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Canadian banks dive into UK covered bond market

Canadian banks have accelerated their borrowing in the UK bond market, with sales of covered bonds during 2017 already surpassing last year’s total.

The country’s banking sector has sold £2.4bn of sterling covered bonds this year, according to data from Citi, compared to £2.35bn for all of 2016.

The data highlights the recently established importance of international covered bond markets for Canadian banks, which have borrowed about €55bn through the European market over the past few years, taking advantage of yields falling to record lows.

The debt instruments, which date back to 18th century Europe, are backed by mortgages, increasing the level of security for investors and helping to fund loans for homeowners.

Covered bonds now account for nearly 10 per cent of the entire C$1.4tn Canadian mortgage market, with banks mostly selling debt in dollars and euros, alongside this year’s increased activity in sterling.

Given their role in funding mortgage lending in Canada, recent jitters over the country’s overheated housing market has raised questions among European investors.

However, yields on the country’s covered bonds have not significantly moved. A euro-denominated Toronto-Dominion covered bond maturing in 2022, for example, is trading at a yield of just 0.2 per cent.

Higher Canadian activity in the UK covered bond market is linked to movements in currency swap markets, which allows issuers to borrow money in a foreign currency, but service the debt in their domestic currency, theoretically removing their exposure to foreign exchange movements.

“The relative pricing for them [Canadian banks] versus their domestic levels and other big markets like euro and dollar covered bonds has been very attractive,” said Peter Mason, co-head of European financial institutions group at Barclays.

“It’s a combination of the demand in sterling leading to good spread levels . . . when you take those [spread levels] and swap them back into Canadian dollars, that’s been very attractive,” he added.

The swap market is also a major factor in international companies switching between bond markets for their borrowing. Over recent years, American issuers have borrowed in euros, benefiting from low interest rates and then swapping their proceeds back into dollars.

The UK’s covered bond market has also proved attractive for Australian issuers. Westpac Banking Corporation this month sold a £500m five-year covered bond at a coupon of just 1 per cent.

Higher covered bond issuance is part of a sharp rise in overall activity in the UK’s sterling bond market. At the start of July, financials had issued £16.3bn of debt in sterling — more than twice the level over the same period in 2016, where borrowers held back in anticipation of the referendum on EU membership.