New Zealand banks have tapped into the covered bond market as a new source of funding in the past year and their Australian parent banks may soon follow, now that the Government there has passed legislation allowing them to go ahead.

ANZ National last week announced its inaugural covered bond issue in Europe raised €500 million ($868.4 million), following in the footsteps of the Bank of New Zealand, which pioneered covered bond issuance here, and Westpac NZ with its first issue early this year.

ASB Bank, a unit of Commonwealth Bank of Australia, is keen to join in and has registered a prospectus in London to raise up to €7 billion.

Covered bonds are debt securities backed by cash flows from a specific pool of mortgages or other loans.


They differ from standard bonds as investors have specific recourse to the assets that secure, or cover, the bonds in the event of default, and retain a claim on the bank's residual assets. Investors in a bank's covered bonds rank higher than depositors should the bank fail, and it's this aspect that has made regulators wary.

They've long been illegal in Australia but last week's law change allows banks to raise funds from this market, limiting them to up to 8 per cent of the bank's assets. In New Zealand, the threshold is 10 per cent.

The National Australia Bank-owned BNZ has raised about $3.5 billion in covered bonds, representing about 6 per cent of its total assets, and will maintain a buffer between the bonds it has on issue and the Reserve Bank's 10 per cent limit.

"My guess will be that offshore would be the next best opportunity to do more covered bonds, probably Europe," said BNZ's head of debt capital markets, Mike Faville.

Covered bonds were a long-established asset class, used in Europe for centuries, and the bank saw them as a useful funding tool.

The covered bond market is booming, €120 billion issued globally in the first seven months of this year. In the past five years, issuers from more countries have used covered bonds to refinance mortgage lending.

Director Peter Sikora said Standard & Poor's was comfortable with local banks using this avenue of funding, because it allowed them to diversify and extend the maturity of their funding, and made them less susceptible to refinancing risk.