Copying and distributing are prohibited without permission of the publisher.

Watermark

Canadian covered bonds find harbour in troubled times

By Bill Thornhill
16 Apr 2021

The Covid-19 pandemic caused severe disruption to financial markets in 2020-2021. During this difficult time, the Bank of Canada and the Office of the Superintendent of Financial Institutions took a number of actions to build resilience and improve the stability of the Canadian financial system. Federally regulated financial institutions were, among other things, permitted the privilege to pledge covered bonds with the central bank, which provided access to long-term repos and benefited from preferential regulatory treatment of loans subject to payment deferrals.

Recent first quarter results have shown that the Canadian banks have so far managed the crisis admirably. However, the pandemic has left some key questions regarding their balance sheets.

The Bank of Canada’s one-year long-term repos were due to expire in March and April and Canadian banks had issued more than C$92bn ($73bn) in retained covered bonds in 2020. Additionally, more than a third of Canadian covered bond redemptions in 2021 were also due in March and April this year. Based on this, Canadian banks had been expected to be active in covered bonds over the first four months of this year. However, by mid-April only three deals with a total value of €2.25bn had emerged, a small fraction of what was issued in the same period last year.

GlobalCapital and DZ Bank hosted a virtual roundtable in late March to discuss the outlook for Canadian covered bonds, addressing the key questions that are expected to shape the market over the forthcoming year.


Participants in the roundtable were:

Matthias Ebert, head of covered bonds, DZ Bank

Mohit Gupta, head of global corporate funding, Bank of Montreal

Wojtek Niebrzydowski, vice-president global term funding, Canadian Imperial Bank of Commerce

Alex Prokoudine, vice-president capital markets, Equitable Bank

Henrik Stille, senior portfolio manager, Nordea Asset Management

Moderator: Bill Thornhill, GlobalCapital


GlobalCapital: CIBC has not placed a covered bond benchmark with investors since April last year. What are the key reasons for this scarcity?

Wojtek Niebrzydowski, CIBC: For the first time ever, the Bank of Canada actually encouraged Canadian banks to access 12 and 24 months repo, for which covered bonds were eligible collateral. Participation in that programme was considered prudent for strategic funding and liquidity management in the context of significant uncertainty due to the pandemic, rather than necessarily a specific funding need.

At the same time, if you look at CIBC’s C$800bn balance sheet for the first quarter 2021 versus the same period in 2020, we had about C$18bn growth in lending and C$83bn growth in deposits. The majority of deposits ultimately funded the High Quality Liquid Assets, which rose from C$124bn to C$190bn. There are various opinions on how permanent those deposits are but, subject to the vaccine roll-out, rate of infections and lifting of lockdowns, the anticipation is for a very strong consumer spending-led economic recovery, which will be funded largely from accumulated deposits.

Finally, and unlike some European countries, Canadian banks were not allowed to defer implementation of their total loss-absorbing capacity (TLAC) buffers, which meant it was necessary for banks to prioritise the TLAC or bail‑in funding.

Mohit Gupta, Bank of Montreal: The only thing I would add is that the vast majority of the C$92bn in central bank repo funding was under one year and this has already been absorbed through deposit growth or replaced by something shorter. In other words, the refinancing of one-year repo funding doesn’t automatically translate to a long-term covered bond funding need.

GlobalCapital: How stable do you expect your deposit base to be?

DZ BankNiebrzydowski, CIBC: We don’t know. We can make various scenario predictions, but the growth of deposits is unprecedented. I’ve been in the business for quite some time. I never recall something of that magnitude. But if there is indeed a strong consumer-led recovery, it should not be a surprise that some of it will be driven by accumulated deposits and some of it may be driven by lending. Both go in the opposite direction and the net result would be an increased funding requirement. But we are still sitting on a significant proportion of HQLA assets and the BOC continues to provide repo facilities — albeit self-issued covered bonds are no longer repo eligible — which shows there are a lot of moving parts. Chances are that the net impact would be increased funding needs, though the degree they will be met through covered bonds remains to be seen.

GlobalCapital: Did BMO’s high share of corporate clients affect the growth or composition of your deposits?

