NEW YORK, Sept 13 (IFR) - Royal Bank of Canada on Wednesday proved that the torturous process of registering a covered bond issue with the SEC actually pays off in the form of spread savings.
Covered bonds are securities that are backed by a pool of loans, usually mortgages or public sector loans.
The bank’s US$2.5bn 1.2% 2017 covered bond was priced at 35 basis points (bp) over mid-swap levels, making it not only the first ever SEC-registered US dollar covered bond, but also the first deal issued since Canadian legislation removed Canadian banks’ ability to use government guaranteed mortgages as collateral.
The deal’s 35bp spread compares with an equivalent trading level of around 28bp for Bank of Nova Scotia’s 1.75% March 2017s, which has collateral backed by the Canadian government’s housing agency, the CMHC.
Considering Bank of Nova Scotia would have to pay a spread in the low 30s for a new deal with guaranteed mortgages, the 35bp spread for RBS’s SEC registered deal implies a good saving.
RBC’s only other US dollar unguaranteed covered, the 3.125% April 2015s, has traded about 10bp back of deals like Nova Scotia‘s.
RBC’s Ben Colice, head of covered bond origination, attributed the tighter spread on the new deal to the fact that SEC registration naturally expands the number of investors who can participate.
“We saw new investors come into the asset class for the first time,” he said. “They were enthusiastic about the transaction being index eligible, providing increased price transparency via TRACE and the expectation of improved liquidity, so many of the benefits of SEC registration that we had hoped for came to fruition.”
Although it was difficult to determine how much of the savings was due to the SEC and how much to a red-hot market starved of Canadian covered supply since March, even a senior banker away from the deal acknowledged that “clearly there is some value to registering with the SEC.”
But so there should be, given the time and effort RBC put into getting the SEC registration. It took at least six months to go through the process of getting SEC approval, was significantly more expensive than going the Rule 144A route all other issuers have taken in the US covered market, and required significantly more disclosure.
RBC has never used government-guaranteed mortgages as collateral, which has meant it has always paid more than other Canadian banks for mortgage-backed issuance.
Going forward, however, all Canadian banks will have to use non-guaranteed mortgages as collateral. The RBC deal is an important pricing reference for Canadian banks determining whether they should continue issuing covered bonds and whether it makes sense to go the SEC registration route to reduce the launch spread.
Even doing covereds of any description is open to debate by Canadian banks, now that the spread difference between issuing a Triple-A covered and an unsecured plain vanilla bond has shrunk.
“Although an SEC-registered offering is a good fact pattern to have in the market, Canadian covered bond spread levels are now so close to unsecured levels that Canadian banks will still go through the debate of whether they are being appropriately compensated for the secured nature of the product,” said Dan Mead, head of Financial Institutions Group syndicate at Bank of America Merrill Lynch.
Yet covered spreads would presumably continue tightening the more issuers go the SEC route and draw in ever greater numbers of new investors.
Covered bonds in the US are usually bought by ‘rate’ investors - those that typically buy only triple-A paper, like US Treasuries and deals by agencies like Fannie Mae and Freddie Mac.
However, more traditional corporate bond investors are starting to look at covered bonds as a safe haven asset class, offering some protection against a sharp plunge in the unsecured corporate bond markets if or when US Treasury rates start backing up again.
“The spread is tight but this is the kind of bond you should buy,” said one investment grade corporate bond investor of the RBC deal.
“If you do see a back-up in spreads or Treasury yields I think there will be liquidity in this deal because it will represent something of a safe harbor for investors.”
Almost 200 investors with about US$6bn came into the RBC order book. Most were rate investors but an encouraging portion were corporate bond investors. Some came from the asset-backed securities markets as well as some European accounts that know the asset class well in euros and were attracted by the index eligibility and trading transparency the SEC registration provided.
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