08/03/2012

Canada Experiencing Covered-Bond Drought

Buyers of Canadian covered bonds can expect a recent issuance drought to continue through yearend.

That’s because covered-bond legislation that Parliament passed in June isn’t expected to be implemented until late in the fourth quarter — and the process could drag on into next year. Meanwhile, Canadian regulators have made it clear that banks should suspend their issuance programs until a regulatory framework is in place.

The upshot: After issuing more than $13 billion of covered bonds in the first half, Canadian banks will remain on the sidelines at least through yearend. The last deal priced May 7, when Scotiabank sold $250 million of bonds.

The outlook marks a drastic shift from a few months ago, when investors were anticipating a flood of fresh deals from Canada. Those expectations stemmed from a covered-bond bill that finance minister Jim Flaherty inserted into an omnibus measure called the Jobs, Growth and Long-Term Prosperity Act on April 26. To the surprise of many, the bill would prohibit Canadian banks from including government-insured mortgages in their deals’ asset pools — despite the fact that guaranteed loans have backed all but a few of the nation’s covered-bond deals to date.

Soon after the bill was introduced, banks sped up their issuance plans with the idea of stuffing the cover pools with as many insured loans as possible before the law took effect. Then regulators put the word out that they didn’t want to see any more covered-bond deals until new rules could be written and implemented.

Industry players initially were led to believe that a covered-bond protocol would be in place in September. More recently, word has spread that the Canadian Mortgage Housing Corp. won’t complete the rule-making process until late this year or early next year. Frustrated by the delay, institutions including Bank of Montreal, Scotiabank and Toronto-Dominion Bank have been quietly lobbying Department of Finance Canada to light a fire under the mortgage agency.

“The banks don’t want to cross swords with the regulator but are politely nudging for a resolution,” a Canadian banker said. “The banks are being locked out of an attractive funding source.”

Although Canadian banks have been issuing covered bonds for five years, the new law will allow them to market their offerings to wider audiences — including institutions that invest only in regulated markets. Last year, Canada was the source of C$24.7 billion ($24 billion) of covered bonds, most of which was distributed to investors in the U.S. Heading into this year, market forecasters expected even higher issuance volume. But that was before regulators told banks to hold off on their deals.

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