Gupta, Bank of Montreal: We did see an increase in utilisation of facilities by corporate and retail clients as a lot of people were rightfully being cautious and trying to build up liquidity. But as the government started providing fiscal and monetary support we also saw a material increase in deposits, which has continued until now but at a slower pace. The mix in growth of retail and commercial deposits has been consistent with our business mix. But we believe commercial deposits are more likely to decline, with loan growth picking up at the same time. Whereas, with retail customers, we expect the process to be more sequential, with customers first using deposits before borrowing. A high level of uncertainty still remains, so it’s really hard to predict the trajectory.

GlobalCapital: In August 2019, Equitable Bank announced its intention to establish a legislative covered bond programme, with a goal to become a covered bond issuer last year. Could you briefly introduce your firm and explain why you postponed your debut trade?

Alex Prokoudine, Equitable Bank: Equitable celebrated its 50th anniversary last year. So, although we are new to covered bonds, we have a long history of operating as a regulated financial institution. Our traditional focus has always been on mortgage lending, both commercial and residential, and mortgages remain by far the largest asset on our balance sheet.

Historically, we funded ourselves with securitization and deposits, but as time went on and our balance sheet grew, we began to explore additional wholesale funding options. We have an active senior unsecured EMTN programme here in Canada, and now the time has come for us to look at alternatives and that’s where covered bonds come in.

We had originally planned to launch the programme last year but decided to put it on hold. The primary consideration wasn’t so much funding needs, but rather concerns about our ability to successfully launch a brand-new programme, given all the uncertainty in the market back in the first half of 2020. As time went on, it became clear that the covered bond market remained receptive to new issuers, and so we resumed work on the project near the end of 2020, and are on track to launch the programme this year.

GlobalCapital: Can you tell us what your target currency is for your debut trade, and why you chose that?

DZ BankProkoudine, Equitable Bank: The covered bond issuance limit in Canada of 5.5% of assets brings us to a programme limit of about €1.1bn, which is insufficient to allow us to be a regular issuer in multiple currencies. We therefore decided to pick a single market and stick with it, and concluded that the euro market is the one that will serve us best in the long-run, given its long history, the depth of liquidity and the number of investors who are focused on the asset class. While our balance sheet is growing steadily, the current €1.1bn limit will constrain us to issuing sub-benchmark transactions of €250m-€300m for now, most likely in the three year tenor, as this would also allow us to be a regular issuer, surfacing about once a year.

GlobalCapital: Given the scarcity of covered bond supply, Henrik, how do you look at short dated, sub-benchmark trades from smaller issuers?

Henrik Stille, Nordea Asset Management: We look at all types of covered bonds across the universe, including sub-benchmarks and shorter maturities. There are many things that we can compromise on in the current market environment but poor liquidity is not one of them. That means, all else being equal, a sub-benchmark needs to provide a higher spread to larger and more liquid bonds. One of the big advantages of Canadian covered bonds is that they are usually quite large and their liquidity is not disrupted by the ECB.

GlobalCapital: Yet, National Bank of Canada priced its relatively small €500m seven year pretty much flat to the national champions, which was a good result.

Stille, Nordea AM: It is possible to price these sub-benchmarks tighter in the current environment, as was seen in Finland recently, for example. This is because many buy-and-hold investors don’t care so much about the size or liquidity. But, as an asset manager, we prefer to have some liquidity as we have constant flows in and out of funds, so we need to be able to trade.

Matthias Ebert, DZ Bank: We expect net supply to be around €60bn negative and in the first three months of this year supply has already fallen 50% from the same time last year. This undersupply is definitely favourable for smaller issuers and sub-benchmark players. Undersupply is likely to increase investment appetite and improve rating flexibility which, in combination with a spread pick-up for a lower rating, should lead to a window of opportunity for sub-benchmark issuers in the current year.

However, a debut trade is always something of a special journey and I’m very happy that clients, such as Oldenburgische Landesbank, which successfully issued a debut €350m 10 year with an Aa1 rating in March this year, have chosen DZ Bank for our trusted distribution capability.

GlobalCapital: On October 15 last year, the Bank of Canada announced that own-use covered bonds will no longer be eligible for repo. Did you welcome the decision?

