5 Min Read
* Canada to unlock international market for covered bonds
* Asian investors open up, others to raise allocations
* Analysts, rating agencies say investors better protected
By Aimee Donnellan
LONDON, Dec 21 (IFR) - Canada's covered bond market will be open to a broader range of international investors in 2013 after sweeping changes to the legal framework for the sale of those securities.
The long-awaited legislation, which offers investors more certainty about the cover pool in the event of a default, is expected to give the sector a huge boost in demand.
"More covered bond investors, particularly in Asia, the Middle East, and Europe, can now move forward with Canadian covered bonds for investment," one banker said.
"These significant investors were precluded previously from purchasing covered bonds without a legal framework."
The Canada Mortgage and Housing Corporation (CMHC) this week announced the details of the framework, under which only banks with registered covered bond programmes can sell covered bonds.
Moody's said that investors will benefit from the new rules requiring issuers to detail cover pool data, undergo tests to protect against credit risks and employ an independent asset monitor to oversee compliance with collateral requirements.
The framework also outlines an 80% loan to value (LTV) limit regarding cover pool mortgage loans, house price indexing and liquidity tests.
"The legal framework seems very detailed and strong but public offering documents will continue to be crucial," said Bernd Volk, head of covered bond research at Deutsche Bank.
Canadian banks have previously 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 over which investors have priority claim.
Under the previous scheme, many international investors were effectively blocked from Canadian covered bonds despite their top-notch Triple A ratings.
Other investors, meanwhile, had restrictions on the amounts they could buy.
One Asian central bank has already approved Canadian covered bonds for investment for the first time, in anticipation of the new legislation, according to a market source.
The source said that the new covered bond law will enable German insurance companies to increase allocation to 15% from 5% in registered covered bonds issued by Canada's banks.
Canada is one of the last few remaining Triple A countries following a raft of sovereign downgrades during the financial crisis. Its top rating - and the fact that its underlying mortgages were previously guaranteed by the Canadian government (CMHC) - meant that the country's bank debt traded more like sovereign debt.
"The new covered bond legislation could widen the investor demand globally, even if CMHC-insured mortgages no longer will qualify for the cover pool," the banker said.
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.
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 and the barring of the country's banks from using government-insured loans 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.
Moody's warned it could cut its ratings on five top Canadian banks on concerns about a softening economy and volatile capital markets, a blow to a banking system named the soundest in the world four years in a row.
Back in June, when CMHC first announced it was seeking to introduce the new legislation, analysts at RBS said the proposed changes would decrease housing credit availability.
"The change should increase residential mortgage funding costs," the RBS analysts said.
"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 credit rating."