CMHC has registered the first covered bond programmes – for CIBC and RBC – under the country’s new legal framework, a move that paves the way for a resumption of Canadian issuance, while BMO has received SEC approval to issue into the US public market.

CMHC headquarters, Ottawa

The US Securities & Exchange Commission issued a no-action letter to Bank of Montreal yesterday (Wednesday), the same day that CIBC’s and RBC’s programmes were registered with Canada Mortgage & Housing Corp (CMHC).

“Having met the requirements of the programme, CIBC and RBC are now in a position to issue the first covered bonds under the framework,” said Douglas Stewart, interim president and chief executive officer at Canada Mortgage and Housing Corporation. “We expect that other issuers will soon have registered programmes in place.”

A legal framework dedicated to covered bonds was introduced in Canada last year, via amendments to the National Housing Act (NHA), with CMHC responsible for administering the regime and acting as registrar. The CIBC and RBC programmes were registered in accordance with requirements that CMHC unveiled in December.

Royal Bank of Canada’s programme is an amended version of its previous programme, while Canadian Imperial Bank of Commerce appears to have set up a new programme. BMO’s request to issue fully-SEC registered covered bonds also pertains to a new, registered programme, and not its existing Public Sector Covered Bond Programme, which is based on insured mortgages as collateral.

RBC was the only Canadian covered bond issuer whose cover pool was not based on CMHC-insured mortgages, which has since been prohibited as covered bond collateral under the country’s legal framework.

Moody’s yesterday said that the amendments to RBC’s Global Covered Bond Programme do not have a rating impact on the issuer’s covered bonds, and that they are “credit positive despite some negative aspects”. (See below for more.)

Meanwhile, BMO has become the third foreign, and third Canadian, covered bond issuer to receive permission from the SEC to issue fully-registered covered bonds into the US, after RBC last year and Bank of Nova Scotia (BNS) in June. This would allow BMO to access a wider US investor base than that possible via the 144A private placement issuance that has dominated US targeted covered bond supply.

RBC amendments positive, no impact from Alberta floods

According to Moody’s, key amendments to RBC’s covered bond programme include: substitute assets, such as Canadian treasury bonds, limited to comprising no more than 10% of the cover pool; enhanced responsibilities of the asset monitor; inclusion in the asset coverage and amortisation tests, from July 2014, of an indexation methodology to account to movements in property values; and a prohibition on the guarantor holding cash in excess of the amount necessary to meet the guarantor’s payment obligations for an immediately succeeding six month period.

By entering into these and other amendments and becoming registered, RBC’s programme will benefit from the protections of Canada’s covered bond law, which provides legal certainty that the cover pool collateral will be available to pay covered bondholders following an issuer insolvency, said Moody’s.

It said that the protections afforded by the covered bond law as well as the oversight by CMHC are credit positives, as is another feature of the revised programme, namely allowing the guarantor to pay off a demand loan in kind.

According to the rating agency, the demand loan is the portion of the intercompany loan that the guarantor must pay back to the issuer prior to bondholders so long as the asset coverage test is passed. It represents the portion of the cover pool in excess of the required overcollateralisation amount, which is the amount of assets needed to pass the asset coverage test.

Allowing the guarantor to pay back the demand loan in kind is credit positive,” said Moody’s, “because it prevents the need to sell a large number of mortgage loans in the market following an issuer default to pay off the demand loan, which could lower the value of the mortgage loans remaining in the cover pool.”

A credit negative, however, is a limitation on the guarantor’s holding cash in excess of the amount necessary to meet its payment obligations for the immediately succeeding six month period. This is because following an issuer default, the guarantor would have to reinvest excess cash in mortgage loans, which would increase refinancing risk, unless the regulator allowed the guarantor to hold excess cash at that time or bondholders directed the guarantor to override the restriction.

The rating agency also identified negative aspects of the restriction on substitute assets, in that it reduces the flexibility to hold high quality stable investments following an issuer default.

Meanwhile, Fitch yesterday said that catastrophic floods in southern Alberta, Canada, should not negatively affect Canadian covered bonds programmes. Loans on properties located in the region represent 15% of cover pools on average, according to the rating agency.

“Regional lenders have even less exposure to Alberta in their cover pools,” it said. “We believe the Canada Mortgage & Housing Corporation mortgage insurance on the loans is another mitigant.

“Covered bond investors have recourse directly to the issuer, first and foremost, and are not reliant on cashflows generated by the assets until the issuer defaults.”