For the first four months of the year, it was only the French and the Germans, with the exception of one Swedish bank, Skandinaviska Enskilda Banken, that had access to a gradually re-opening jumbo market in covered bonds. But then the European Central Bank announced that it would buy up to Eu60bn of covered bonds, triggering a market recovery that has lured in an ever increasing number of jurisdictions.
A deal from Bank of Ireland on September 9 as good as sealed this recovery at least in terms of access. But despite being able to boast of their strong credit and high quality mortgage collateral, Canadian issuers have not made an appearance in the benchmark market since September 2008, when Canadian Imperial Bank of Commerce priced its inaugural jumbo.
And it is not because investors would not buy Canadian covered bonds, says Torsten Elling, head of covered bond syndicate at Barclays Capital in Frankfurt. "Without a doubt, the market is open for Canadian issuers," he says.
"They could issue whenever they want, but its a question of whether the spread they will have to pay makes covered bonds an attractive funding tool compared to alternatives."
For now there are good reasons why Canadian financial institutions have kept their distance from the benchmark covered bond market, despite a remarkable tightening of spreads to near pre-crisis levels.
"The Canadians are faced with the problem of market mispricing," says Elling. "The banks are in a much better position than their spreads would suggest."
In a research note published mid-August, Barclays Capital analysts pointed out that spreads on Royal Bank of Canadas senior unsecured debt are being quoted tighter than those on the banks covered bonds. The sale of RBCs 3.25% January 2013 senior unsecured debt versus its 4.5% November 2012 covered bond would generate a pick-up of around 5bp-10bp, they said.
"That makes no sense whatsoever," says Elling.
And it would complicate pricing a new issue. "Recent transactions have shown that you can price new issues inside an institutions secondary curve," he says. "You can try to do the same with a Canadian deal, but at the same time you cant completely ignore secondary market levels."
Reaching out and talking to investors about the mispricing of outstanding Canadian issues is also important, Elling says.
"I have the impression that in the context of a negative newsflow about the subprime crisis a lot of risk managers have suspended credit lines for North American issuers, and that includes the Canadians even though they hardly had to make any writedowns."
Jerry Marriott, managing director, Canadian structured finance, at DBRS, which rates all outstanding Canadian covered bond issues, suggests that from a credit rating perspective Canadian covered bonds are a strong proposition for investors.
"We are comfortable with the credit quality of the issuers themselves," he says. "Canadian banks have avoided most of the problems that other financial institutions have had to deal with, and they have also significantly enhanced tier one capital levels."
Canadian covered bonds are backed by high quality collateral, which to various degrees is also insured by the government agency, Canada Mortgage and Housing Corporation, he adds.
"DBRS takes a slightly different perspective on Canadian covered bonds from our competitors," says Marriott, "and its not because were not paying attention to the same issues, such as liquidity, that they are.
"But weve come to the conclusion that Canadian covered bonds, on all three legs of our analysis issuer, legal framework and collateral come out in a very strong position. Were not a cheerleader for any security, but where theres a real strength we think its important to share that information."
Its better at home
For now, however, there is little incentive for Canadian banks to tap the euro jumbo market. "Part of the dilemma we have here at CIBC," says Wojtek Niebrzydowski, vice president of treasury at Canadian Imperial Bank of Commerce in Toronto, "is that despite no Canadian bank ever having required a government bailout, ever using a federal government sponsored guarantee scheme even though there was one available, and no Canadian bank cutting dividends, there is probably around a 50bp-60bp equivalent difference between issuing senior unsecured debt domestically and in Europe."
Based on indicative covered bond levels that difference narrows to around 15bp-25bp, he says, with the cross-currency swap a material contributing factor.
"Its difficult to justify putting our best agency guaranteed collateral out there at a cost above domestic senior unsecured levels, especially when there are a lot of liquidity sources internal and domestic available at very economic levels."
One element that needs to change to make the benchmark covered bond market a more cost-effective source of funding for Canadian issuers is the cross-currency basis swap.
"Canadian banks hardly have any euro assets so they have to swap proceeds into dollars," says Elling, "but when you compare post-swap levels to domestic levels for senior unsecured debt, tapping the euro market doesnt look attractive."
Elling identifies a sequence of events that could change this. "If spreads continue to tighten, and traders quote tighter bid-offer spreads, the turnover on the secondary market will hopefully increase as a result and we will able to achieve tighter primary spreads that might make funding levels after the cross-currency swap more attractive," he says. "Maybe then well have a deal."
Niebrzydowski says if CIBC could price a new covered bond benchmark in the euro market around 15bp-20bp over mid-swaps inside equivalent domestic senior unsecured levels, that would probably be an attractive enough level for the issuer to return to the market with a benchmark-sized transaction.