DZ BankGupta, BMO: Definitely. We weren’t using that facility any more and I think it was good to clarify to the market that we don’t plan on using it. It was also a sign of market strength reflecting strong deposit growth, so it made sense. BMO’s retained issuance was around C$3bn, which was a relatively small amount compared with some of our peers, with maturities up to 2.5 years. We may look to wind them down before maturity, though we still have plenty of issuance capacity and do not need to free up collateral.

Issuance limit

GlobalCapital: Not long ago the Singaporean regulator increased the covered bond limit to 10%. In this context, would it not make sense for the Canadian banking industry to lobby the federal banking regulator (OSFI) to make the temporary limit increase from 5.5% to 10% a permanent one?

Niebrzydowski, CIBC: You are talking to someone who has been involved in that industry initiative for 13 years and, as I’ve said before, for me personally that’s hands down the least successful industry initiative I’ve been involved in. But hope is eternal.

Humour aside, it was very good to see both the Bank of Canada and OSFI work together to come up with a facility that allowed self-issued covered bonds to become eligible for repo, and this was associated with a temporary increase in the issuance limit. It’s actually good to see this when there was a perceived need.

The initial limit was 4% but this was improved to 5.5% and, if you look at the regulatory narrative at that time, the 5.5% was not viewed as explicit increase, it was to accommodate a slight change in the calculation. The temporary 4.5% increase to 10% is for covered bonds pledged for repo and since this is no longer available we are, for all intents and purposes, effectively back to 5.5%.

GlobalCapital: Equitable Bank, as a smaller player, would benefit most from a change in the covered bond limit. What is your view on the topic?

Prokoudine, Equitable Bank: A larger limit would give us more flexibility with respect to currency, deal size and term. As we’ve just heard from Henrik, larger benchmarks would probably be issued at tighter spreads. There is also the fact that there are significant upfront costs to establishing the programme, as well as meaningful ongoing annual cost to maintain it. Many of these costs are fixed rather than variable.

A larger programme would allow us to spread those costs over a larger base, and decrease our cost of funds. We’ve been advocating for a larger limit for several years now, and have had meetings with OSFI and the Department of Finance and the Deposit Insurance Corporation to present our perspective on the topic, as we want to make sure that the relevant decision-makers are aware of the impact on smaller institutions like ourselves. We hope that, once we actually complete the inaugural transaction, those discussions will take on a more relevant and convincing meaning.

We believe a fair solution would be to adopt a customised approach, as I believe happens in the UK, whereby the regulator would take into account the composition of the issuer’s balance sheet, its business strategy and so forth. For example, a balance sheet that has got more term deposits as opposed to demand deposits could perhaps accommodate a larger bond limit. Regulatory capital levels could be another factor in determining covered bond limit for an institution.

GlobalCapital: Henrik, as a holder of Canadian covered bonds would you welcome an increase in the limit?

Stille, Nordea AM: From a pure credit perspective, it is better to have fewer covered bonds because, if the bank runs into difficulties, it’s easier to save the covered bonds if there are few outstanding. But, since we’re not overly concerned about covered bond credit risk, it’s more important for us to have an asset class that can grow, which means having more banks that are able to use covered bonds as a funding instrument. It’s important from our perspective that we have an active primary market so we can market our products and offer liquidity to our clients.

Housing market

GlobalCapital: BMO’s first quarter results showed your Canadian residential mortgage loan book had the strongest uptick since the fourth quarter of 2019. How is the housing market looking?

Gupta, BMO: The Canadian housing market remains strong and we’ve seen a double digit pick-up in sales in many regions, driven by low mortgage rates and demand for more space as the lockdown extended. Working from home is expected to be part of the workplace environment, so we do see increased demand for detached properties compared with apartments, where demand has been relatively muted.

Historically immigration has been one of the biggest factors driving the housing market and the government has set a target of 1.2 million immigrants coming to Canada over the next three years. That’s a big number relative to Canada’s 37.5m population.

And, after peaking at 13%, unemployment has improved to below 9% and is trending towards the pre-pandemic range of 6%-7%. So, we’re making strides there too.

