RBNZ Covered Bonds = Securitisation? = CDO's? = Deja Vu?

Recently the Reserve Bank released a discussion paper on the merits or otherwise of 'Covered Bonds'. A new financial instrument designed to broaden access to international funding sources. The consultation paper can be found at the following link:

www.rbnz.govt.nz/finstab/banking/

I read through it, and in simple terms, these are proposed financial instruments which are issued by major banks, where loans/securities are packaged into a pool, and sold as bonds, at an agreed interest rate to offshore institutional investors. Hmmmm. Sounds an awful lot like Collateralized Debt Obligations to me (CDO's - otherwise known as the root of all evil). These were essentially the clearing house that fuelled lender behaviour and borrower demand, and ultimately led to the sub prime crisis and then the GFC.

I asked this question of the Reserve Bank, and received the following reply:

"Covered bonds are not comparable with Collateralized Debt Obligations (CDOs). In a CDO, investors are paid directly from the cash flows generated by the assets that are held as collateral within the structure. By contrast, payments on covered bonds will generally be made directly from the issuing institution. The cover pool therefore only becomes relevant if the bank defaults on the payments. At the point of default, a covered bond then provides dual recourse for investors. In the first instance, investors have a full claim on the assets in the cover pool. If this is not sufficient, they also have an additional claim on the residual assets of the issuer. This claim ranks equal to the claims of other creditors and depositors. In addition, covered bonds generally contain restrictions on the quality of assets that can be placed into the cover pool, and a requirement for the issuer to maintain the quality of the cover pool (i.e. replace any non-performing loans)."


I now have other issues with this proposal. It seems to me from reading this response, that these are similar to CDO's, but they create the reverse problem. Instead of packaging up toxic loans and selling them off, which caused institutional distress over the last few years, the issuing banks will be obliged to package up good/performing loans to fill these product requirements. Even to the point of having to swap out non performing loans.

While this will provide protection for the insitutional offshore investors, it is of cold comfort to the average joe citizen whose money sits in our banks secured by a now diluted pool of securities.

It seems unfair to the average NZer that their deposits will be secured by a pool of mortgages and securities that by default will own the lesser performing groups of loans, as the Covered Bonds Pools are regularly upgraded to ensure their 'safety'. Our domestic depositors will likely not be informed of this change, and are in effect getting a riskier product without opting into it or receiving adequate disclosure.

Essentially it is subprime in reverse isn't it? I understand the need to obtain acces to good international funding sources, but should it be done sneakily at the expense of the average New Zealand depositor?

Let me know if there are any holes in my thinking, or if I am reading it wrong.... Other thoughts appreciated.

Original article written here http://www.propertytalk.com/forum/showthread.php?27350-RBNZ-Covered-Bonds-Securitisation-CDO-s-Deja-Vu 

 

 

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