered bonds of ANZNZ and ASB as a result of this variation to criteria.

KEY RATING DRIVERS

ANZNZ Mortgage Covered Bonds

The 'AAA' rating of ANZNZ's mortgage covered bonds is based on the bank's Long-Term IDR of 'AA-', the newly assigned IDR uplift of zero notches, the newly assigned PCU of six notches and a recovery uplift of one-notch. The covered bonds are issued through ANZ New Zealand (Int'l) Limited, a guaranteed issuing vehicle ANZNZ uses for international funding. The recovery uplift is capped at one-notch as the programme is significantly exposed to FX risk from recoveries. This is because the assets are denominated in New Zealand dollars while all its covered bonds are non-New Zealand dollar denominated, despite swaps being in place on the liabilities.

The relied upon asset percentage (AP) of 67.6%, the highest nominal AP of the past 12 months, which Fitch uses in its analysis, provides more protection than the 90.0% breakeven AP for the 'AAA' rating. The breakeven AP is also equivalent to the programme's maximum contractual AP and corresponds to a 'AA+' tested rating on a probability of default (PD) basis and a one-notch recovery uplift. The Stable Outlook on the covered bonds' rating reflects the Stable Outlook on ANZNZ's IDR and the significant buffer against downgrade from the uplift above the issuer's IDR.

ASB Mortgage Covered Bonds

The 'AAA' rating of ASB's mortgage covered bonds is based on the bank's Long-Term IDR of 'AA-', the newly assigned IDR uplift of zero notches, the newly assigned PCU of three notches and a recovery uplift of one-notch. The offshore covered bonds are issued by ASB Finance Limited, a special purpose vehicle guaranteed by ASB. The PCU is capped at three notches due to the limited cure period of up to six months under the 12 month pre-maturity test for the outstanding hard bullet bonds, which remain relevant to the assessment of liquidity. The recovery uplift is capped at one-notch as the programme is significantly exposed to FX risk from recoveries. This is because the assets are denominated in New Zealand dollars while 87.4% of covered bonds are non-New Zealand dollar denominated, despite swaps being in place on the liabilities.

The relied upon AP of 71.7%, the highest nominal AP of the past 12 months, provides more protection than the 87.5% breakeven AP for the 'AAA' rating. The breakeven AP corresponds to a 'AA+' tested rating on a PD basis and a one-notch recovery uplift. The Stable Outlook on the covered bonds' rating reflects the Stable Outlook on ASB's IDR and the one-notch buffer against downgrade from the uplift above the issuer's IDR.

BNZ Mortgage Covered Bonds

The 'AAA' rating of BNZ's mortgage covered bonds is based on the bank's Long-Term IDR of 'AA-', the newly assigned IDR uplift of zero notches, the newly assigned PCU of six notches and a recovery uplift of one-notch. The offshore covered bonds are issued through BNZ International Funding Limited, a guaranteed issuing vehicle BNZ uses for international funding. The recovery uplift is capped at one-notch as the programme is significantly exposed to FX risk from recoveries. This is because the assets are denominated in New Zealand dollars while 71.2% of covered bonds are non-New Zealand dollar denominated, despite swaps being in place on the liabilities.

The relied upon AP of 84.4%, the highest nominal AP of the past 12 months, provides more protection than the 90.5% breakeven AP for the 'AAA' rating. The breakeven AP corresponds to a 'AA+' tested rating on a PD basis and a one-notch recovery uplift. The Stable Outlook on the covered bonds' rating reflects the Stable Outlook on BNZ's IDR and the significant buffer against downgrade from the uplift above the issuer's IDR.

Kiwibank Mortgage Covered Bonds

The 'AAA' rating of Kiwibank's mortgage covered bonds is based on the bank's Long-Term IDR of 'AA', the newly assigned IDR uplift of zero notches, the newly assigned PCU of six notches and a recovery uplift of one-notch. The recovery uplift is capped at one-notch as the programme is significantly exposed to FX risk from recoveries. This is because the assets are denominated in New Zealand dollars while all covered bonds are non-New Zealand dollar denominated, despite swaps being in place on the liabilities.