Niebrzydowski, CIBC: The total labour force is about 20m out of a population of 38m. As of February, employment was down 599,000 compared with the same period of last year. But, having said this, Canada is the only G10 country where all sectors of the working population have experienced an increase in disposable income and/or net worth — thanks largely to a significant amount of government support, as well as stock market and residential real estate performance.

We’ve been explaining the Canadian real estate market for, I think, 14 years now and in that time there have probably been a few hundred analyst projections that the crash is just around the corner. So far it hasn’t happened. The increase in prices was much more pronounced outside the bigger cities, so Vancouver and Toronto are up as well but the likes of Montreal, Ottawa, Halifax are up quite a bit more. Smaller condominium prices are still probably down a little bit, but there seems to be anecdotal evidence that, for much larger units, prices are up as people like to have more space and can afford it.

GlobalCapital: In September last year OSFI announced that they would gradually phase out the beneficial regulatory treatment on loans subject to payment deferrals. Are borrowers making regular payments again and what’s happened to the quality of your residential loan book?

Gupta, BMO: The majority of borrowers have exited the deferral programme and I think that’s pretty much true for the industry. We’ve not seen a material impact on the quality of our residential mortgage loan book and it’s performed as well as expected. Delinquency rates are comparable to pre-pandemic levels, partly because of government support. But, even coming out of payment deferral schemes, we’ve seen rates stay relatively low. Looking forward, we expect them to normalise from these very low levels but I wouldn’t expect a material uptick. Overall losses have been less than a basis point, and delinquencies are a little bit higher.

GlobalCapital: How did the Canadian consumer indebtedness change during the pandemic and how does that compare with other countries?

Niebrzydowski, CIBC: Not surprisingly over the first few months we’ve actually seen a decrease in the overall indebtedness level and that’s a function of at least two things. The first is that the ability to spend was somewhat limited. At the same time, given a significant amount of government income support, people have maintained their income or that income has even increased. That changed once the real estate market opened up, after being effectively closed for the first few months in the spring and early summer last year, and indebtedness began to rise again.

In 2019 Canadians’ average debt to disposable income ratio was 186%. In Sweden it was 188%, Australia 210%, the Netherlands 235% and Denmark 256%. Going in the other direction, Ireland was 130%, the UK 141%, France 122% and Germany 96%. So, I would say we are in the middle of the pack and more or less have been there consistently over the last few years.

GlobalCapital: What’s your view on residential mortgage loan growth this year — is there an opportunity for you as a niche player?

Prokoudine, Equitable Bank: Nine times out of 10, economic predictions end up missing the mark, but from what we’re seeing right now, the outlook is relatively positive and hopefully, with the continued improvement in unemployment and resumption of flow of immigration into Canada, that will continue to support growth. As for Equitable in particular, we don’t play in every single space in the Canadian mortgage market. We’re very strong in select niches, where we continue to provide a very compelling value proposition to our customers, and that hasn’t changed. With a strong and motivated team, I truly believe we will do well regardless of how the markets turn out.

GlobalCapital: Henrik, what’s your view on the pool quality of Canadian banks?

DZ BankStille, Nordea AM: We don’t have any major concerns regarding the quality of Canadian cover pools. We think they look good. When it comes to real estate prices, yes, a lot of people always worry about real estate prices, both when they go up and when they go down. I think in general it’s better they go up than down. So it’s not like we have any major concerns there.

GlobalCapital: Do you think that the Bank of Canada and OSFI are right to have already withdrawn their crisis support?

Stille, Nordea AM: We think that was a good decision, especially with reference to what I touched on earlier about having more issuance of covered bonds. It’s not good for the European market to have the ECB continually offering very cheap loans to banks so they don’t have to issue covered bonds. I don’t think the Bank of Canada’s decision to temporarily improve repo access resulted in too much economic stimulus compared with what would have happened naturally if the Canadian banks had funded themselves directly in the market with covered bonds. The additional central bank stimulus was only very marginal. I think it is healthier to see a functional market in which capital markets are used by the banks for funding.

