With the exception of a debut Swiss franc issue for Canadian Imperial Bank of Commerce last December, Canadian covered bonds were absent from the international markets in 2009, in spite of the resilience of the country to the crisis. The reason for this, according to bankers, was that European investors werent rewarding Canadian issuers for their strengths, particularly issuance backed by cover pools comprising only mortgages insured by Canada Mortgage & Housing Corporation, a Canadian state-backed institution.
"When the Canadians first came to the European markets and CIBC marketed its deal as a public sector covered bond, there was something of a mixed response from European investors," says Andrew Porter, global head of covered bonds at HSBC in London. "Some absolutely bought into that and really understood and appreciated the quality of what was on offer, but there were definitely some other parts of the more traditional investor base who were still focused on the lack of legislation in Canada."
This resulted in pricing wider than Canadian issuers considered justified, and with alternative funding options available domestically and in other markets, through either senior unsecured issuance or CMHC programmes, for example, they were not going to be held hostage to European investors pricing demands.
Canadian issuers were nevertheless keen to make use of covered bonds as a funding tool, and towards the end of 2009 began exploring new ground: the US.
Although US investors enthusiasm for covered bonds had blossomed but then quickly withered in 2007, some bankers considered that the US investor base could be receptive to Canadian offerings, particularly in light of the quasi-government collateral.
"Government guaranteed issuance in the US was drawing to a close," says one DCM banker, "and we had the idea that CIBC would be a great candidate to re-open the covered bond market in the US because it could be a replacement for government guaranteed debt. While the bonds werent government guaranteed, the collateral is."
But while that idea made sense in theory, those pushing to re-open the US market wanted to make sure that it would work in practice. A thorough educating and marketing process therefore followed before CIBC decided to go ahead with putting together 144A documentation as a prelude to a US dollar benchmark.
Having faith and giving credit
A $2bn three year covered bond that followed in January proved that US investors had bought into the Canadian offering in a big way. An order book of $4bn built by leads Bank of America Merrill Lynch, CIBC, HSBC and Royal Bank of Scotland, and distribution of 85% of the paper to US accounts was a resounding endorsement of the US project.
"We were flying slightly blind," says Tim Skeet, head of covered bond origination at Bank of America Merrill Lynch in London, "but we did see the opportunity and we had a borrower bold enough to make the call, and the rest is history.
"They tried to do $1bn and ended up doing $2bn, with a well oversubscribed book."
Wojtek Niebrzydowski, vice president, treasury at CIBC, says that US investors gave the issuer full credit for the strengths of its offerings.
"Ever since we launched our programme in Europe we consistently argued that it has a combination of three important attributes: highly rated issuer, rock solid jurisdiction, and collateral benefiting from credit default insurance backed by a sovereign agency," he says. "All three factors played a key role in introducing US investors to the programme.
Indeed, CIBC priced its US dollar issuance tighter than the only European issuer to tap the 144A market in the first half of the year, Compagnie de Financement Foncier, reversing their relative pricing in euros.
"The covered bond programme has now become one of the most important vehicles that we have at our disposal," adds Niebrzydowski, "and the second most effective after the Canada Mortgage Bond programme which I dont think we could ever beat."
Since CIBCs landmark issue Canadian covered bond issuers have made themselves at home south of the border, with a total of $10.75bn of US dollar issuance sold between January and July.
"CIBC was a pioneer," says Sarah Kanes, director, global banking and markets, at Royal Bank of Scotland in New York, "not just in terms of exploring the US dollar opportunity, but also for their exclusive use of the CMHC collateral."
Not only did Bank of Montreal, Bank of Nova Scotia and Toronto-Dominion Bank follow CIBC into the US dollar market BNS and TD with debut covered bonds; they have also followed CIBCs example of using cover pools comprising solely CMHC-insured collateral.
Bankers say that the homogeneity of the Canadians offerings helps explain how smoothly absorbed have been the billions of dollars of US targeted supply this year.
"While on the first deal there was a lot of discussion with investors about the offering, they have been able to transfer that knowledge to subsequent issues," says Michael Banchik, head of structured finance for the Americas, at HSBC in New York. "On each deal that has come since then it has been more a discussion of what the collateral is because there was one deal that did not utilise government guaranteed mortgages until we reached the point where its more a question of checking the box that its a CMHC cover pool."
Jerry Marriott, managing director, Canadian structured finance, at DBRS in Toronto, says that investors are justified in considering the cover pools alike."They are pretty homogenous," he says. "With CMHC insurance there is essentially a de facto guarantee of the Canadian government. CMHC is a Crown corporation and their insuring of these mortgages which is a full insurance of principal and interest for the entire amortisation term effectively puts a government guarantee behind the collateral pool.
