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Canadian pools

09 May 2019
Richard Kemmish

The only problem with Canadian covered bond issuers is that there aren’t enough of them. Can pooling structures increase the universe of potential issuers?


According to GlobalCapital there are 8 Canadian covered bond issuers. According to Wikipedia there are 316 banks in Canada (technically speaking: banks, credit unions and caisses populaires, but you know what I mean).  What can be done to bring some of the other 308 banks into the covered bond family? Several things.

We could make covered bonds more cost effective for banks. That could be by reducing the upfront costs of an issue – although lawyers and rating agencies don’t offer much in the way of discounts for smaller bond programmes – or by reducing the spread demanded by investors, for example by improving the prudential treatment of their investments – risk weightings, liquidity eligibility, that sort of thing. Reciprocity will likely be one of the conditions demanded by the EU for equivalent treatment for Canadian covered bonds, so there will need to be some form of prudential recognition of covered bonds under Canadian law, might as well be sooner rather than later. 

The best way to make covered bonds in the current model more cost effective though would be to relax the 4% of balance sheet limit on a bank’s total issuance. That would allow the upfront costs to be amortised over more funding. But that’s a topic in its own right, and one that I may have touched on before now….

I said ‘in the current model’ because there could be an alternative – pooling, the combination of lender’s funding needs in covered bonds backed by all of their assets. The covered bond directive’s recognition of the concept, there were two articles dedicated to the topic, was divisive. Some people think that it is one of the many exceptions in the directive for ‘relic’ behaviour in the quirkier countries (namely, Switzerland and Denmark). Others think that it is Commission trying to broaden the covered bond concept to smaller issuers. Which view is right? And could covered bond pooling work in Canada? 

Those who believe that pooling is a cul-de-sac in the history of covered bond structuring point to the decline of the concept in countries such as Austria, France and – most numerically significant – Spain. Others point to its potential to fund the many smaller banks who dominate some of the new countries to come on line. 

Of course, there is no simple answer. Although there are many ways to pool covered bonds – transfer of assets to a central issuer, loans secured on the assets, multiple bonds bundled up – most of the models differ according to structuring details rather than the underlying commercial motive of the trade. And as an ex-structurer (who knows his place) I know that the structuring niceties are of comparatively little importance when the bond hits the screens. Compared to, for example, the issuer, asset quality or over-collateralisation.  

The success or failure of a pooling model for me rests with the commercial relationship between the issuers in the pool. If they are the same banking group then pooling is a minor structuring convenience. This seems to be the idea at the heart of the directive’s logic and, for example, the use of the concept in Denmark.

If they are competing and differing banks then pooling is very difficult to establish – the first time I ever heard the expression ‘herding cats’ was in this context - and quite difficult to rationalise after their establishment – joint and several liability is indefensible for pure rivals, the structure fails without it.

The interesting middle ground is when potential issuers are not in the same group, but not exactly rivals. Small banks with clearly defined regional responsibilities who already share common services, local sparebanken in Norway or Caixa in Spain before the crisis for example.

If there is enough common ground between issuers then the commercial objections can be overcome and the use of pooling becomes a purely technical problem.

Does this apply in Canada? I don’t know, but I’d be interested to learn more in the Euromoney North America Covered Bond Forum next month. 

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