Global investors fleeing volatility are taking refuge in an unlikely place: a Canadian housing market that some speculators are still betting is a bubble ready to pop.
Investors, mainly in Europe and the U.S., have already bought a record amount of Canadian mortgage-backed covered bonds this year, according to Fitch Ratings. The demand comes amid record household debt and lofty home valuations, which have made the stocks of Canada's largest private mortgage insurer and biggest non-bank lender the two most shorted in the country.
“If you didn't really have people believing the Canadian housing story, you wouldn't have them buying Canadian covered bonds,” Gennadiy Goldberg, a fixed-income strategist at Toronto-Dominion, said by phone from New York. “I think it's a testament that maybe some of the worst fears are overblown.”
Covered bonds offer the double collateral of both a pool of mortgage loans and the backing of the banks that make them. And it's the support of Canada's lenders — rated the world's soundest for seven straight years by the World Economic Forum after avoiding major bailouts during the financial crisis — that's helped investors look past bubble concerns.
“The analysis only comes down to the mortgage pool if the bank is insolvent, and they're AA rated entities,” Suzanne Mistretta, the senior director at Fitch covering the securities, said by phone from New York. “Our rating of the banks and the sovereign take into account those risks.”
At $31 billion worth of bonds, sold mainly in euros, British pounds and U.S. dollars, 2015 has already seen Canadian banks sell a record amount of covered bonds to finance mortgage lending, according to Fitch.
Canada's euro-denominated covered bonds' 0.6 per cent return makes them the best performers in the world this year for the segment, trailing only those from Italy, Portugal and Spain, economies only starting to emerge from the worst of the eurozone debt crisis, according to Bank of America Merrill Lynch data.
The advance comes amid a tumultuous time for markets. Commodity prices have plunged to multi-year lows, while a recent crash in China's stock market sent the Chicago Board Options Exchange Volatility Index, known as the fear index, to its highest since 2009.
Sales of the top-rated Canadian covered bonds tended to be strongest amid general demand for other traditional haven assets like U.S. or Canadian government debt, said Fitch's Mistretta.
“If there's volatility in the markets and spreads tighten, and there's a demand or flight to quality such that the spreads come in and its economic for them to issue, that's when they'll issue,” she said. “It's cheap.”
Foreign investors' willingness to finance the mortgage lending of Canada's largest banks comes amid speculation the combination of inflated home prices and heavy debt loads have the nation set for a housing crash. Those concerns have been exacerbated by the downturn in oil and as Canada's economy shrank in the first half of 2015.
Short interest — or bets on a decline — in the eight-company Standard & Poor's/TSX Commercial Banks Index has climbed to the highest this year, according to data compiled by Bloomberg.
The stock of Genworth MI Canada Inc., the largest non-government mortgage insurer, and Home Capital Group Inc., the largest non-bank lender, are the two most-shorted in the country, at almost 50 per cent and 36 per cent.
Yet, investors faced with volatile global markets will continue to seek a haven in Canadian covered bonds, according to Fitch, which said in a report this month issuance could as much as double through the rest of the year to $62 billion.
“They are backstopped by multiple things,” said TD's Goldberg. “That's one of the draws.”