Land of Opportunity

On Sept. 12, the Royal Bank of Canada (RBC) pitched what some see as a game changer for U.S.-dollar covered bond issuance by foreign banks. The Canadian bank launched the very first U.S. Securities and Exchange Commission (SEC) fully registered covered bond deal — a $2.5 billion, five-year bond that priced at mid-swaps plus 35 basis points.

RBC has historically accessed the U.S. investor base only through the 144A market. The SEC registration afforded RBC approximately 10 basis points in incremental savings relative to 144A, said one person familiar with the deal.

"Compared to an RBC 3.125%, three-year covered bond issued today, with the curve adjusted from 3s to 5s and a new-issue premium tacked on, that new RBC 144A bond would have priced at mid-swaps plus 45," said the market source. "The SEC bond priced at mid-swaps plus 35, hence the 10 basis points in value for SEC registration."

There are a number of significant advantages associated with SEC-registered covered bonds, but of course the decision to register will be easiest for foreign issuers that are already U.S. reporting entities. Canadian banks have dominated U.S. dollar issuance since RBC's inaugural 2007 Canadian covered bond program. According to figures reported by Bank of America Merrill Lynch, Canadian banks account for 50% of the outstanding U.S. dollar-denominated covered bond market. These institutions have the advantage of already being registered with the SEC, which makes following RBC's lead a natural choice.

Yet pending Canadian covered bond legislation that will limit collateral to non-government-guaranteed mortgages is sure to slow the pipeline even for these issuers.

On the European side, issuers still grapple with the stigma of the ongoing sovereign debt crisis in the region, which could make placing covered bonds with a U.S. investor base less of a bargain.

Although the U.S. still lacks a statute that would permit U.S. depository institutions to issue covered bonds, foreign banks have found that U.S. investors are interested in covered bonds.  Foreign banks have met investor demand by issuing covered bonds into the U.S. relying on their domestic covered bond frameworks. The cover pools supporting these foreign-issued covered bonds are made up exclusively of assets located outside the U.S.

Foreign issuers of covered bonds have traditionally accessed the U.S. investor base through the 144A market, which exempts debt securities offered to U.S. investors from public registration. U.S. dollar-denominated covered bond issuance via the 144A market reached $100 billion at the end of May 2012, or just 10% of the euro-denominated outstanding benchmark market and 3.5% of the total covered bond market, according to figures reported by BofA Merrill.

However, this buyer base is restricted to qualified institutional investors that often have allocation restrictions that limit covered bond purchases to 15% of their holdings.

Jerry Marlatt, a securitization partner at Morrison & Foerster who was on the team that advised RBC on its SEC registration filing, said that the book of investors that bought into RBC's registered covered bond was about three times the size of the investor book on the bank's past private 144A offerings.

"It brought a lot of new investors into the covered bond space," he added. "You can expect to see the investor base grow as people who had never looked at covered bonds now have the opportunity to purchase this product."

Accessing this broader investor base via SEC shelf registration also broadens the marketability of the product by making the bonds eligible for the corporate bond transparency system known as Transaction Reporting And Compliance Engine (TRACE) as well as for inclusion in the bond indices, such as the Barclays Aggregate Bond Index.

"SEC-registered covered bonds are eligible to be included in broad bond indices, qualifying them for more internal investment policies," said Ben Colice, head of covered bonds at RBC Capital Markets. "Registered bonds’ eligibility for the TRACE system brings more transparency on pricing and better trading liquidity.”

Before SEC registration, the U.S. investor base consisted primarily of a select group of institutions or broker dealers that were comfortable with the covered bonds market.

Now with the registration, said Darren Getek, vice president in portfolio trading at Conning Asset Management, "you are forcing the hand of several other investors in the market to actually come in and learn the sector because they do need to have exposure to those bonds in order to match their investment benchmarks or to be a part of that particular market."