"Until then, printing a trade at current levels would be an expensive premium to pay for investor and funding diversification," he says.
Levelling the field
While Canadian issuers have been keen to stress that investors should be comfortable with their covered bonds without specific legislation, they also want to eliminate any possible source of a pricing disconnect between covered bonds from Canadian issuers and those of their European counterparts.
"Our interest is in a level playing field," says Cathy Cranston, senior vice president of the financial strategy group at Bank of Montreal. "Technically we dont need legislation, but we understand the benefit from an investor perspective, and it also makes sense as there are so many jurisdictions that have moved in that direction."The Canadian Bankers Association has asked the Canadian government to consider introducing covered bond legislation. EuroWeek understands that the CBAs covered bond working group has made several submissions to the Department of Finance which is considering arguments for whether legislation is needed. No decision has been made, an official at the department told EuroWeek.
The initiatives timeframe is in line with expectations. "The government has been quite clear that it will be a well thought-out process," says David Power, vice president of market strategy and execution at Royal Bank of Canada, and chairman of the CBA covered bonds working group.
Although achievable pricing levels on the benchmark covered bond market are not attractive enough to prompt Canadian issuance at the moment, there is another side to the equation, as Cranston points out. "There are two things:" she says, "the need for funding and access to cost-effective funding."Canadas issuers are in a good position in terms of liquidity, they tell EuroWeek. "Going into the crisis Canadian banks had not fallen behind in their funding," says Power. "We were not starting off with a structural liquidity deficit, unlike some issuers in other jurisdictions."
In addition to this, Canadian financial institutions have been able to obtain funding by participating in the Insured Mortgage Purchase Program that the Canadian government introduced in October 2008.
Under this programme, which expires at the end of September, CMHC buys securities consisting of pools of insured residential mortgages from Canadian financial institutions through a competitive auction process. The scheme was designed to provide long term funding to Canadian mortgage lenders, and has been well used, in particular last autumn.
In contrast, the Canadian Lenders Assurance Facility, which provides for government insurance of term borrowing raised by Canadian deposit-taking institutions in the wholesale markets, has not been used by Canadian banks.
The guarantee facility was established to build on the IMPP and although it has been extended beyond April, when it was originally supposed to expire, Canadian banks are not expected to issue guaranteed debt under the facility.
"So Canadian banks had not fallen behind, and with the IMPP as an extra source of funding, banks had enough liquidity to carry them through the summer," says Power.
Speaking for RBC, he says: "When we see the market reopening it is not something we feel we have to jump into."
Bank of Montreal, which launched its inaugural benchmark in January 2008, has benefited from accessing the IMPP and from strong deposit growth, says Cranston. "We are in very good shape for this fiscal year," she says.
Newcomer nears programme completion
In Toronto-Dominions case, a lack of need for wholesale term funding also partly explains why it has not yet filed its covered bond programme, which was originally intended to be in the final stages around this time last year.
"A combination of market and TD-specific reasons delayed things," says Peter Walker, senior manager, capital finance at TD Bank in Toronto. "We became more focused on capital initiatives, for example, and also experienced strong growth in funding, in particular deposits.
"We havent been active in the wholesale term markets this year in any substantial way," he says. "But we are still committed to covered bonds, and are back working on the programme, especially because the market has improved since the ECB started buying covered bonds."
TD is aiming to file its programme this autumn. It will be the second Canadian covered bond programme to provide for the issuance of covered bonds backed entirely by residential mortgages insured by CMHC; CIBC launched the first benchmark backed solely by CMHC-insured mortgages in September 2008.
The issue signalled a change in direction for the Canadian covered bond market, and has set a certain benchmark, says Elling. "The CIBC deal with a CMHC wrap was marketed as a public sector covered bond and future deals will have to compete against that."
While TDs covered bond programme is back on track, another project appears to be on hold.
Canadas credit unions have been working on setting up a covered bond programme. They had been hoping to be ready to approach the covered bond market this year, according to a presentation by the funding services team of Central 1 Credit Union, the central banker for British Columbias and Ontarios credit unions, that was prepared for a forum that took place in October 2008. The goal had been to develop a C$3bn (Eu1.91bn) or more covered bond programme.But interest in the project has waned as a result of the financial markets crisis, with little need for such funds, also a contributing factor, EuroWeek understands.
"Its pretty much dead in the water," says an official involved in the project.
But the message elsewhere is different. Established and forthcoming Canadian covered bond issuers say they are committed to covered bonds as a funding platform.
That they are patiently waiting for the right opportunity to launch a covered bond benchmark on the euro market is in line with that commitment, if not testimony to it.