Regulatory funding

GlobalCapital: Matthias, Canadian domestic systemically important banks are required to maintain a risk-based TLAC ratio of at least 22.5% and a leverage ratio of 6.75% by November 1 this year. This has often been mentioned as another reason for subdued covered bond supply. Where do the Canadian bank ratios stand as of the first quarter this year, and when would you expect supply to improve?

Ebert, DZ Bank: In their first quarter results Canadian banks’ TLAC ratios ranged from 22.5% to more than 25% and TLAC leverage ratios from 7.2% to 8.4%, which is at or above the regulatory minimum. In order to play it safe, however, I think that the Canadian banks are planning to build a buffer above the regulatory minimums, due to the many uncertainties on RWA developments and OSFI’s domestic stability buffer. I think this buffer will probably be built up until the end of July. After the summer break there’s another C$12bn of Canadian covered bond redemptions that come due and banks could then begin to shift their focus back to secured funding. This scenario is particularly likely if residential mortgage loan growth remains strong and if deposit growth declines as people start spending again.

GlobalCapital: Wojtek, what is your funding strategy for this year and, given your TLAC and leverage ratios, would you agree that TLAC issuance has replaced covered bond funding in 2020?

Niebrzydowski, CIBC: As of the first quarter, our TLAC ratio was at 24.5% and leverage was 8.3% on an RWA basis. Since early 2019 we decided against issuing any bonds that would lose their TLAC eligibility up to November this year. So, technically we don’t have any TLAC refinancing to do. But obviously there are a lot of moving parts. Although we don’t expect any material developments in RWA migration, there is a question over the extent of anticipated loan origination.

All else being equal, we don’t anticipate a lot of TLAC funding needs over the balance of this year but things may change. Term funding issuance is therefore likely to be a function of balance sheet dynamics — namely, deposits versus loan originations. To the extent there is a need for term funding and given the somewhat limited TLAC needs, it’s only logical to look at covered bonds. I’m not in a position to make any commitments as to any specific issuance, but it’s on the radar.

And, as most of you would probably know, CIBC has made repeated commitments over the year to maintain a meaningful market presence, at least in the context of our key markets. So, at some point we may get to a situation where, notwithstanding the possibility that our funding needs may not necessarily warrant material issuance, we may choose to do some funding to maintain our presence in the market.

GlobalCapital: BMO’s TLAC ratios are at similar levels to CIBC’s. What does your funding strategy look like and would you consider issuing a covered bond despite tight senior spreads?

Gupta, BMO: There is a consideration to being present in the market and continuing to be a regular issuer. We’re in a similar boat to CIBC as we have continued to issue TLAC‑eligible senor unsecured, as well as covered bonds. We have experienced a bit of a drought that was driven more by deposit growth than TLAC-eligible issuance.

If we look at the last 12-16 months, we’ve probably issued the least amount of TLAC paper among the Canadian banks. I agree with Wojtek in that it may come to a point where we may issue covered bonds irrespective of whether we need the funding or not. That’s something we’re keeping a close eye on as we like to be a regular issuer and euros are unquestionably an important market for us.

GlobalCapital: How important is the covered-senior differential to you as a debut issue — does it have an impact on the timing of your first trade?

Prokoudine, Equitable Bank: As my boss would say, every basis point counts — and for sure it does. But I think, realistically, for the inaugural trade, barring any major dislocations in the covered to senior unsecured spreads, it’s probably not going to be at the top of our list defining success. More importantly, we’ll focus on making sure that the programme is launched on the right footing, and the important factors in determining that would be things such as spread versus relevant comparables in the covered space. The other critical point for our inaugural trade is that we attract a broad range of investors with a high subscription ratio, leading to a solid secondary market performance. As the programme matures, the relative cost of funds versus senior unsecured would become more important in our decision making.

GlobalCapital: During the crisis the European Single Resolution Board extended the phase-in period for European banks to meet their MREL targets by two years to 2024 but Canadian banks need to be compliant by November 1 this year. Do you think this puts them at a disadvantage or could this be a benefit?

Niebrzydowski, CIBC: I have mixed feelings about that. Having that requirement deferred for certain European countries is not necessarily ideal for Canadian D-SIBs which are also active in international markets.

