Covered bonds are to be offered to US retail and secondary
investors for the first time, following a Securities &
Exchange Commission (SEC)
no-action letter sent to Royal Bank of Canada (RBC) on May
RBC’s $12 billion cross-border covered bond
offering are the first to be registered with the SEC, under the
US Securities Act. They are also distinctive in using as
collateral underlying mortgages which are not insured by Canada
Mortgage and Housing Corporation (CMHC) unlike covered bonds
issued by most other banks.
Covered bond issuances are carried out on a contractual
basis in Canada, with banks selling underlying mortgage loans
to a subsidiary special purpose vehicle (SPV) that guarantees
the bonds. Both the guarantee and the bond have to be
registered with the SEC under the Securities Act, making it
difficult to rely on shelf registration as a foreign private
issuer under form F-3.
A Canadian bank that has issued securities in the US can
qualify for shelf registration but an SPV guarantor cannot
because it is not a wholly-owned subsidiary of the bank and has
not been reporting annual and quarterly reports with the SEC
under form F-1. This is why a no-action letter was needed.
Issuers were initially put off by the amount of time and
expense involved in getting a no-action letter, with a lot of
uncertainty as to whether or not it would be successful.
But Lawton Camp, a partner with Allen & Overy who acted
for the underwriters, said RBC was willing to put in the time
to get it done.
Jerry Marlatt, a partner with Morrison & Foerster who
represented RBC in the
registration of the securities said selling covered bonds
was similar to selling medium term notes. "You take advantage
of market opportunities and you come to market as quickly as
you can," he said.
The SEC allowed shelf registration for the guarantor under
the condition that the guarantor provide monthly reports to
investors and annual reports to the SEC. While the disclosure
requirements are similar to those of asset backed securities
under regulation AB, the SEC made it clear the covered bonds
are not to be considered asset backed securities.
"The SEC took the view that a covered bond is a package of a
bond and a guarantee that was half way in between a corporate
bond and an asset backed security," Marlatt said. "What
they’ve done is try to put together a set of
disclosure guidelines that cover this hybrid kind of
The cover pool of mortgage loans acts as the covered bond
collateral and secures the SPV’s guarantee. This
means covered bond investors are not subject to default risk on
"That’s why it’s not like asset
backed securities," Marlatt said. "Collections on the mortgage
loans don’t go to pay investors; instead the
collections are used to buy new mortgage loans to replace the
ones they are paying down."
It is hoped the deal will prompt more Canadian covered bond
Camp believed issuers that currently file on form F-3 would
be the first movers. "If the market starts to move towards
having a clear prejudice for those deals that are registered, I
expect others will feel the need to follow," he said.
There is not yet a legislative framework governing Canadian
covered bond issuances. But Canadian Parliament recent proposed
a legal framework for covered bonds, which would also restrict
the use of insured mortgages as collateral. If enacted,
Canadian banks will have to set up new covered bond programs.
Excess demand and a flurry of bank exits could follow.
Canadian banks are therefore expected to view this offering
as a model in the use of uninsured mortgages as underlying
"It is expected that in Canada most of the CMHC insured
programs will go into wind-down mode," Camp said. "New programs
will be established with assets that are not CMHC insured."
Until now all covered bond offerings in the US have relied
on a registration exemption under Rule 144a of the Securities
Act. Rule 144a covered bonds can only be sold to qualified
Marlatt said the market for covered bonds in the US issued
under rule 144A is beginning to tap out because there are only
so many qualified institutional investors and some of them have
a limited capacity to buy unregistered 144A securities.
"It’s a lot of work, a lot of time and
dedication. It makes less sense when the market is just
starting. The more mature the market gets the more sense it
makes [to register covered bonds with the SEC.]"