BMO Sells $2 Billion U.S. Dollar-Denominated Covered Bond

Bank of Montreal (BMO) has priced a five-year, US $2 billion covered bond (June 2), becoming the third Canadian bank to issue a covered bond that is denominated in U.S. dollars (rather than the euro or other currencies).

Pricing was reportedly at 72.3 basis points over comparable U.S. Treasuries.

"This issue is an attractive complement to high-grade credit portfolios," Dow Jones quotes an interested portfolio manager (from Dwight Asset Management) as saying.

BMO's main branch in MontrealThe BMO USD covered bond (CB) follows a US $2 billion CB issue by Canadian Imperial Bank of Commerce (CIBC) in January of this year and a US $1.5 billion issue by Royal Bank of Canada (RBC) in April.

The CIBC and RBC USD offerings were both sold primarily to U.S. institutional investors, with clear success.  BMO's USD issue also is expected to target the U.S. investment community.

Like the BMO issue, the CIBC and RBC CB issues were both backed by residential mortgages.  The mortgages in the BMO cover pool — like those for the CIBC USD issue — are insured by the Canada Mortgage and Housing Corporation (CMHC), which effectively amounts to a government guarantee.  BMO tightened the terms of its covered bond program in December 2009 to require that all loans must be CMHC insured, according to Moody's Investors Service.

BMO's initial entry into covered bonds was in January 2008, when it issued a euro-denominated CB in the amount of  €1 billion (US $1.225 billion).   But RBC and CIBC have been far more active, including an issue by CIBC in Swiss Francs and one by RBC in Canadian dollars.

The flipside is that BMO has substantial room to grow its covered bond issuance before hitting the cap of 4% of total assets imposed by Canada's Office of the Superintendent of Financial Institutions (OSFI).  As of Oct. 31, 2009, BMO could potentially issue more than C$12.5 billion (US $12.05+ billion) in additional covered bonds before hitting the cap, according an analysis by DBRS.

Of the four U.S. dollar-denominated covered bonds to hit the market this year, three have been from Canadian issuers (including BMO's entry).  The fourth was from France's France's Compagnie de Financement Foncier (CFF), which priced a debut US $2 billion CB on April 15.

No U.S. financial institution has issued a covered bond since 2008, although a bill that would provide a comprehensive U.S. legal framework for CBs was introduced in Congress on March 18.

Covered bonds are dual-recourse debt obligations that give an investor recourse for payment both (1) directly against the issuer and (2) to a pool of assets — the cover pool — that secures or "covers" the bond if the issuer becomes insolvent.  Still little known in the U.S., they are widely used in Europe for real estate and public sector financing.