Toronto bank towers
justek16/123RF

If the Office of the Superintendent of Financial Institutions (OSFI) decides to raise the current limit on covered bond issuance, smaller banks could start to take advantage of this funding source — and the big banks would benefit as well, suggests a new report from DBRS Ltd.

The Toronto-based credit-rating agency reports that covered bonds have become an important source of funding for the big banks’ uninsured mortgages. To date, the big banks have issued a total $160 billion in covered bonds, which represents a cheaper source of funding compared with deposit notes.

Fixed Income Isn’t Working Like It Used To

To generate yield and manage risk for clients in today’s complex fixed-income
markets, take an active approach with active fixed income ETFs from
Franklin Templeton Investments.

Get active with Franklin Templeton ETFs: FLGA | FLSL | FLUI | FLCI

The big banks’ usage of covered bonds amounts to an estimated $428 million in combined annual savings for the banks over the cost of funding with deposit notes.

However, smaller banks aren’t using covered bonds, the DBRS report says, noting that covered bond issuance is capped at 4% of assets by banking regulators.

That cap, combined with the relatively high administration costs of setting up a covered bond program, means that the vehicle isn’t as cost effective for small banks, the report says.

OSFI is considering whether to increase the limit on covered bond issuance, the report says. DBRS notes that some are advocating for a doubling of the cap to 8% of assets, which could increase new issuance capacity to $265 billion if adopted.

Although this could generate even more savings for big banks, this could also enable smaller banks to launch their own covered bond programs, the DBRS report suggests.