Crumbling foundation?

IFR Covered Bonds Report 2012
6 min read

Without the Canadian banks, there wouldn’t be much of a US covered bond market.

To view the digital version of this report, please click here.

Canadians have accounted for 52% of all US dollar covered bond issuance since 2010, providing the market a solid foundation at a time when the US has failed to give its own banks the right to access the cost-effective market.

Of the roughly US$26bn raised in the first half of this year, about US$11bn came from Canadians. Top banks from the eurozone issued over US$6bn, with Barclays returning for the first time in a few years; Australians more than US$3bn, with a debut from National Australia Bank and the remaining amount from UBS and Credit Suisse. That compared with US$18bn in the first half of 2011, and US$39bn for the entire year.

Yet now even the Canadian foundation for the fledgling US market could be crumbling.

Canadian banks are precluded from issuing any Yankee covereds until their own country’s legislation for the structure is enacted, a process which could take months.

“The timing of US dollar covered bond supply during the second half of 2012 is uncertain – New Canadian supply may be delayed [conceivably for six months or more] while legislation is implemented and the CMHC, as administrator of the new legislative framework, sets up its registration and oversight processes,” said Riz Sheikh, head of Americas covered bond structuring at Barclays in New York.

Lobbyists in the US have also once again failed to get the politically unsexy subject of covered bonds on this year’s legislative agenda for congress.

As for the Australians, they are likely to return to the US market, but for how much and how often is unknown. Westpac, for instance, chose the euro market instead in July to issue a seven-year covered, a tenor it probably could not access at the same competitive pricing in the US.

Worst of all, there’s a possibility Canadians won’t bother accessing the US covered market at all once their new legislation is enacted.

The new law prohibits Canadian banks from using mortgages insured by the government’s Fannie Mae, called the CMHC, one of the principle reasons why Canadian banks have to date been able to price at half the spread of its closest comparables. (See “Shifting the goalposts”.) Without that pricing advantage, some bankers are wondering whether they will bother to go through the process of setting up a US programme and tying up collateral for just a few extra basis points of savings versus senior unsecured issuance in the US.

“There is some uncertainty as to whether the Canadians will be as active in the US dollar covered bond market as they have been in the past, because without the CMHC insured collateral, the cost savings of issuing covereds versus senior unsecured will not be as material,” said one senior syndicate manager at one of the biggest US banks.

“It will clearly cost the Canadian banks more to issue covered bonds with uninsured collateral, than where their deals now trade, but how much more expensive they will be we’re not sure,” he added.

Canadian five-year covereds with CMHC insured collateral trade around 50bp, versus around 105bp for the Australians, so an uninsured five-year covered would presumably price somewhere between the two.

Scotiabank’s five-year covereds trade around 45bp over Treasuries, compared with NAB’s debut covered this year at 105bp. That would compare with five-year Canadian senior unsecured trading around 125bp for five years.

“Yes there are savings implied in the issuance of covereds versus senior. It’s just a matter of whether those savings are considered enough by a Canadian issuer to justify the cost of setting up a covered programme and using up the collateral that goes into play,” said the syndicate manager.

Royal Bank of Canada, which does not use insured collateral, has an outstanding US dollar covered that trades at about 10bp–15bp back of Canadian comparables backed by insured mortgages. Those RBC bonds, however, are very illiquid and the bank has not been back to the market in two years. The bank is breaking new ground by seeking out an SEC-registered deal, hoping that by expanding the investor base for US covereds it will be able to shave enough spread off a deal collateralised with uninsured mortgages to make it worth doing versus senior unsecured.

“It will be a slightly different product once you remove the CMHC insured collateral, but we are confident it will be something the US covered bond investors will be willing to look at,” said Ben Colice, head of covered bonds at RBC in New York.

Having registered deals in the covered bond market would definitely deepen the investor base, according to Bill Hobbs, managing director in debt capital markets at Bank of America Merrill Lynch.

“Some investors can only allocate a certain amount of their funds to 144a bonds,” said Hobbs. “Also, SEC registered bonds can be index-eligible, which would open the covered market up to investors who benchmark their performance against certain bond indices. All of this will improve the liquidity and price discovery of a covered bond, which can only make it more attractive.”

But the debate on SEC registered or 144a deals is begging the question, according to Hobbs.

“From a planning perspective, the key issue is how much funding do banks need in the second half from a covered bond perspective?” he said.

“Some banks will look for diversification of funding, but at the end of the day the decision to go to any market is primarily based on efficient pricing.”

?Crumbling foundation?