Further use of the covered bond structure is anticipated throughout Europe, and possibly in other markets as well, as financial institutions begin tackling the new capital risk accords under Basle II.

Under the new guidelines, financial institutions are encouraged to diversifying funding opportunities.

According to ABN Amro, the covered bond market could globalize within three years. U.S. investor portfolios have been picking up quite a bit of volume, primarily because of the strong euro. The structure allows exposure to corporate risk of the originator though its guaranty, while still protecting investors through an amortizing pool of assets that remain on the issuer's balance sheet.

"Covered bonds are transforming into a mainstream alternative funding source and international interest is building quickly," said Christoph Anhamm, senior covered bond analyst at ABN Amro. "Issuers are attracted by the opportunity to run on-balance sheet securitization and reach attractive funding across the curve, driven by high ratings. Investors also favor the high degree of liquidity the market offers, the homogenous character of the asset class and rating stability."

The challenge for the market is adopting a structure that complies with each region's respective legislation, which oftentimes do not cater to covered bonds. Germany's structured covered bond market, the Pfandbrief, is the oldest in Europe and, as such, specifies a clear framework for the instrument. However, countries looking to emulate the Pfandbrief will need to structure their deals according to their regional legislation. This was seen in the successful U.K.-originated HBOS covered bond offering launched earlier this year (see ASR 7/7).

One of the key reasons issuers would pursue a covered bond structure is that it can be cheaper and require less complicated preparation than securitizations.

"We're talking about two completely different spread levels," said one market source. "Investors look at deals like the HBOS covered bond as a liquid instrument you buy as an alternative to treasuries, while an HBOS securitization investor would see it as too expensive."

ABN Amro recently published a comprehensive directory for the European covered bond market and last week announced its new covered bond team. Niall Cameron was named Global Head of Credit Markets and Graham Bird was named Global Head of Rates Markets. The Association of German Mortgage Banks will hold a conference in Boston this week dedicating talks to the growth of the covered bond market as well as the outlook for the Pfandbrief and pending legal changes that will further enhance its standing.

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