Fitch expects more USD-denominated covered bonds

U.S. investors could have more access to U.S. dollar-denominated covered bonds after the Securities and Exchange Commission cleared a foreign bank to issue the product last week, according to Fitch Ratings.

The SEC allowed the Royal Bank of Canada (RY) to offer covered bonds in the U.S. backed by mortgages last week. RBC believes it can be an effective alternative to securitization.

Considered a safe-haven in Europe because of the cover pool of mortgages, in which investors hold a preferential claim in the event of default, proponents are eager to see covered bonds take hold in the U.S.

Foreign banks increased dollar-denonimated covered bond issuance dramatically last year to roughly $50 billion, said Vanessa Purwin, senior director of U.S. structured finance at Fitch. Half of the issuance came from Canadian banks.

“The soundness of the country’s financial system, as well as the strong performance of Canadian residential mortgages during the financial crisis, has made Canadian covered bonds particularly attractive to investors. In addition, the mortgage insurance provided by the government-supported Canada Mortgage and Housing Corporation (CMHC) on mortgages in existing programs (with the exception of RBC) insulates investors from the credit risk on the underlying assets,” Purwin said in a research note Wednesday.

The Canadian Department of Finance said laid out a plan for regulating covered bonds earlier in the month. Canadian issuers have a six-month window to continue operating their unregulated programs.

U.S. lawmakers continue to work on covered bond legislation as well, but the few bills introduced hit roadblocks in a gridlocked Congress. Until it thaws, the SEC may have just cleared the way for a new market itself.

“U.S. dollar-denominated covered bonds are likely to benefit from a larger group of U.S. investors that have been approved to invest in them,” Purwin said. “The SEC’s statement also opens the door for U.S. dollar-denominated covered bonds to be included in benchmark indices investors use to track returns.”

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