Superannuation funds stand ready to invest in covered bonds issued by Australian financial institutions as the federal government paves the way for their introduction into Australia.
But according to one large industry fund, some investors might question the value of covered bonds when compared to unsecured bank debt offering higher yields.
In late March, the government released draft legislation that would allow banks to issue covered bonds of up to 8 per cent of their assets in Australia.
Covered bonds are backed by cash flows from a pool of assets, typically residential mortgages that remain on the bank's balance sheet.
The issuer must ensure the pool consistently backs the covered bond. In the event of default, the investor has recourse to the pool of assets, as well as the issuer. The covering enhancement typically results in the bonds being assigned AAA credit ratings.
Australia is one of the last developed countries in the world not to allow the issuance of covered bonds because they rank ahead of deposits in a wind-up.
Association of Superannuation Funds of Australia chief executive Pauline Vamos said covered bonds would likely attract superannuation funds as investors, given their high level of safety and the exposure to mortgage securities.
"You've got triple A-rated paper, which might be issued by a double A-rated entity. The feedback we're getting from members is that the level of safety offered by such bonds is very appealing," Vamos said.
"The underlying asset of the bond is transparent and this helps trustees understand what their weights are in a particular asset class, so that's very important."
The government has indicated it wants super funds to buy such bonds, which it hopes will help the big banks lower their cost of funding and offer cheaper mortgages to Australians as covered bonds are a cheaper form of funding for Australian banks than offshore sources.
"That sits nicely with the superannuation funds' value set; the more people that are able to own their own homes and retire debt-free, the better the prospects for a person's retirement. Another point is that super funds are large investors in the banks, so it's good for us as investors in those banks if they can lower their funding costs," Vamos said.
AustralianSuper head of income assets John Hopper said covered bonds would be eligible securities for the industry fund. However, a judgment would have to be made about the value of covered bonds compared to senior unsecured bank debt and government debt.
"If investors buy covered bonds, that will eat into their ability to buy bank bonds. It's a question of the value proposition," Hopper said.
"Investors would be looking at senior unsecured debt which yields about 120 basis points above the swap curve and looking at similar margins for residential mortgage-backed securities.
"There's an expectation that covered bonds would yield 40 to 50 basis points above the swap curve, so investors might have to give up 50 to 70 basis points in return for the security offered by covered bonds. Some investors might prefer the value offered by unsecured bank debt.
"I suspect a lot of the demand for covered bonds will come from other banks, including central banks, and offshore investors who don't know the Australian debt market so well, so they may be attracted by the dual security."
