Paulson, Banks Unveil
Plans for Covered Bonds

By MEENA THIRUVENGADAM
July 28, 2008 3:48 p.m.

WASHINGTON — Four of the U.S.’s leading banks are jumping on a government bandwagon to promote the development of a covered-bond market in the U.S.

Bank of America Corp., Citigroup Inc., J.P. Morgan Chase & Co. and Wells Fargo & Co. Monday unveiled plans to launch covered-bond programs and become leading issuers of the financial instruments, which date back to 18th-century Europe.

Associated Press

Treasury Secretary Henry Paulson speaks during a news conference on mortgage finance. ‘We are at the early stages of what should be a promising path, where the nascent U.S. covered bond market can grow and provide a new source of mortgage financing,’ he said.

The bonds, secured by residential mortgage assets that would remain on the issuer’s balance sheet, are seen as a new liquidity tool for banks. Covered bonds, although unfamiliar to many U.S. investors, are a $3 trillion market used heavily in Europe.

“We believe a robust U.S. covered-bond market would provide an additional stable and cost effective funding source for banks to originate and hold mortgages on their balance sheet,” the four banks said in a joint statement.

“A new source of liquidity provided by the capital markets is certainly welcomed and should help provide stability to the mortgage market as a whole,” said Jeff Brown, Bank of America’s corporate treasurer.

“Covered bonds will allow the investing community to diversify portfolio holdings and will provide banks with greater lending capacity,” he said.

Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke have in recent months been touting the bonds as a way to help revive the nation’s struggling housing market.

“Covered bonds have the potential to increase mortgage financing, improve underwriting standards, and strengthen U.S. financial institutions by providing a new funding source that will diversity their overall portfolio,” Mr. Paulson said in a statement Monday. (See the full text of Paulson’s statement.)

The Treasury Department on Monday released guidelines that would direct the development of a U.S. covered bond market. The guidelines require issuers to maintain overcollateralization value of at least 5% of the outstanding principal balance of the bonds, to have a specified investment, to disclose specific information about mortgage pools by which the bonds would be backed and to test assets on a monthly basis to ensure the quality of collateral.

Non-performing mortgages would have to be removed from the pool, insuring the quality of underlying mortgages.

The guidelines are thought to provide the necessary legal, regulatory and market framework necessary to develop a covered-bond market in the U.S.

Only two U.S. financial institutions — Bank of America and Washington Mutual — have issued covered bonds in the past and investors have been reluctant to embrace them.

A recent policy statement from the Federal Deposit Insurance Corp. has alleviated some concerns about regulatory uncertainty that have kept financial institutions from embracing the bonds, according to a client note co-authored by former FDIC general counsel John Douglas, now at the law firm Paul Hastings.

Still, “it remains to be seen whether the current restrictions and inherent execution costs on covered bonds will allow the vehicle to become a viable substitute for alternatives,” Paul Hastings said in a note to clients Monday.

Restrictions of acceptable collateral and the size of issuance make the bonds less attractive to issuers. Under FDIC guidelines, covered bonds can account for no more than 4% of an issuer’s liabilities.

Paul Hastings also said it was concerned the bonds could increase deposit insurance assessments and would remain on a bank’s books, thereby providing no capital relief.

The first U.S. covered bonds were issued by Washington Mutual in 2006 and had been expected to bring a flurry of activity in the sector that never materialized.

“We knew that this initiative would be successful only if the largest banks paved the way,” Mr. Paulson said Monday.

Write to Meena Thiruvengadam at meena.thiruvengadam@dowjones.com

http://online.wsj.com/article/SB121727042664390535.html?mod=hps_us_whats_news

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