BNS SEC Filing Expires
On September 9, 2016, the SEC registration statement of Bank of Nova Scotia for its covered bonds expired without renewal.* This was followed by the pricing on September 13, 2016, of a $1.5 billion offering of five year covered bonds by BNS in a 144A private placement. Apparently BNS, like BMO, has abandoned the SEC registered format for its covered bonds.
On inquiry, BNS stated that ……. This action now leaves Royal Bank of Canada as the sole Canadian bank with an SEC registered covered bond program.*
The RBC program was inaugurated in September 2012 to much acclaim. While RBC has not publicly stated what action it will take regarding the loan-level disclosure requirements imposed under Regulation AB starting in November 2016, the response of BMO and BNS suggest that there may be no further issuances of SEC registered covered bonds after November. This will certainly be a disappointment to investors and will increase the funding costs of the banks.
Reg AB II — BMO Abandons SEC Filing
BMO Abandons SEC Filing
On December 16, 2015, Bank of Montreal quietly withdrew its SEC registration statement for covered bonds. The registration statement became effective on November 8, 2013. The registration statement was originally filed in July 2013. Prior to the filing, BMO had obtained a no-action letter from the SEC staff to permit the Guarantor to register its Guarantee on the same shelf registration statement as the bond to be issued by the bank.
On inquiry, BMO reports that there were a number of reasons for their withdrawal of the registrations statement. One of the reasons for the withdrawal was the prospect of needing to comply with the loan-level disclosure requirements of Regulation AB beginning in November 2016. That compliance requirement arose from the conditions imposed on BMO by the no-action letter. BMO cited the uncertainty of its ability under Canadian law to provide the information required and the significant cost of altering its systems nationwide to collect the information.
This is the first of the three Canadian banks with SEC registration statements to react publicly to the new loan-level disclosure requirements imposed by the SEC. (See Regulation AB II and Canadian Covered Bonds– the end of SEC registered covered bonds?). This action suggests that the other two banks, Bank of Nova Scotia and Royal bank of Canada, may cease issuing SEC registered covered bonds by the November 2016 date. Neither of the two banks, however, has publicly stated its intent in this regard.
Regulation AB II and Canadian Covered Bonds — the end of SEC registered covered bonds?
The recent amendments to Regulation AB (commonly referred to as “Reg AB II”) were a policy response to the perceived inadequacy of securitization disclosure prior to the financial crisis and a response to a request by very large investors for extensive, detailed information about the assets in a securitization. The adoption of the changes to Regulation AB was only possible after the SEC negotiated protection from the Consumer Financial Protection Bureau (the “CFPB”) for issuers filing the data required by the SEC. The CFPB statement provides that an issuer filing data in accordance with the SEC rules will not be in violation of the financial privacy laws.
The result of the amendment is a package of regulations that call for the disclosure of loan-level data that varies by asset class. In the case of assets that are residential mortgage loans, the rules call for the disclosure of 272 data fields for each mortgage loan, including the first two digits of the postal zip code for the property.
In a study conducted by the SEC staff prior to the adoption of the amendments, the staff calculated that disclosure of the full five digit postal zip code for a property would result in an 80% likelihood that the identity of the borrower would be discernable. With the reduction to disclosure of only the first two digits of the postal zip code, the staff concluded that there was still a 20% likelihood that a borrower could be identified. Thus the need for the SEC to obtain CFPB protection for issuers.
But what has this to do with covered bonds? After all, covered bonds are not securitizations, but rather special form of secured debt. The answer is somewhat complex.
Reg AB II and Covered Bonds
Updated: 12/28/2015
The United States Securities and Exchange Commission (the “SEC”) adopted revisions to Regulation AB on August 27, 2014, after a four year process of proposals and review. Regulation AB is the rule that governs the offering disclosure and periodic reporting obligations of issuers of asset-backed securities (“ABS”).
Insofar as covered bonds are concerned, several things are clear. First, covered bonds are not included in the definition of “asset-backed security.” Item 1101 of Regulation AB provides that:
Asset-backed security means a security that is primarily serviced by the cash flows of a discrete pool of receivables or other financial assets, either fixed or revolving, that by their terms convert into cash within a finite time period, plus any rights or other assets designed to assure the servicing or timely distributions of proceeds to the security holders; provided that in the case of financial assets that are leases, those assets may convert to cash partially by the cash proceeds from the disposition of the physical property underlying such leases.
It is clear that covered bonds are not “primarily serviced by the cash flows of a discrete pool of receivables or other financial assets.” Instead, covered bonds are senior obligations of the issuing financial institution and are expected to be repaid from the general funds of the institution. Accordingly, covered bonds should not be asset-backed securities and Regulation AB should not apply generally to covered bonds.