On the other hand, one could view it as a resounding vote of confidence, on the part of the Canadian regulator, in the Canadian D-SIBs, as it shows that they fully expect us to be compliant as of the original date. It talks to the D-SIBs’ ability to access the market throughout the pandemic and build capital ratios, not only with TLAC issuance, but also with additional tier one — and all of those transactions were well received.

But, it obviously impacts earnings to a degree, because if we were totally indifferent as to how we issue term funding, without consideration of underlying regulatory requirements, it would make more sense to issue covered bonds rather than senior unsecured. But we are fully compliant, as I expect all banks to be.

GlobalCapital: In March 2020 OSFI lowered the domestic stability buffer requirement for domestic systemically important banks from 2.25% to 1% of risk-weighted assets and committed to not increase it for at least 18 months. How do you deal with the risk that OSFI could increase the buffer before November 1 2021? What would be the impact for covered bond supply?

Niebrzydowski, CIBC: It was actually good to see the DSB working the way it was supposed to, which is to go up in the good times and down in stressful times. So that decrease was a good move and welcomed, as were the Bank of Canada’s term funding facilities. Obviously we would appreciate advance guidance as to what is likely to happen with the DSB ratio. Nevertheless, we’ve always run a strategically prudent funding profile and it’s logical for a D-SIB to carry some buffer that would account for a potential increase in DSB, which has a potential range of 0%-3%. All else being equal, a rise in the DSB would potentially mean more TLAC issuance and less covered bond funding, though of course there are a lot of moving parts.

GlobalCapital: Not including retained covered bonds, Canadian banks have normal covered bond redemptions of about C$40bn this year. The dollar market is practically niche, as is Aussie dollars, sterling and Swiss francs. Is the euro covered bond market the only real refinancing option?

Gupta, BMO: These C$40bn of covered bond maturities will not necessarily be refinanced like-for-like, as we plan to split the funding between senior unsecured and covered bonds. The euro covered bond market is one of the important markets where we really like to be a regular issuer. We have always relied on the euro market for long-term covered bond and senior funding, and we see it as important to our funding strategy. That said, I think the other smaller markets also provide the desired diversification and each one of them also has a role to play within our overall funding strategy, which means we will continue to be active in all markets in the long term, though there will at times be factors that trump that thinking.

Covered bond options

GlobalCapital: What does the recent shift of investor demand towards 10 year-plus tenors do to the attractiveness of the euro market for Canadian banks?

Gupta, BMO: From an asset profile perspective there is definitely a preference for terms shorter than 10 years, but we have been able to accommodate up to 10 year funding, which provides a little bit of diversification for us. But I think the euro market has a large depth of investor demand that continues to be good for shorter than 10 year tenors, even though the preference in the current environment seems to have been in the long end so far this year.

GlobalCapital: How do you look at different covered bond markets in your funding options?

Niebrzydowski, CIBC: Europe has always been and still is a key market. Nevertheless, it is notable that there were no euro covered bonds from Canada between September 2008 and July 2013. That was not for the lack of want. The attractiveness of euro funding is basically a combination of euro credit spread and, more importantly, the cross-currency basis. Given that euro needs are minimal for most Canadian banks, it’s necessary for them to swap back to dollars which, at that time, made the cost of issuance prohibitive.

After the global financial crisis CIBC was the first Canadian bank to issue covered bonds in dollars and Australian dollars, and was the first to issue in Swiss francs. We continue to have bonds outstanding in these currencies as well as sterling and euros, which shows that we value currency diversification.

GlobalCapital: In mid-March Berlin Hyp issued the first trade shorter than 10 years since January and since then several others have followed, with CCDJ most recently issuing a five year. How have higher yields affected investors’ sweet spot on the euro curve?

DZ BankEbert, DZ Bank: In January and February increasing yields pushed the investor sweet spot out on the curve and suddenly 15 and 20 year covered bonds offered attractive coupons of a quarter or three-eighths and even 10 year deals were no longer negative yielding. However, the steeper yield curve has also made medium-term trades attractive again. In early January five year swaps were close to the ECB deposit rate of minus 0.5%, but now they’ve risen to minus 0.35%, so there’s now an attractive premium, in particular for bank treasury investors.

