Tuesday, July 29, 2008

U.S. Banks announce covered bond issuance plans

(WSJ) Four of the nation's largest banks will begin issuing a type of debt the Bush administration has been pushing as a way to help reinvigorate the housing market.

On Monday, Bank of America Corp., Citigroup Inc., J.P. Morgan Chase & Co. and Wells Fargo & Co., said they would begin issuing so-called covered bonds, a popular method of financing in Europe that could make more mortgage financing available in the U.S.

The move came as federal regulators announced a set of voluntary industry guidelines intended to provide clarity to issuers and investors about the types of assets banks must hold if they issue such bonds and how investors would fare in the event of a bank failure.

"As we are all aware, the availability of affordable mortgage financing is essential to turning the corner on the current housing correction...covered bonds have the potential to increase mortgage financing," Treasury Secretary Henry Paulson said at an event to announce the agreement.

The move is the latest step by the Bush administration to aid the beleaguered housing market. Two weeks ago, the Treasury unveiled a plan to shore up mortgage titans Fannie Mae and Freddie Mac by creating an unlimited line of credit for the firms and getting authority to invest in the companies. The two firms are critical to the housing market because together they own or guarantee about $5.2 trillion of U.S. home mortgages -- nearly half of all those outstanding. The firms have seen their shares pummeled by investors concerned about their capital levels.

Washington's interest in pushing covered bonds stems from the success of Europe's $2.75 trillion covered-bond market. Such bonds are the primary source of mortgage-loan funding for European banks. Some analysts have predicted that a covered-bond market in the U.S. could grow to $1 trillion over the next few years. There are currently $11 trillion in home mortgages outstanding in the U.S.

Covered bonds are backed by mortgages but they are considered safer investments than the products that fueled the housing boom and landed many Wall Street banks in trouble. That's because the bonds stay on a bank's balance sheet and are backed by a "cover pool" of high-quality mortgages that must meet certain criteria, such as being up to date in their payments. Investors are also protected because if the mortgages go bad, the bank must step in to ensure that bond holders get their interest.

U.S. banks can issue covered bonds but only two have done so: Bank of America and Washington Mutual Inc. The market in the U.S. has been hampered in part because of regulatory uncertainty surrounding the products. Investors have worried about where they stand in the event of a bank's demise and issuers have wanted clarity about the types of assets they must hold, among other things.

The voluntary guidelines announced by the Treasury and supported by the Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and the Office of Thrift Supervision outline the types of collateral issuing banks must hold and the types of disclosure banks must make to investors. Among other things, the guidelines require that mortgages backing the debt be underwritten with fully documented income, current when added to the pool, replaced if they become more than 60 days delinquent and held on an issuer's balance sheet.

The guidelines are intended to reassure investors who have kept money on the sidelines after suffering heavy losses on bonds backed by subprime mortgages over the past year. At the same time, most banks and financial institutions, which have also incurred losses and write-downs on similar assets, have been unwilling to create or underwrite new mortgage securities.

Providing an alternative method of financing could help the housing market since investors would provide money to banks to make home loans. How much it could help remains to be seen and federal officials said they don't expect covered bonds to solve the housing problem.

"There are no magic bullets to solve the housing crisis," said FDIC Chairman Sheila Bair.

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