In the 2023 Fall Economic Statement, the government announced that it would purchase $30 billion of Canada Mortgage Bonds (CMBs). This commitment followed an earlier statement that it would increase the annual issuance limit from $40 to $60 billion. The primary objective of this initiative is to offer affordable funds to developers for the construction of new multi-unit housing projects.
Last week, the Bank of Canada released the operational details of the upcoming CMB purchases. The government intends to participate in the ongoing issuance of 5-year and 10-year fixed-rate CMBs – and will purchase the bonds directly from the syndicate lead – but it will not participate in the issuance of Floating Rate Notes (FRN). FRNs represent a very small percentage of total CMB supply, so this omission is insignificant. The Bank of Canada, acting as the government’s fiscal agent, will manage the government’s purchases and new CMB portfolio.
Following the purchases, CMB market supply is expected to decrease from $40 billion to $30 billion. These purchases will not affect the net debt, since the decrease in CMBs will be balanced by an increase in the issuance of Canada debt. However, this reduction is likely to have a positive effect on the spreads over Canada bonds. This is particularly beneficial for residential borrowers, since it has the potential to lower the funding costs for lenders who primarily rely on the CMB program for their funding.
The Bank’s release highlights the need to establish a repurchase (repo) agreement, which is expected to enhance the support for the CMB program by fostering more active trading in these bonds. The use of such a facility is unlikely unless the bonds become highly sought after, a situation referred to as “going on special.”
Going on special occurs when there is exceptional demand in the repo and cash market for a specific issue of securities. In such cases, potential buyers in the repo market offer inexpensive cash in exchange for borrowing the bonds for the repo term. ‘Specialness’ is driven by excess demand for a particular security compared to its supply. The spread between the general collateral repo rate and a special repo rate represents the return the buyer of that security is willing to forgo on the cash paid for that security.
It’s not clear whether the government plans to recapture the dealer commissions on their bond purchases. As we noted in a previous post, it doesn’t make sense for the government to pay investment dealers for selling bonds to itself, especially when there’s no underwriting risk involved. With the first transaction nearing, we’ll be watching closely to see that the government is doing the right thing.
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