Combined with a flattish credit curve for triple-A rated covered bonds and fears of a further curve steepening not being contained, investors’ sweet spot has shifted back towards medium tenors. Berlin Hyp’s long six year green trade played an important role as it was 2.4 times subscribed despite a negative yield and spread.

We also saw high subscription ratios and low price sensitivity for negative yielding five and seven year follow-on deals from VUB, NBC and CCDJ. That stands in contrast to some recent 20 year bonds where oversubscriptions were lower and price sensitivity higher. In a nutshell, the shift in gears has already further opened up the issuance window and has moved the sweet spot towards the medium term.

GlobalCapital: Henrik, do yields play a role in your investment decisions? Where’s your sweet spot?

Stille, Nordea AM: The natural fit for our funds is no longer than 10 years, ideally between five and 10 years. These longer deals that we’ve had recently are not such a good fit, but with no other covered bonds coming to the market, we looked at them as well and hedged the curve risk. We don’t exclude these longer deals, but they’re not appropriate for many of the portfolios, so it’s better to have shorter bonds. Since yields rose, interest in the shorter part of the curve has improved and there is quite good demand at the moment in the five to seven year. That’s also what I hear from various traders who see much more demand in that part of the curve compared with the beginning of the year when five year swap rates were trading close to the ECB’s deposit rate.

I think there is quite a good opportunity now to issue shorter deals, where absolute yield is not that crucial. As we can hedge the duration, spreads are the most important thing for us. The absolute yield is only important to us insofar as it is seen to be an important factor for other investors. And of course we won’t necessarily buy a five year covered bond if a lot of other investors are not buying because the yield is too low. In that case such a bond is of course not that attractive for us because no one is interested in buying it, except for maybe the ECB. So, we also need to adjust a little to what the broader investor community thinks.

GlobalCapital: A number of Canadian banks have established sustainable bond frameworks and have issued green or social senior deals. BMO has already issued a green social bond but never a sustainable covered bond. Why is that and do you expect to do so in future?

Gupta, BMO: ESG is definitely a big focus for us at BMO and, I think, more important for us is to approach issuance in the right way —and that’s what we’ve done with both our sustainable and social bond issuances in the past few years. One of the key requirements for us is to have a robust framework and regular transparent reporting. In general I’d say that in the Canadian market there’s been no clear or established framework for what’s considered green. There is work under way on that front, but I would say it’s probably still in its early stage. I don’t expect that we’ll be issuing a sustainable covered bond in the near future, but I do think that at some point in the more distant future we will be looking more closely into that.

GlobalCapital: Would you consider issuing green or social covered bonds in the future?

Niebrzydowski, CIBC: I would basically echo what Mohit just said. The focus on ESG is very high at CIBC and we have issued both social and green bonds in the last couple of years. With green covered bonds there’s an issue as there is no established definition of what constitutes a green mortgage and there is no established reporting framework either. So, it’s a bit difficult contemplating issuing something if you are not certain what the collateral should be. These issues are being looked at as we speak. There are various working groups in the industry that are looking at clarifying those items. So, to the extent the framework is there and the collateral is available, I see no reason why we wouldn’t want to issue either social or green covered bonds when all these things fall into place.

GlobalCapital: One of those things that is currently falling into place is the EU’s draft Taxonomy for Sustainable Activities. It has had a mixed reaction as far as mortgages are concerned because they’re targeting energy performance certificate labels ‘A’ and ‘B’, which in some countries represent a miniscule proportion. Does the EU taxonomy have any impact for Canadian banks?

Niebrzydowski, CIBC: It would be good to have a level playing field and I realise it’s difficult to get that within the EU, as far as I understand, but it’s difficult to get there across continents. So, to the extent that various aspects of the taxonomy are in line with how CIBC looks at sustainable and green financing, we would expect to be compliant, but again if there’s no final product in the EU, there is no final product in Canada. To the best of my knowledge all EU countries are signatories to the Paris Accord, as is Canada, so one would like to think that at some point there’s going to be a general global agreement on how these matters should be approached and reported. But until such time we will obviously follow what’s happening in the EU, but it doesn’t necessarily mean we will be in a position to be fully compliant.GC

By Bill Thornhill
16 Apr 2021