Equitable Bank is calling on regulators to boost the current limit on covered bonds, arguing that it would level the playing field for smaller banks and make the Canadian mortgage industry more competitive.
Currently, covered bonds – which are a popular source of funding for uninsured residential mortgages among the big Canadian banks – are not allowed to exceed 4 per cent of a bank’s total assets. That makes it cost-prohibitive for smaller banks such as Equitable to issue the bonds, which offer a cheaper source of funding than deposit notes, given the costs of launching a covered bond program relative to their assets.
The Office of the Superintendent of Financial Institutions is currently in the process of revising that cap, which was implemented to protect the stability of the financial system but has since been deemed too conservative.
Tim Wilson, Equitable Bank’s chief financial officer, said he would like to see the limit move up to above 8 per cent. But ultimately, he’s advocating for the cap to be set on a case-by-case basis, which is the approach that regulators in Britain take. That’s because balance sheet structures and risk appetites can vary between institutions, Mr. Wilson said.
Equitable Bank also believes that, while the limit should be raised across the board, smaller institutions should have a higher cap than the big banks.
“One of the things about the big banks is they have lots of assets that are not mortgages," Andrew Moor, Equitable Bank’s chief executive, said in an interview on Thursday. "So if you say 8 per cent of your total assets can be covered bonds, it might be a very high proportion of your mortgage book [for a big bank]. For us, we’re more focused as a mortgage lender, so it’s a smaller proportion of our overall mortgage book.”
Equitable Bank currently has roughly $11-billion of uninsured single-family mortgages, Mr. Wilson said.
The comments by Mr. Wilson and Mr. Moor come after a report issued earlier this week by ratings agency DBRS Ltd., which said that raising the covered bond limit could spur smaller banks to establish such programs.
Covered bonds have been on a growth spurt since they were first introduced in 2013 and now make up 4 per cent of the combined $1.5-trillion of outstanding mortgage loans issued by Canada’s six biggest banks – Royal Bank of Canada, Toronto-Dominion Bank, Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce and National Bank of Canada – and Desjardins Group.
Covered bonds, which bundle uninsured mortgages, are generally sold to investors overseas; they are known as “dual recourse” bonds, so if the bank fails to pay the interest, then mortgage payments from the homeowners will be used to pay investors.
Annik Faucher, a spokeswoman for the Office of the Superintendent of Financial Institutions, said the agency is still discussing the covered bond limit internally and has not yet set a date for the public consultation.