Written by 8:12 PM Government and Regulation • 18 Comments Views: 0

Waiting on Covered Bond Legislation

[ File # csp0156170, License # 1274184 ] Licensed through http://www.canstockphoto.com in accordance with the End User License Agreement (http://www.canstockphoto.com/legal.php) (c) Can Stock Photo Inc. / webkingCovered bonds have been an important and fast-growing method of funding mortgages.

In simple terms, covered bonds provide a way for large lenders to raise money, which can then be lent out.

This relatively new liquidity source can translate into lower mortgage funding costs, and those savings can theoretically be passed on to consumers in the form of lower mortgage rates.

Two years ago, the government announced a new “legislative framework” for covered bonds. The goal was to increase their appeal to institutional investors and create a sounder and more regulated market. Many expected details of that framework to be unveiled in the March 29 federal budget, but that didn’t happen.

When the government finally does roll out the new covered bond regulations, the first thing analysts will look for is whether insured mortgages are allowed as collateral. That’s been the case thus far, but many predict the government will ban the practice. This would raise costs for lenders (and borrowers) but reduce the government’s risk exposure to default insurance.

Fortunately, any such cost increase would likely be modest, at least for top-rated issuers (lenders).

“Estimates of the additional cost of uninsured versus insured mortgages in covered bonds range from a low of 10 basis points to a high of 20 basis points,” said Canaccord Genuity analyst Mario Mendonca. (Source: Globe & Mail)

Big-Banks“Applying 20 basis points for conservatism, we estimate that the additional cost to the industry would be only $120-million or 0.7 per cent of domestic retail pretax income over the last 12 months.”

Besides the collateral questions, industry folks also want to know how CMHC will operate in its newly-announced role as administrator of the federal covered bond program.

The Finance Department says a more robust covered bond market will provide a funding source for “federally and provincially regulated mortgage lenders.” Right now, only seven of the country’s biggest lenders have the ability to issue cost-effective covered bonds.

Will CMHC’s involvement somehow improve the ability of smaller lenders to tap this important market? We’re not optimistic of that, but we’ll likely see more details of the government’s plan later this year.


Sidebar:  Despite conventional mortgages being the dominant form of covered bond collateral, these securities can provide a funding method for high-ratio mortgages as well.

Last month, Desjardins issued covered bonds backed by mortgages with an average loan-to-value of 91.2%. That’s the highest LTV we recall seeing in a Canadian cover pool, which shows the growing flexibility of our covered bond market.


Rob McLister, CMT

Visited 1 times, 1 visit(s) today

Last modified: April 29, 2014

Canada’s preeminent mortgage information resource.

Close