The Banking Amendment (Covered Bonds) Act 2011 has amended the Banking Act 1959 to allow Australian banks and other authorised deposit-taking institutions (ADIs) to issue covered bonds. The amendments became effective on 17 October 2011.
Covered bonds are dual recourse securities with investors having a claim against the both the issuing ADI and a cover pool of high quality assets held by a special purpose vehicle which guarantees the securities issued by the ADI.
An initial exposure draft of a bill to amend the Banking Act to allow for covered bonds was published by the Treasurer in March this year. We commented on this Bill in our alert on 24 March.
A revised exposure draft was published in July and, following further consultation with industry, the amendment bill, including some important changes, was introduced into the House of Representatives on 15 September 2011. It is this bill which has now become law. The final version dealt with a number of the concerns identified with the exposure drafts. The Banking Act, as amended, provides a workable framework for covered bonds issuance by Australian ADIs. In this note, we comment briefly on some of the key features of the framework.
Limit on covered bonds to be issued
An ADI may not issue covered bonds if the combined value of assets which form part of the cover pool would exceed a prescribed percentage, currently 8%, of the value of the ADI’s assets in Australia.
This restriction only applies at the time of issuance of covered bonds. Unlike the position in the exposure drafts, an ADI is not prevented from providing further assets to the cover pool in respect of covered bonds which have already been issued.
A corresponding amendment has been made to clarify the operation of section 13A(4) of the Banking Act which requires an ADI to hold assets in Australia (excluding goodwill and other prescribed assets) of a value that is equal or greater than the total amount of its deposit liabilities in Australia. A new section 13A(4A) provides that, for the purposes of this requirement, assets do not include any interest in an asset in a cover pool securing covered bonds issued by the ADI or any loan to a covered bond special purpose vehicle.
It should be also noted in certain circumstances (see Section 11CA of the Banking Act) APRA may give directions to an ADI which could include a direction not to transfer an asset to the cover pool. If as a result of such an order, an ADI fails to maintain the required value of the cover pool, can that led to an event to default under the covered bond terms?
The new section 31B of the Banking Act attempts to clarify this matter to some extent by providing that such orders do not prevent the exercise of a contractual right in relation to an asset that secures liabilities to covered bondholders if payments under the covered bonds are not made.
Value of assets in the cover pool
The value of assets in a cover pool must be at least 103% (or such other percentage prescribed by regulations) of the face value of the covered bonds secured by the assets. This requirement is an ongoing requirement which applies for so long as the covered bonds are outstanding.
Assets which can form part of the cover pool
Eligible assets for a cover pool may include residential mortgage loans (with a loan to value ratio of less than 80%), commercial mortgages loans (with a loan to value ratio of less than 60%), other incidental assets such as cash and other assets prescribed by regulation from time to time.
What is the cover pool?
Not all of the assets owned by the covered bond special purpose vehicle will form part of the cover pool for the purposes of the Banking Act. Assets not beneficially owned by the covered bond special purpose vehicle are excluded (for example, assets held on trust for the issuing ADI, rather than forming part of the security provided to investors in the covered bonds).
More importantly, the cover pool only consists of beneficially owned assets “to the extent that they secure the liabilities to holders or representatives equally or in priority to other claims”. The intent of this provision is to ensure that in determining the value of assets in the cover pool, assets having a value equal to the value of secured liabilities which rank prior to the liabilities of the covered bond special purpose to the covered bond holders are excluded.
Cover pool monitor
The Amendment Act also provides for the mandatory appointment of a cover pool monitor which must be either a registered auditor under the Corporations Act or an entity which holds an Australian financial services licence that covers the provision of financial services as the cover pool monitor (or is exempt from the requirement to do so). The cover pool monitor cannot be the issuing ADI or an associated entity of the issuing ADI.
The amendments to the Banking Act also contemplate an aggregated issue of covered bonds. However, at this stage, the aggregation model is limited to the establishment of a new entity, called the aggregating entity (essentially a repackaging vehicle), which would issue debt instruments secured by covered bonds issued by ADIs).
Whilst the amendments keep the door open, by contemplating that the regulations may prescribe other arrangements that may be entered into by two or more ADIs for the purposes of issuing covered bonds, for the time being at least, the aggregation model would appear to be more limited than originally proposed.