RBC's USD Covered Bond Deal and the Future of North American CBs

With a successful $1.5 billion covered bond from Royal Bank of Canada (RBC) coming hard on the heels of a landmark $2 billion issue from Canadian Imperial Bank of Canada (CIBC), Canada is currently the only game in town for U.S. dollar-denominated covered bonds.

The RBC and CIBC deals were both pitched to big U.S. institutional investors under SEC Rule 144A, which permits private placement of non-U.S. securities with "Qualified Institutional Buyers" (QIBs).

Michael DurrerWhere do Canada's recent USD issues fit into the big picture for the future of North American covered bonds?  In particular, what are the implications for development of the U.S. market?

Five covered bond experts contacted by Covered Bond Investor™ provide a variety of perspectives on those questions — all generally optimistic.  The major themes: U.S. investors' appetite for covered bonds is growing, and Canada's success may increase support for pending Congressional legislation intended to facilitate issuance of covered bonds by U.S. banks.

"My main reaction to the RBC deal is that, coming fairly soon after the CIBC U.S. offering in January, it shows a building interest from U.S. investors in the covered bond product," said Michael Durrer, a partner and head of the covered bond legal team at Sidley Austin LLP. 

Ted LordA similar point was made by Ted Lord, Head of Covered Bonds at Barclays Capital.  "The Canadian covered bond issuers of CIBC and Royal Bank of Canada are acting as true Northern Stars for the development of the covered bond market.  American investors, through these issues, are becoming more comfortable about where to put covered bonds in their various portfolios."  [Ed. note: Barclays served as one of the lead arrangers for the RBC deal.]

Need for U.S. Covered Bond Legislation

One feature of Canadian covered bonds that makes them appealing to U.S. investors is that their structure is relatively straightforward "from both a legal perspective and a credit perspective," according to Howard M. Goldwasser, a partner at Curtis, Mallet-Prevost, Colt & Mosle LLP.   

During the first push for covered bonds in the U.S. (2006-2007) — before momentum ground to a halt during the global economic crisis — both Bank of America and now-defunct Washington Mutual (WaMu) successfully launched huge covered bond issues.   In the absence of covered bond legislation, certain aspects of U.S. law required those covered bond programs to use a complicated two-tier structure so as to protect investors in the event of issuer default.

Howard Goldwasser"The key distinction between the RBC structure, which is more or less identical to the other Canadian structures, and U.S. issuers' structures to date is that the RBC structure is so much simpler," Goldwasser stated.  "It is modeled on the single-tiered issuance, 'true-sale' structure that evolved in the UK, and it doesn't involve any of the complexity that was required for Bank of America and WaMu's structure as a result of U.S. bank-regulatory provisions."   

For this reason, Goldwasser sees passage of a U.S. covered bond bill such as the one introduced March 18 by Rep. Scott Garret (R-NJ) as very important to any future covered bond issues from U.S. banks. 

"If the legislation that is currently proposed in the U.S. were to become law, I am reasonably confident that U.S. issuers, who need the liquidity and funding, would come to the market and be on a level playing field with the Canadian issuers to the north," Goldwasser said.

Some observers hope the Canadians' success will provide a catalyst.

"I think the success of Canadian banks in tapping U.S. investors could be a spur to adoption of covered bond legislation here," Michael Durrer said. "I should think potential U.S. covered bond issuers would like to corral some of those dollars being invested in Canadian covered bonds."

Boost from Change in Canadian Tax Policy

From a Canadian perspective, an additional factor facilitating RBC's and CIBC's success in attracting U.S. investors is investors' growing access to Canadian assets triggered by a change in Canadian tax policy, according to Martin Fingerhut, a partner in the Canadian law firm Blake, Cassels & Graydon LLP and chair of its structured finance group.  Fingerhut acted as Canadian counsel to the dealers on the CIBC transaction.

Martin Fingerhut"The CIBC and RBC covered bond issuances highlight two developments that are impacting Canadian corporate finance: (i) the growing attraction of U.S. and other non-Canadian investors to well-structured and strongly-performing Canadian financial assets and (ii) the virtual elimination of Canadian withholding tax on cross-border interest payments," Fingerhut said. "These subtle changes have fuelled significant growth in Canadian covered bond and securitization transactions that have accessed U.S. and European investors and have seen billions of dollars of Canadian consumer and corporate assets funded outside Canada."

Although the Canadian banks' USD covered bonds involved residential real estate mortgages, Fingerhut pointed out that other Canadian investments which have been securitized cross-border to U.S. and European investors involved assets such as "credit cards, auto loans and leases, equipment loans and leases, fleet leases, commercial mortgages (through CMBS) and floorplan loans, as well as plain vanilla trade receivables."  He expects the trend to continue. 

With regard to covered bond laws, Fingerhut added that a recent announcement by the Canadian government (March 4) of plans to create a legislative regime for covered bonds may help spur the enactment of similar legislation in the U.S.

USD Covered Bond Issuance by European Banks?

A couple of European banks issued U.S. dollar-denominated covered bonds and pitched them to U.S. investors during the 2006-2007 period, but not since.  A further question is whether banks from European countries will now decide to follow the Canadians' example.

"Successful transactions should interest European covered bond issuers to look to tap the [Rule 144A] market in the future," Ted Lord said. 

Tim SkeetLord's view was seconded by Tim Skeet, Head of Covered Bonds at Bank of America Merrill Lynch. "I had a message back from one of the German [institutions], saying that something that looks a bit more like a traditional European deal or Pfandbrief would be good," Skeet said.  "That's what we should look forward to.  Hopefully we can persuade Europeans that there's enough in it here — let's get back in."

Indeed, shortly before CIBC's USD issue in late January, Germany's Commerzbank publicly announced its intention to launch a U.S. dollar-denominated Pfandbrief (German legislative covered bond) in this calendar year, although at this point the timing is now reportedly more in question.

As a member of the Steering Committee of the U.S. Covered Bond Council (along with Michael Durrer), Skeet is actively involved in trying to develop the use of covered bonds as a supplemental form of funding in the U.S.  Like Durrer, he believes the Canadian banks' success — in addition to possible future USD issuance by European financial institutions — will help. 

"I think it's encouraging and it's positive and it's all pointing in the right direction," Skeet said.  "We want to get more activity.  It's a very simple formula.  Get more people going and getting volume out there, and let's get the market cranked up."

Related:

• RBC Prices USD $1.5 Billion Covered Bond