Fitch Rtgs: Higher Canadian Covered Bond Cap May Aid Small Bank Funding

(The following statement was released by the rating agency) Fitch Ratings-New York-May 30: The recent revision of the Canadian covered bond (CB) issuance cap by regulators to 5.5% from 4.0% of issuer assets is not likely to impact the funding or credit profiles of the existing CB issuers, Fitch Ratings says. However, to the extent the cap increase provides smaller banks access to low-cost funding, it would be viewed positively from a credit perspective. The Office of the Superintendent of Financial Institutions (OFSI) stated that the upward adjustment to the CB cap, effective August 1, 2019, is not meant to increase issuance capacity, but to account for varying levels of issuers' pledged assets. Under the new calculation, the numerator now uses "total assets pledged" instead of "CBs outstanding". Depending on the quality of pledged assets and issuer rating, overcollateralization could be as much as 9% of the issuance for the highest rated CB programs. Notwithstanding the inclusion of overcollateralization, the higher 5.5% cap may make it marginally easier for smaller banks to start covered bond programs. The benefit of access to stable, lower-cost secured funding may mitigate the incremental risk of higher asset encumbrance. To date, smaller, non-systemic Canadian banks have claimed that the cost of establishing a CB program under the 4% regulatory cap had been prohibitive. As a result, these banks tend to rely more on higher-cost wholesale funding and brokered deposits. Any ratings implications of an increase in CB funding would depend on how prudently banks manage their liquidity reserves, capital, and credit risk in light of this increased access to secured funding. The seven Canadian CB issuers rated by Fitch will most likely continue to focus on rolling over maturing deposit notes with instruments that qualify for Canada's bail-in debt regime to fulfill TLAC requirements. These issuers have deposits in excess of 90% of market share, and material CB capacity remaining. Fitch-rated Canadian covered bond programs are at an almost 70% utilization rate with capacity to issue roughly CAD53 billion as of March 2019.