"That makes for a great story."
Apples and pears
Given the resilience of Canadas economy, market participants are also enthusiastic about the only covered bond programme not to comprise CMHC collateral, that of Royal Bank of Canada.
"We also rate RBCs programme AAA," adds Marriott, for example. "The performance of their conventional residential mortgage assets is still extremely sound and the structure of the programme enhancements addresses the fact that the collateral pool is not insured.
"And that goes to the quality of the underwriting that the Canadian banks have done, as well as how Canadian mortgages have performed relative to mortgages in other jurisdictions."
However, some market participants have suggested that as a result of RBC not offering investors the quasi-sovereign stamp of CMHC, it has not gained so much from issuing covered bonds in the US dollar market, which it did for the first time in April with a $1.5bn five year issue via Barclays Capital, Goldman Sachs and RBC.
"The outlier is RBC," says one. "Their dollar covered bond backed by residential mortgages went well, but testament to having a CMHC insured cover pool is that those issues trade well through RBCs.
"RBC, as a national champion, used to have the US market pretty much to itself, but the CMHC covered bonds have enabled the other Canadian banks to advance over RBC in the US market."
According to the banker, CIBCs five year US dollar issue was trading some 12bp inside RBCs in August. And another banker says that while BNSs five year issue trades some 25bp inside its senior unsecured US dollar debt, RBCs US dollar covered bond in the same maturity has at times traded no tighter than its senior unsecured debt.
David Power, an executive in RBCs treasury department, says that it is too early to judge the relative pricing of different Canadian offerings in the US market.
"Spreads have moved throughout the year, so its not exactly apples to apples," he says. "We did our five year US dollar covered bonds at swaps plus 30bp we were satisfied with the pricing dynamics of that transaction and it compares well with any of the other offerings that have come out in the five year space."
Comparisons are further complicated if one has to factor in the costs of CMHC insurance, which can be confidential and vary from one bank to another. Power also points out that the bank uses its CMHC insured mortgages to raise funding through the CMHC Canada Mortgage Bond programme.
Looking back to October 2007 when RBC launched the first ever Canadian covered bond, Power says that the bank compares its funding levels more with its European counterparts.
"Our benchmark at the time when we were issuing was the European precedents, and thats the basis under which we feel we want to compete," he says. "And under that model its the strength of the mortgage collateral and the issuer name that allows you to position yourself successfully.
"We think that we are very well situated for competing on that basis."
RBC also stands out by being the only bank to have issued covered bonds domestically. The bank opened the local market in October 2009 with a C$750m five year deal and followed that up with a C$850m five year issue in March.
"These transactions were some of the most cost-effective transactions that we have executed in the current environment," says Power. "For example, after you adjust for the currency basis swaps the equivalent euro re-offer levels were about flat to euro swaps, and at the time, in contrast, our euro covered bonds were wide of those levels.
"In addition, we always want to seek to expand our investor base whenever possible and the first transaction did bring in 11 new investors to the RBC name in the fixed income product. And finally, domestic issuance has a positive effect in validating the structure and collateral benefits of our programme, since domestic investors are the most familiar with the Canadian mortgage market and legal environment that supports the covered bond structure."
No other Canadian issuer has yet tapped the domestic market, with some market participants suggesting that the other four big banks have been more focused on their US dollar projects, and others that there could be difficulties in offering CMHC-backed covered bonds in competition with issuance under CMHCs own programmes, such as the Canada Mortgage Bond, in the local currency.
Through the Canadian Bankers Association (CBA), Canadas banks have, however, collectively targeted the government in a bid to have covered bond legislation introduced, and in March they were rewarded by the federal government announcing plans to do so.
RBCs Power, who is also chair of the CBAs covered bond specialist group, says that the move is a "tremendous development".
In April, Quebecs financial regulator, Autorité des marchés financiers, also published a notice relating to covered bond issuance. Jean Blouín, vice president, funding, at Caisse Centrale Desjardins, said shortly afterwards that the Desjardins group Quebecs largest credit union was getting ready to begin work on a covered bond programme."We have seen that RBC (Royal Bank of Canada), for example, is very active in this market," Blouín told The Cover, EuroWeeks sister publication. "They issued in the US and the Canadian markets, as well as the in the European market.
"So it is something that we have to look into deeply, because we have to make sure that we have exactly the same tools as our competitors to make sure that we will achieve good funding at a good price."
Other market participants are also bullish about growth in Canadian issuance.
"We fully expect that if not by the end of the year, then certainly by this time next year there should be more than the current number of Canadian issuers," says DBRSs Marriott, "because they see it as being a viable and valuable funding alternative."