Critical Liquidity Source in Times of Stress
In the past ten days, covered bonds have shown their value in a crisis for the Canadian banks. They have issued covered bonds in Europe at least seven times in that last ten days. When senior debt and ABS is difficult to bring to market, covered bonds have a ready investor base. Covered bonds represent a flight to quality when markets are difficult. The Canadians have been so successful that they have irritated European funding officials. See the story in Global Capital.
Canadian banks survived the last financial crisis in better condition than perhaps any other OECD banking system. And the Canadian banking system, although relatively small, remains one of the preeminent banking systems in the world. The six major Canadian banks dominate the banking market in Canada. They are quite conservative. They tend to follow each other and particularly the traditional leader, Royal Bank of Canada. Compared, for example to the banking system in the United States, the Canadian banks have had remarkably few crises. It is a close-knit community and a comfortably profitable business in Canada.
When the crisis created by the coronavirus COVID-19 began to envelope the Western world, the Canadian banks moved quickly to shore up their liquidity. An important tool for accomplishing this has been covered bonds. In uncertain times, investors tend to seek sovereign paper in a flight to quality. Covered bonds provide an attractive alternative to sovereign paper. Covered bonds have a similar risk profile to sovereign bonds but generally provide better yields.
Why did the banks choose Europe to issue their bonds? Because of favorable currency swap costs. And the market proved quite receptive. Even though there were at times two or three Canadian banks in the market at same time, they all managed to issue benchmark-size offerings at favorable rates. There was clearly an investor hunger for safe assets with a decent yield and the Canadians met that need quickly. They were in and out of the market before their European competitors had even contemplated challenging the market turmoil.
And although the Canadians deserve credit for moving quickly, the moral of the story is really the value of covered bonds in stressful times. As it did during the financial crisis, the covered bond market continues to be open and available to provide critical liquidity when other finding sources are spotty or not available at all. And just to note, this is a funding tool that U.S. banks do not have access to.