Canadian issuers are working on setting up new programmes and weighing up prospectus options, according to funding officials, with several factors influencing the timing of their return to market after an absence prompted by a new legislative framework.

Financial district, Toronto

Except for Royal Bank of Canada, whose programme is not backed by CMHC-insured mortgages, Canadian covered bond issuers have been absent from the market for a year, with a US$2.75bn (C$2.81bn) dual tranche transaction for Bank of Nova Scotia on 15 March 2012 the last deal to have been priced. This is because legislation was implemented in June last year that prohibited the use of insured mortgages as collateral and, among other provisions, mandated Canada Mortgage & Housing Corp (CMHC) to establish a registry of covered bond issuers, with the latter releasing related guidelines in December.

According to Aaron Palmer and Mark Selick, partners at law firm Blake Cassels & Graydon in Toronto, the prohibitions against the issuance of covered bonds outside the new legislative covered bond regime by Canadian banks and other federal financial institutions are not yet in force, and will become effective on such day or days as may be fixed by ministerial order.

However, issuers are working on setting up new programmes that satisfy the legislative requirements and the requirements of the CMHC guide.

Andrew Fleming, senior partner at Norton Rose in Toronto, says that although issuers could amend existing programmes, this would probably negatively affect their ratings given the shift from insured to uninsured collateral, and that, except for RBC, issuers will be “starting from scratch”.

This has implications for when Canadian issuance will resume, which could still be some time in coming.

“It’s a fairly involved process to get a new programme up and running,” says Paras Jhaveri, director, corporate funding at Bank of Montreal. “I think the summer is a possibility in terms of establishing a programme, but exact timing is dependent on a number of factors.”

“We are supportive of the development of covered bond legislation, and see it as a natural step forward that will be helpful in growing the market,” he adds. “However, the collateral eligibility and other requirements under the legislation require most issuers to establish new programmes, which is why there is this thinking about timelines.”

Wojtek Niebrzydowski, vice president, treasury at CIBC, said that it will take some time to establish a programme that complies with CMHC’s guide and that he is working towards a date “but it’s not a few weeks away”.

“The new framework is a positive step on the one hand but on the other is has effectively shut down market access for a year,” he says, “as we work to make sure the infrastructure is in place and compliant, including new programme documentation and hiring all the required counterparties, such as a custodian, which was not required for the old programmes.

“I would expect new programmes to be ready in the second half of the year, but it is not impossible that someone goes ahead earlier than that although I don’t know who that would be.”

The prohibition on insured collateral leaves issuers with fewer assets to use as collateral so the time that it will take to set up new programmes is also valuable for some to allow their asset base to grow, although the availability of non-insured residential mortgage assets is not an issue for all, in particular given a 4% cap on issuance relative to total assets.

According to a Moody’s report, based on data effective 31 October 2012 sourced from the Office of Superintendent of Financial Institutions (OSFI), RBC has C$111.6bn of uninsured mortgages, Bank of Nova Scotia C$63.3bn, TD C$36.9bn, CIBC C$36.1bn, Bank of Montreal C$28.7bn and National Bank of Canada C$10.1bn. The rating agency said that CIBC is the highest user of insurance (76% of its mortgage book) and RBC the lowest (43%).

All Canadian mortgages over 80% LTV at origination are required by regulation to be insured, but according to Moody’s uninsured mortgages have a modest average current loan-to-value in the low 50% range.

Documentation decisions

Many issuers are taking advantage of the transition to new requirements to consider the issuance formats they use to access the US market, which has been their staple market for several years given less attractive pricing available in euros.

Apart from Royal Bank of Canada, which last year pioneered full SEC registration for covered bonds, Canadian issuers have sold US dollar covered bonds in the 144A private placement format, but many are exploring other options.

Peter Walker, TD

“We are evaluating options and leaning towards SEC registration rather than 3(a)(2),” says Peter Walker, associate vice president, TD Bank Group. “At this stage we are not yet in a position to issue, and we want to be measured in our approach to make sure we are getting things right.”

One of the decisions facing any issuer, according to Walker, is whether to refile a programme for euro issuance with the UK Listing Authority in line with the Prospectus Directive, and off which it can also launch 144A US dollar issuance, or to focus on a form of US offering document.

Rule 144A issuance can only attract qualified institutional buyers (QIBs), which may also have limits on their exposure to non-fully SEC registered bonds, and 144A covered bonds are also not eligible for the leading Barclays Capital US Aggregate Index. Issuance in 3(a)(2) format, like fully-SEC registered deals, would be eligible for the index, thereby opening up a larger investor base.

Fleming at Norton Rose says that Canadian issuers will be weighing up whether they want to make a UK Listing Authority (UKLA) prospectus their base document or “bite the bullet” and file a SEC registration statement and prospectus, which they could then use as the basis for a UKLA prospectus.

“The approach to date has been to use the UKLA filing as a base document, even going into the US,” he says, “although with changes to the Prospectus Directive the ULKA route is no longer necessarily seen as the most attractive one.”

Jhaveri at Bank of Montreal says that weighing the benefits of issuance in 3(a)(2) or full SEC registered format is “absolutely one of the considerations” as the issuer goes through the process of setting up a new programme.

“We see merits in the public format – the bank already has an existing SEC registered debt programme,” he says, adding that the timeline for the issuer to be in a position to issue will partly depend on the regulatory process associated with the offering format selected.

CIBC is also considering 3(a)(2) or SEC registration, according to Niebrzydowski.

‘Substantial’ CMHC requirements

The covered bond guide released by CMHC in December describes a “comprehensive” application process for registration of programmes, say Palmer and Selick at Blake, Cassels & Graydon. This can take place once an issuer is itself registered, after having met the necessary requirements, with CMHC mandated to establish the registry.

“The guide also imposes numerous requirements on covered bond programmes that in large part codify the provisions set out in existing contractual (non-legislative) covered bond programme documents but also introduces many important new requirements,” say the lawyers.

Fleming at Norton Rose says that a requirement, effective 2014, to mark-to-market the collateral in the cover pool is one of the areas where the guide goes beyond existing practice.

“No Canadian issuer has done that before, which is why they are allowing a transition period,” he says.

Rating agency DBRS previously noted that the CMHC guide is positive, and that it expects implementation of the guide and the covered bond registry to increase the global investor base for Canadian covered bonds and improve the liquidity of Canadian covered bonds globally.

According to Palmer and Selick at Blake, Cassels & Graydon, the Canadian ministry of finance is empowered to make regulations to carry out the purposes of the provisions of the covered bonds regime, but it appears that no regulations will be adopted at this time.

“Instead, CMHC’s guide provides a comprehensive set of requirements that must be satisfied in order for an issuer and its covered bond programme(s) to qualify for registration,” they said.