Laurentian Bank successfully debuted in covered bonds on Thursday with the first Canadian dollar issue since 2019, and the bank’s treasurer told The CBR that adjustments to OSFI’s limit and Laurentian’s ambition to increase conventional mortgage origination played into its move.

Laurentian Bank of Canada’s entry into the market, with a C$250m (€169m, US$203m) five year covered bond jointly led by Laurentian Bank Securities and RBC Capital Markets, represents an extension of the Canadian market in terms of issuer size – its C$2bn programme compares with C$5.23bn of issuance outstanding from the next smallest issuer, HSBC Canada, while RBC, with the most outstanding, has issued C$66bn.

Sarim Farooqi, senior vice president and treasurer at Laurentian Bank of Canada, said covered bonds are attractive for Laurentian in being the most cost-efficient way to fund conventional (prime uninsured) mortgages, and the onset of the crisis and adjustments to OSFI limits prompted it to take up the funding instrument.

“We had been working on our mortgage process, looking to originate more on the conventional mortgage side,” Farooqi told The CBR, “and we felt the easiest way to deal with the price competitiveness was to get cheaper funding for those mortgages, and covered bonds are the most efficient way to fund them.

“The changes to the OSFI limit then provided us with the occasion to go ahead and set up the programme.”

The Office of the Superintendent of Financial Institutions (OSFI) initially, in May 2019, changed how it calculates covered bond issuance limits in a way that afforded issuers greater flexibility. It then in late March 2020 – shortly after the pandemic hit financial markets – temporarily lifted the issuance limit from 5.5% (assets pledged for covered bonds/total assets) to 10% as long as the extra issuance be used for newly available Bank of Canada repo operations. The previous issuance limit (4% covered bonds issued/total assets) was one of the strictest for covered bond issuers globally, and the 5.5% remains relatively restrictive – the extra headroom to 10% was removed last month.

“For a bank like us with a smaller balance sheet, the upfront cost of setting up the programme are on the higher side relative to the bigger banks with the bigger balance sheets,” said Farooqi (pictured). “Nevertheless, we felt that that the adjustment gave us enough of an incentive to look at this more closely, and as were doing that, the pandemic hit and there was obviously another adjustment in the limit.

“We knew that wasn’t going to last for long, but having worked in financial markets for 20-odd years, one thing we know for sure is that crises come and go, and this programme could become really useful if this type of scenario were ever to happen again, bearing in mind the kind of facilities central banks have been offering during the pandemic. Meanwhile, we can get the programme going with regular issuance.”

Laurentian’s C$250m issue is the first publicly placed Canadian dollar covered bond since Royal Bank of Canada (RBC) sold a C$1.25bn three year floating rate note in June 2019. Although Canadian dollar-denominated covered bonds make up the majority (C$92bn, or 38%) of Canadian outstandings (as of end-March, according to DBRS), the majority of this is retained issuance spurred by last year’s pandemic measures. Only around C$14bn of Canadian dollar covered bonds have been publicly issued, with benchmark issuance in euros and, to a lesser extent, US dollars having historically made up the backbone of supply from Canada’s larger banks.

“To access the European market, ideally you have more size, and you also have to think about the structure of the covered bond,” said Farooqi. “It was easier for us to structure the programme without having the cross-currency component, so we found it a lot easier to think about the Canadian market.

“This was untapped and hence we felt there was room for somebody like us to come in. We felt that there would be good demand for a Canadian dollar covered bond and the deal is absolutely testament to that.”

Laurentian has the lowest senior ratings yet of any Canadian issuer – it is rated A (low) by DBRS, for example, while established issuers’ ratings range from AA (high) for RBC and Toronto-Dominion to A (high) for HSBC Canada. To mitigate this, Laurentian’s is the first Canadian programme where the issuer is not also the swap provider, with RBC instead playing this role. The covered bonds are rated AAA by DBRS.

Laurentian announced it had received approval from Canada Mortgage & Housing Corporation (CMHC) for its programme on 21 April and last week began marketing its debut to investors. According to Andrew Franklin, managing director at RBC Capital Markets – joint bookrunner with Laurentian – the lack of recent Canadian covered bond issuance was no impediment to bringing the new issue to market.

“We haven’t seen a ton of supply in this market,” he said, “but it is a product that the Canadians are familiar with and certainly Laurentian Bank is a name that they buy in a number of other different debt classes.”

The C$250m five transaction was on Thursday priced at 63bp over the Canadian government curve, the tight end of 63bp-65bp guidance, with the books 6.5 times covered and 41 accounts participating.

“A week ago we felt that the pricing might be a little wider,” said Farooqi, “but the momentum in the book allowed us to bring in pricing and hit the tight end of guidance, so it was a great outcome.”

The 63bp spread compares with an estimated 110bp-115bp level at which Laurentian might price a new five year senior unsecured benchmark, according to Farooqi. The pricing was meanwhile equivalent to around mid-swaps plus 20bp in euros.

With Laurentian having become Canada’s ninth covered bond issuer, Equitable Bank is set to make it 10 shortly, with a planned sub-benchmark euro debut. Farooqi said that while he will be watching Equitable’s issue with interest, Laurentian is likely to remain focused on Canadian dollars in the next couple of years.

“If growth comes in higher than expected, we’ve got the capacity to do a little bit more in Canada,” he added. “I don’t think anyone would complain if our deal sizes went to the C$300m-C$400m area or half a billion.

“But if it’s more than that, then we’ve done some homework on the European side and we could look at euros.”

Main photo: Laurentian Bank/Banque Laurentienne, Montreal; Source: Sergio Ortega/Wikimedia Commons