Fitch Ratings has affirmed Bank of New Zealand's (BNZ, A+/Stable/F1) NZD6.5 billion of outstanding mortgage covered bonds at 'AAA'.

The Outlook is Stable.

Cross-border covered bonds have been issued through BNZ International Funding Limited, a guaranteed issuing vehicle BNZ uses for international funding. Offshore issuance through the vehicle accounts for 38.0% of BNZ's total covered bond issuance. The remaining offshore issuance was through BNZ directly.

The affirmation follows a periodic review of the covered bond programme.

KEY RATING DRIVERS

The rating on the mortgage covered bonds is based on BNZ's Long-Term Issuer Default Rating (IDR) of 'A+', the various uplifts above the IDR granted to the programme, and the overcollateralisation (OC) protection provided through the programme's asset percentage (AP).

The covered bonds are rated four notches above the bank's IDR. This is out of a maximum achievable uplift of seven notches, consisting of a resolution uplift of zero notches, a payment continuity uplift (PCU) of six notches and a recovery uplift of one notch. Fitch's analysis relies on the highest nominal AP in the last 12 months of 83.0%. This provides more protection than Fitch's unchanged 'AAA' breakeven AP of 98.0%.

The Stable Outlook reflects a three-notch buffer against an IDR downgrade.

Uplifts

The resolution uplift remains unchanged at zero notches. New Zealand does not explicitly exempt issued covered bonds from bail-in under the open bank resolution (OBR) regime. Upon resolution of the bank, there is a risk of a switch of recourse to the cover pool from the issuer, as secured assets are exempt from the OBR process. Therefore, BNZ's Long-Term IDR remains the resolution reference point, as there is no preferential treatment of covered bonds compared with the bank's other senior debt under the OBR.

The PCU remains unchanged at six notches and reflects the strength of liquidity protection in the form of a 12-month extension period on the soft-bullet bonds. It also reflects the interest protection in the form of a reserve fund covering three months of interest payments and one-quarter of annual senior fees. At the date of the analysis, the reserve has not been fully funded. BNZ has confirmed to Fitch that the reserve will be fully funded at the next payment date. The documented trigger to fund the reserve (F1+) is higher than the minimum threshold in our criteria - the loss of 'A-' and 'F1' ratings.

The recovery uplift on the rating is capped at one notch, as the programme is significantly exposed to foreign-exchange risk that could affect recoveries in the case of a default of the covered bonds. There are swaps in place on the liabilities, but we expect these swaps to terminate upon a covered bond default. This would mean the longer-dated New Zealand dollar asset cash flow would be providing recoveries for the outstanding euro-denominated covered bonds, which can lower recovery expectations.

'AAA' Breakeven AP

Fitch's unchanged 'AAA' breakeven AP of 98.0% corresponds to the 2.0% 'AAA' breakeven OC, which supports an 'AA+' timely payment rating level and a one-notch recovery uplift to 'AAA'. The credit loss component, reflecting the credit quality of the underlying cover pool, is at 3.3%. The ALM loss component, which reflects modelled asset and liability mismatches including the modelled excess spread and the effect of the pro rata sales clause documented in the programme, is at -1.1%.

Cover Pool Summary

The cover pool consisted of 38,877 loans as of August 2023, secured by first-ranking mortgages of New Zealand residential properties, with a total outstanding balance of NZD7.8 billion. The cover pool's weighted-average loan/value ratio was 44.5%, and the pool had seasoning of 49.9 months. Interest-only loans formed 7.4% of the pool by balance.

The key rating drivers listed in the applicable sector criteria, but not mentioned above, are not material to this rating action.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

The rating on the covered bonds is at the highest level on Fitch's rating scale and cannot be upgraded.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

The covered bond rating would be vulnerable to a downgrade if the bank's IDR were downgraded by four or more notches to 'BBB' or below, or if the relied-upon AP provided less protection than Fitch's 'AAA' breakeven AP of 98.0%.

There is no rating impact on the rating of the bonds even if the relied-upon AP in the programme equals the maximum 97.0% contractual AP stipulated in the programme documents, as it supports a greater level of OC than Fitch's 'AAA' breakeven AP.

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

SOURCES OF INFORMATION

The issuer has informed Fitch that not all relevant underlying information used in the analysis of the rated bonds is public.

The principal sources of information used in the analysis are described in the Applicable Criteria.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS

The covered bond rating is driven by the credit risk of the issuing financial institution, as measured by its Long-Term IDR.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the programme. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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