Canadian Parliament proposed
legislation on March 29 that would create a statutory
framework for investment in covered bonds, and enable
previously-restricted international investors to purchase
shares in the collateralised pools. But excess demand and a
flurry of bank exits could follow.
Canadian covered bonds are currently issued on a contractual
basis, in which a bank sells assets into a covered bonds pool.
This is owned by a special purpose vehicle that guarantees the
But regulated financial institutions are not allowed to
issue covered bonds greater than four percent of regulated
assets, limiting growth in the market.
The new framework would incur greater costs for banks
issuing the product.
Issuers would be required to register with the Canada
Mortgage and Housing Corporation (CMHC), for example. And while
the CMHC will not be setting overcollateralization limits,
issuers will have to disclose to the registrar the minimum and
maximum ratio of total covered bonds in relation to the total
assets backing the bonds.
Banks who choose to register as a covered bond issuer,
despite the cost of uninsured collateral, would also have to
unwind any other bond issuing programs in accordance with the
The outstanding amount of insured mortgages is not to breach
$600 billion as required by the National Housing Act (NHA). The
close to hitting that ceiling. And it is expected that some
will drop out of the market if insured mortgages - the primary
asset in covered bond pools - are restricted from use as
collateral in accordance with the law.
The amount of CMHC insurance currently stands over
$560 billion, Torys partner Michael Feldman said.
CMHC is quickly running out of room.
It is unclear if non-insured mortgages will be able to fill
the void. According to a consultation
paper released by Canadas Department of Finance last
year, using uninsured mortgages as collateral can, in the
longer term, reduce reliance on government-backed mortgage
insurance and also improve the liquidity of uninsured
But James Lisson, counsel at Fasken Martineau said that in
instances of higher stress, uninsured mortgages would be more
exposed than insured mortgages. Covered bonds will be
more expensive to issue as a result, and a higher cost of
funding for the Canadian banks, he said.
Feldman said the limits on the CMHC mortgage insurance and
ability to fund the NHA mortgage-backed securities program
would start to lead to an increase in mortgage interest rates.
I think thats what the government wants to see
happen, he said.
[Collateral] would be uninsured residential
mortgages, he said. Whether banks continue to have
a covered bond programme is debatable.
While others predicted that as covered bonds and other
insurance backed mortgage financing become more limited, the
Canadian market could see the return of reverse mortgage backed
International investors have previously not purchased
contractually issued covered bonds because of regulatory
restrictions in their jurisdiction or hesitance over a market
without legislative structure.
In Canada there is this refinancing risk in the
mortgage market which Canadian institutions are very
comfortable with, Feldman said. International
investors look at that as higher default risk, but in practice
you have one of the lowest mortgage default rates.
Covered bond issuances totaled roughly $60 billion compared
to the $170 billion of outstanding Canada mortgage bonds in
2010, and insured mortgages can still be securitised through
Canadas National Housing Act Mortgage-Backed Securities
(NHA MBS) program.