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Record start to covered bonds sales leads way for Canada’s banks

Looking up from the southwest corner of King Street West and Bay Street on March 30, 2015.

Fred Lum/The Globe and Mail

Canadian banks started their 2017 funding programs by selling a record amount of bonds backed by residential mortgages abroad, taking advantage of lower borrowing costs amid demand for their top-rated debt.

The country's biggest financial institutions have sold about $6-billion in covered bonds denominated in euros, U.S. dollars and pounds this year, the most on record for a year through Jan. 9.

Bank of Montreal and Toronto-Dominion Bank have issued the most, with a $1.75-billion deal each, followed by a €1.25-billion euro ($1.32-billion) sale from the Bank of Nova Scotia, according to data compiled by Bloomberg.

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"It's a sound economy, a sound housing market still, and good credit quality of the banking sector itself," Joost Beaumont, senior fixed-income strategist at ABN Amro Bank NV, said by phone from Amsterdam. Canadian issuers are drawn to Europe by interest rates that are still relatively low, and ahead of possible market risks posed by upcoming European elections, he said.

Canadian banks are continuing their trend of looking outside the domestic market for lower borrowing costs and diversified funding sources, issuing nearly €28-billion in covered bonds last year across multiple markets. Canadian financials will issue about €12-billion of covered bonds in the European market this year, in line with last year's sales, due to caps on the amount of covered bonds they can issue, Beaumont said.

Toronto-Dominion is Canada's top-rated bank by Moody's Investors Service with a Aa1 rating, one notch below the highest rating, and the remaining big five banks are all rated two steps lower.

Most 'Bang'

Covered bonds are attractive to foreign investors because they offer recourse to both the highly rated issuing bank and the underlying pool of mortgage assets, Kris Somers, a fixed-income analyst at Bank of Montreal's BMO Capital Markets, said by phone from Toronto.

The extra yield over government debt demanded by investors to hold the bonds averages 58 basis points, the narrowest of the issuers on the U.S. Covered Bond index, according to Bank of America Merrill Lynch data. The spread for Canadian bonds in the euro market is 61 basis points, compared with the 63-basis point average, according to the data.

"They get the most bang for their buck outside of Canada for these secured instruments," Altaf Nanji, managing director Canadian fixed income at Manulife Asset Management Ltd., said from Toronto. "Canadian investors appear just as happy to buy unsecured debt and take the extra spread."

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But that may change this year as details of the bail-in regime for banks are unveiled, Somers said.

"If a bank falls apart, the unsecured debt gets converted to equity, but this stuff would not," he said, expressing BMO's expectations for the regulations that have yet to be finalized. If the covered bonds remained senior on the capital structure, meaning they were more likely to be paid off in case of bankruptcy, they would be more attractive to domestic investors, he said. Canadian banks sold about $4.5-billion (Canadian) of covered-bond debt denominated in Canadian dollars last year, according to Bloomberg data.

"We think there could be more covered bonds issued domestically over the near to medium term," he said.

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