Canadian banks hoard cash with record ultra-safe bonds overseas

Instead of waiting to see if Canadian policymakers achieve a soft landing for the economy, banks are hoarding cash by selling mortgage covered bonds around the world at the fastest pace on record.
The country’s lenders, including the Royal Bank of Canada and the Toronto-Dominion Bank, have raised more than 52.2 billion euros ($53.3 billion) by issuing the debt primarily in euros, pounds and dollars Americans and Australians so far this year, according to data compiled by Bloomberg.
This makes them the world’s largest issuers of widely marketed covered bonds in 2022 with around 19% of all sales, ahead of German and Swedish lenders.
Consumer price inflation in Canada accelerated in June to its highest level since January 1983 – rising gasoline prices being the main culprit – adding to expectations that the Bank of Canada will continue hikes aggressive interest rates. That in turn threatens to bite into household wealth, forcing some to dip into savings to pay off debt as their leverage hits near-record levels amid a years-long property boom that cools quickly.
“Part of the increase in the supply of Canadian covered bonds is due to Canadian banks worrying about deposit outflows as savings rates fall with rising energy prices, the disposable income is shrinking,” said Cristina Costa, Paris covered bond analyst at Barclays. Plc. “Banks appear to be increasing wholesale funding to protect against outflows.” Press officers for RBC, TD, Canadian Imperial Bank of Commerce, Bank of Nova Scotia, National Bank of Canada and Bank of Montreal had no comment.
Sales of secured debt – which is cheaper for banks to fund than unsecured debt – were driven by demand from fund managers, favorable market conditions and refinancing activity, “despite the overvaluation of Canadian home prices by nearly 30%,” Fitch Ratings wrote in a July 13 report. Covered bonds were pioneered in Prussia in the 18th century, when Frederick the Great let aristocrats, churches and monasteries raise funds by pledging their property as collateral.
They generally have higher credit ratings than unsecured bank debt because they have first-ranking security from the issuer and first call on specific asset groups, residential mortgages in the case of Canadian banks.
Among recent deals, TD sold 2.5 billion euros worth of covered bonds due July 2025, which were listed on Thursday at a yield of around 1.52%, which equates to around 70 basis points on the Canadian government yield curve when traded against loonies, according to data from Bloomberg. . TD’s senior unsecured bail-in bonds due March 2025, on the other hand, are priced at a spread of about 126 basis points, according to Bloomberg prices.
Canadian covered bonds remain an attractive funding option even though the extra yield required by investors to hold such debt in euros instead of the safest government bonds has doubled this year. The cost stood at 91.6 basis points on Thursday, 2 basis points lower than the widest spread since 2011, according to a Bloomberg index. Bond supply rises as household residential mortgages outstanding topped C$2 billion ($1.56 billion) for the first time in May, from C$1.85 billion a year earlier and C$1.67 billion as of May 2020, according to government data. .
Household debt as a share of disposable income stood at 182.5% at the end of the first quarter, down from a record 185% in the last quarter of 2021, according to government data released in June. Net worth rose 2.6% to C$17.6 billion, driven by gains at that time in the housing market, although prices fell for a third consecutive month in June.
The Bank of Canada, which is ending the extraordinary liquidity and asset purchase programs put in place at the start of the pandemic, has so far raised its key rate by 225 basis points to 2.5%. That’s the highest since the credit crunch in 2008, and it could rise another 100 basis points by the end of this year, based on rates implied in swap markets.
“We expected an increase in supply from Canada compared to previous years. Nevertheless, the current amount is above our expectations,” said Daniel Rauch, a Frankfurt-based fund manager at Union Investment. “The mix of rising mortgage production, question marks over the deposit base, waning central bank support and a rather challenging senior market, from a transmitter, fueled the dynamic.”

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