LONDON, May 1 (IFR) - New collateral requirements will open
Canada's bank-issued covered bonds to international investors,
who have steered clear of the country's bank debt up until now.
Without a legal framework in place, many international
investors have been effectively blocked from participating in
covered bond programmes, which began in Canada in 2007.
But the new legislation should open the doors to outside
investment, even though it bans banks from using
government-guaranteed mortgages as collateral for covered bonds.
"The new legislation will add an extra layer of protection
and comfort for conservative investors that have been unable to
buy into Canadian covered bonds up until now," said Ted Lord,
managing director and head of European covered bonds at
The changes to the National Housing Act will require 10%
overcollateralisation for covered bonds, which in Canada can
only be issued by banks and the Canada Housing Trust.
The legislation comes as the Canadian government tries to
get to grips with a sky-rocketing property market that has seen
prices triple in some parts of the country.
"The proposed changes should increase housing finance costs
and decrease housing credit availability," said analysts at RBS.
"The change should increase residential mortgage funding
costs. Canadian banks will likely have to pay more to investors
to accept an uninsured collateral pool, and could have to
provide more assets to the collateral to achieve the desired
The legislation, introduced last week, will also see the
Canada Mortgage and Housing Corporation (CMHC) take
responsibility for administering the new framework.
A wide range of investors have shown interest in the
country's covered bonds, due to their Triple A rating and the
underlying guaranteed mortgages, which make the bonds seem more
like sovereign debt than bank debt.
But Canadian banks have had limited scope on such funding,
as a number of institutional investor accounts require their
bond investments to be under some kind of legal legislative
In the past, Canadian banks issued covered bonds under a
contractual framework that involved a bank establishing a
covered bond programme, creating a cover pool and selling assets
into that pool.
The cover assets were then sold to a bankruptcy remote
entity - a special purpose vehicle which investors have priority
While the new legislation is ultimately expected to make the
covered bond market more solid, the removal of CMHC mortgages as
possible collateral marks a sea change for the sector.
The majority of Canadian covered bond issuance over the past
two years has had collateral pools backed by those mortgages.
Along with the requirement for the country's banks to stump
up the overcollateral, the changes are expected to drive up the
banks' cost of funding by around 10bp.
Analysts at Fitch said the exclusion of insured mortgages is
likely to increase the cost of future issuance via higher credit
"This measure may also cause a contraction in credit
availability, which has the potential to negatively affect home
prices," they said.
With most of Canada's banks currently in a pre-earnings
funding blackout period in May, it will be some weeks before we
know if the changes ultimately shrink or grow the covered bond
Covered bonds currently represent only a small portion of
funding for Canadian banks, as they are limited to 4% of total
assets, and some institutions are already near the cap.
Canadian banks ramped up issuance earlier in the year when
reports of the new legislation first emerged, and covered bond
issuance is already at CAD12.4bn year-to-date, compared with
CAD22bn for all of 2011.
But one thing seems clear: investors are likely to be more
discerning now that the guaranteed collateral has been removed,
meaning it may be more difficult for riskier issuers to get the
"For those issuers that have demonstrated a strong business
performance throughout the financial crisis, there should be
little change in funding costs. For those that have a more
volatile earnings stream, there could be a slight change,
although Canadian banks are generally favoured by investors
globally," said Lord.