Smaller Canadian banks are likely to be put off pursuing registration as covered bond issuers because of the effort and cost involved as well as a 4% issuance limit, according to DBRS, while new legislation and CMHC’s requirements could also stifle innovation.

Kevin Chiang, DBRS

Based on discussions DBRS has had with several Canadian issuers over the past few months the rating agency considers that these are two “unintended consequences” of the introduction of covered bond legislation in Canada and a Canadian Registered Covered Bond Programs Guide managed by Canada Mortgage & Housing Corporation.

“First, as the requirements for continuous disclosure and data compliance required by the Guide are broad, extensive and, at times, onerous, the amount of time and effort required to comply with the mandated standard is substantial, which is also expected to be costly,” it said last week.

“Therefore, DBRS is of the opinion that lenders other than domestic systemically important banks (DSIBs) are not likely to pursue registration as a covered bond issuer under the legislation, and would therefore be at a disadvantage without the benefit of covered bond funding.”

Canada’s Big Six were identified as DSIBs by the Office of the Superintendent of Financial Institutions (OSFI), the country’s financial regulator, on 26 March: Bank of Montreal, Bank of Nova Scotia, CIBC, National Bank of Canada, Royal Bank of Canada, and Toronto-Dominion Bank.

Kevin Chiang, senior vice president, structured finance at DBRS, told The Covered Bond Report that second tier Canadian banks view as prohibitive the cost – in terms of time, effort and fees – involved in pursuing registration in accordance with the CMHC Guide, in particular given a 4% issuance limit set by OFSI.

“The smaller banks have said that the Guide shuts them out in combination with the limit,” he said, “but that if the limit is increased this could change the economics.”

Canada’s credit centrals will also have to weigh up the costs and benefits of pursuing registration, he added, and decision-making could take longer where the centrals need to get consent of their members, as is the case for Central 1 Credit Union in British Columbia, whose decision-making is less centralised than Caisse Centrale Desjardins du Québec (CCDQ or Desjardins, its trade name), for example.

CCDQ has publicly issued covered bonds twice, while officials at Central 1 Credit Union previously told The CBR that it has been considering covered bonds.

Under new covered bond legislation introduced in Canada in April last year financial institutions cannot sell covered bonds unless they are registered with CMHC, which will administer the new regime and act as registrar.

Given this stipulation, DBRS does not expect there to be any coexistence of registered covered bonds and non-registered covered bonds in Canada, it said, except for existing grandfathered covered bond programmes. In addition, given the requirements prescribed in CMHC’s guide any deviation from or innovation outside the terms of the guide would be limited, if at all possible, it said.

Chiang said that this raises the question of how the Canadian regulator or central bank would view what would amount to innovative structures or instruments, such as commercial mortgage backed covered bonds or commercial backed instruments that are structurally identical to covered bonds.

“The legislation states that you cannot issue covered bonds unless they are registered, and only residential mortgages are allowed as cover assets under the Guide,” he said. “What if a bank issued an instrument identical to a covered bond but not backed by residential mortgages and it didn’t call it a covered bond – how would the central bank or regulator react if a Canadian bank did something like what Commerzbank did with SME loans?”

As a result of the uncertainty over whether the Canadian regulator, central bank or the markets would consider a commercial mortgage backed issue as senior unsecured debt or covered bonds, said DBRS, it is unlikely that issuers would spend any effort developing innovative instruments without clear prior dispensation from the regulator.