RBC's Issuance of Covered Bonds Great News for Borrowers

What does RBC's recent historic issue of covered bonds mean? Lower funding costs for them which could be passed onto you as a borrower.

As I've noted in previous newsletters banks raise money in the bond markets in order to lend out money for mortgages. A recent article in Canadian Trends reported on the recent issuance of covered bonds by RBC on Sept. 12th. It's noteworthy because it was the world's first SEC-registered bond, meaning it could be purchased by U.S. investors for the first time. This enormous group of buyers makes bonds easier to trade and less expensive to issue. Why might this matter to you. It will lower RBC's funding costs that could possibly be passed on to us borrowers.

Some "Covered Bond" facts:

  • RBC’s new covered bonds are “AAA,” the best rating a bond can get.
  • Demand was high: Investors lined up for $5 billion worth, but RBC was selling just $2.5 billion.
  • Its 5-year covered bonds sold for an impressively low yield of 1.20% (just 51 basis points above “risk-free” 5-year U.S. Treasuries).
  • Most covered bonds are sold privately to big institutional investors (i.e., via “private placements”).
  • A reported 180-200 investors bought into this latest deal, versus normal covered bond issuances which draw about 50 or so.
  • Canadian banks are allowed to issue covered bonds equalling up to 4% of their assets.
  • RBC reportedly worked about two years to get the SEC’s blessing for its new covered bonds.
  • Of the 110,698 mortgages used as collateral in RBC’s covered bond program as of August 31:
Only 434 were delinquent.
The average drawn loan-to-value was 61.46%.
Only 3.7% had non-prime credit scores (i.e., scores under 600).
59.76% had fixed rates. The rest were variable.

Below is the last part of the article from Canadian Mortgage Trends:

  • On a fair value basis, RBC’s SEC-registered covered bonds have traded less than 5 bps above traditional covered bonds (which rely on mortgage collateral insured by CMHC). That’s a surprisingly tight spread given that insured mortgages entail less risk.)
  • According to a dealer source, RBC paid about a quarter percentage point less than it would have paid to issue regular bonds (a.k.a. subordinated debt). That saves it almost $30 million on a $2.5 billion 5-year issue.
  • Funding through Canada Mortgage Bonds (CMBs) is still cheaper than covereds, but banks are limited to how many CMBs they can issue.
  • RBC can reportedly issue an additional $9.5 billion more worth of U.S. covered bonds with its current SEC approval (“shelf registration”).
  • Roughly 14% of RBC's outstanding uninsured mortgages are used as collateral in its covered bond program according to Q3 2012 DBRS data.
  • No covered bond has ever defaulted.


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