Equitable Bank is set to launch a three year sub-benchmark debut covered bond next week, after announcing the mandate yesterday (Monday), with the maturity, size and double-A ratings expected to position the Canadian issue in unique spread territory in euros.

Barclays and TD are global structuring coordinators, and also joint lead managers alongside DZ, LBBW and Scotiabank (passive) for the new issue, which is expected to be a €250m-€350m three year.

The bank in July received approval from Canada Mortgage & Housing Corporation (CMHC) for its C$2bn (€1.34bn, US$1.56bn) legislative covered bond programme, the 10th from the country.

According to an investor presentation, the issuer sees the covered bond programme as a “cornerstone” of its funding diversification strategy, and the debut issue is planned as the first of regular covered bond issuances.

Equitable’s deal will be the first sub-benchmark from Canada and the first without triple-A ratings – it has expected ratings of AA/AA from Fitch and DBRS.

Price discovery for the new issue is therefore expected to be challenging, according to analysts and syndicate bankers.

“Given that Canadian issuers do not have any euro sub-benchmark covered bonds outstanding, and moreover, all other Canadian covered bonds benefit from a triple-A rating, we need to correct for a one notch lower rating and the sub-benchmark character,” said Joost Beaumont, senior fixed income strategist at ABN Amro.

He estimated fair value in the mid to high teens, putting it in the same area as an inaugural C$250m five year covered bond issued by Laurentian Bank in April that is currently quoted at the equivalent of around mid-swaps plus 17bp in euros – although longer dated, that transaction is higher rated, Beaumont noted. Such a spread would offer a double-digit pick-up versus Canadian benchmark covered bonds.

A syndicate banker at one of the leads acknowledged such pricing considerations, but also noted that technicals – notably the prevailing supply/demand imbalance in covered bonds – should prove supportive.

“It’s sort of early days,” he said. “Let’s see what the eventual outcome of this will be, but it’s definitely going to leave something in addition on the table.”

The sub-benchmark will also offer a very rare three year maturity in euros: no three year euro benchmark has been launched since a series of Canadian trades in the three year part of the curve at the height of Covid’s impact on financial markets in March and April 2020.

Equitable is rated BBB- by Fitch (issuer default rating) and BBB by DBRS (issuer rating).

Under Fitch’s covered bond rating methodology, Equitable does not benefit from any notches of resolution uplift, since the bank is not a domestically systemically important bank (D-SIB) and as such is not part of Canada’s bail-in regime.

The programme is eligible for six notches of payment continuity uplift (PCU) and two notches of recovery uplift, but Fitch noted that a committed asset percentage (AP) of 90.9% (equivalent to 10% overcollateralisation) does not sustain its AA+ stresses, but is satisfactory for AA, so only one notch of recovery uplift is assigned. The programme hence has one unused notch of rating uplift.

Equitable is a market leader in alternative mortgage lending in Canada. DBRS noted that the assets in the cover pool might not meet the criteria of the large Canadian banks, but are from Equitable’s alternative single-family lending, which includes loans to self-employed and other customers that meet its underwriting standards and also Office of the Superintendent of Financial Institutions (OSFI) requirements on sound mortgage underwriting (B-20 guideline).

“Over the years, OSFI has taken various steps to tighten mortgage underwriting guidelines,” said DBRS, “and as a result, the credit quality of alternative mortgage originations has improved as borrowers who were previously considered prime have entered the alternative market.”