The relied upon AP of 60.6%, the highest nominal AP of the past 12 months, provides more protection than the 90.0% breakeven AP for the 'AAA' rating. The breakeven AP is also equivalent to the maximum contractual AP in the programme and corresponds to a 'AA+' tested rating on a PD basis and a one-notch recovery uplift. The Stable Outlook on the covered bonds' ratings reflects the five notch buffer against Kiwibank's IDR before the covered bond rating will be subject to downgrade, all else being equal.

WNZL Mortgage Covered Bonds

The 'AAA' rating of WNZL's mortgage covered bonds is based on the bank's Long-Term IDR of 'AA-', the newly assigned IDR uplift of zero notches, the newly assigned PCU of six notches and a recovery uplift of one-notch. The covered bonds are issued through Westpac Securities New Zealand Limited, London branch, a guaranteed issuing vehicle WNZL uses for international funding. The recovery uplift is capped at one-notch as the programme is significantly exposed to FX risk from recoveries. This is because the assets are denominated in New Zealand dollars and all covered bonds are non-New Zealand dollar denominated, despite swaps being in place on the liabilities.

The relied upon AP of 88.5% published in the programme's ACT that Fitch uses in its analysis provides more protection than the 90.0% breakeven AP for the 'AAA' rating. The breakeven AP is also equivalent to the maximum contractual AP in the programme and corresponds to a 'AA+' tested rating on a PD basis and a one-notch recovery uplift. The Stable Outlook on the covered bonds' rating reflects the Stable Outlook on WNZL's IDR and the significant buffer against downgrade from the uplift above the issuer's IDR.

RATING SENSITIVITIES

ANZ Bank New Zealand Limited - Mortgage Covered Bonds

The covered bonds would be vulnerable to a downgrade if the bank's Long-Term Issuer Default Rating (IDR) falls below 'BBB+'. The 'AAA' breakeven of 90% is equal to the maximum contractual AP in the programme; if the AP relied upon by Fitch rises to the maximum contractual AP, ratings would not be affected.

ASB Bank Limited - Mortgage Covered Bonds

The covered bonds would be vulnerable to a downgrade if the relied upon AP rises above the 'AAA' breakeven AP of 87.5% or if the bank's Long-Term IDR falls below 'A+'. If the nominal AP in the programme rises to the maximum 90% contractual AP stipulated in the programme documents, the rating on the covered bonds would fall to 'AA', one notch above the IDR.

Bank of New Zealand - Mortgage Covered Bonds

The covered bonds would be vulnerable to a downgrade if the relied upon AP rises above the 'AAA' breakeven AP of 90.5% or if the bank's Long-Term IDR falls below 'BBB+'. If the nominal AP in the programme rises to the maximum 97.0% contractual AP stipulated in the programme documents, the rating on the covered bonds would fall to 'AA', one notch above the IDR.

Kiwibank Limited - Mortgage Covered Bonds

The covered bonds would be vulnerable to a downgrade if the bank's Long-Term IDR falls below 'BBB+'. The 'AAA' breakeven of 90% is equal to the maximum contractual AP in the programme; if the AP relied upon by Fitch rises to the maximum contractual AP, ratings would not be affected.

Westpac New Zealand Limited - Mortgage Covered Bonds

The covered bonds would be vulnerable to a downgrade if the bank's Long-Term IDR falls below 'BBB+'. The 'AAA' breakeven of 90% is equal to the maximum contractual AP in the programme; if the AP relied upon by Fitch rises to the maximum contractual AP, ratings would not be impacted.

Fitch's 'AAA' breakeven AP for a given covered bond rating will be affected by, among other factors, the profile of the cover assets relative to outstanding covered bonds, which can change over time even in the absence of new issuance. Therefore, the 'AAA' breakeven AP to maintain the covered bond rating cannot be assumed to remain stable over time.