Banks cash in on covered bonds
COMMENT
It’s a meeting place that seems to be working for the benefit of all parties. On the one hand there are t he well- capitalized Canadian banks which are seeking capital at low rates; on the other there are non-Canadian investors who are more than willing to provide the capital in a variety of currencies at low yields for reasonable periods of time.
The two parties are brought together by covered bonds, a AAA- rated security issued by the banks that give investors two types of protection: the credit rating of the banks and an underlying pool of uninsured residential mortgages. To the extent residential mortgages don’t throw off enough cash to meet the interest and principal repayments, investors rely on the credit of the banks.
The latest example played out Tuesday when the Bank of Nova Scotia launched a US$ benchmark, SEC-registered five- year covered bond. The bank hoped to raise US$ 2.5 billion from t he offering. The bonds were issued under BNS’s US$ 20 billion global program, at a yield of 1.988 per cent.
So what’s the attraction? Certainly the terms and the flexibility make such borrowings very attractive. Depending on the currency, yields vary from less than 50 basis points to above two per cent; issuers can issue either fixed or variable rate securities and in a variety of currencies. Since 2013, issues have been denominated in Canadian, U. S. and Australian dollars, as well as Swiss Francs, euros and pounds.
BNS’s deal continues a recent flurry of activity. At the end of December 2015, outstandings, according to a monthly covered report prepared by DBRS, stood at $ 88 billion. ( At the end of 2014, outstandings were $ 50.6 billion.) Two months l ater, February 2016, the outstandings had risen to $96.23 billion.
While numbers haven’t been published by DBRS for March 31, we know March was a busy period: RBC completed three issues ( for 350 million euros; for 1.5 billion euros and US$ 1.5 billion); while Bank of Nova Scotia did one ( for 750 million euros) and Toronto Dominion did one (for US$1.75 billion.)
The DBRS numbers show the seven eligible Canadian issuers have considerable room to issue even more covered bonds. Those seven became eligible by applying to OSFI, the federal regulator, to issue covered bonds following regulatory changes unveiled in July 2013.
One of the key changes was that no insured mortgages ( meaning no residential mortgages insured with CMHC) could be included in the pool of residential mortgages. Those mortgages came with what is essentially a timely payment guarantee from Ottawa. That guarantee effectively subsidized the issuer, which, in turn, lowered the return to investors.
Since then seven issuers — the six Big Banks plus Caisse central Desjardins du Quebec — have registered their covered bond programs.
Under the program each bank i s allowed to i ssue covered bonds up to four per cent of its total assets. ( Because each bank’s assets grow steadily the absolute amount of the four per cent rises over time.) At Feb. 29, the banks were allowed to have issued $ 148.629 billion of such bonds. In reality they had issued a mere $ 96.231 billion of such securities — meaning a gap of more than $ 50 billion. Of the total amount of covered bonds issued, RBC had the largest outstanding at $ 32.839 billion — almost one third of the float. At the end March, RBC had issued $ 38.044 billion – giving it room to issue another $ 6.7 billion of such bonds given that its covered bond limit is $ 44.734 billion.