The U.K.'s third structured covered bond issue came out last week, while the roster continues to grow. The new product will continue to work side by side with the country's RMBS deals, sources said.

Northern Rock and Bradford & Bingley followed HBOS' inaugural structured covered bond program, which has to date launched three issues. According to market sources, Northern Rock's inaugural issue was upsized to 2 billion (US$2.4 billion) from 1.5 billion (US$1.8 billion) after bids reached 3.5 billion (US$4.23 billion). The deal priced at the tighter end of initial talk, said sources. According to market reports, about 44% of the deal was allocated to German investors - signalling a growing comfort with the U.K. market since the structure's inception last year.

Unlike other covered bond markets, the U.K. does not employ specific regulations that apply only to structured covered bonds. Instead, the features under U.K. structures function much like the German styled Pfandbriefe-type structure. Under U.K. law, the structured covered bonds will carry 20% risk weighting, whereas the neighbouring European framework only requires 10% risk weighting. Initially, industry sources expressed concerns that such a difference might be enough to put off the traditional covered bond investment base from looking at U.K. deals. German participation has grown to about 44% in the Northern Rock deal from a 23% participation recorded in HBOS' first deal, said sources familiar with the deal.

The major difference between the three deals is that both Northern Rock and Bradford & Bingley are single-A rated banks; HBOS is a double-A bank. Deals that followed the inaugural transaction from HBOS were likely to be structured differently, sources said, given that most banks did not have the critical mass of HBOS' portfolio. The size of the portfolio for both of these deals is apparently very different. "Northern Rock and Bradford & Bingley used 75% indexing for calculating their cover pools, HBOS uses a 60% indexed LTV threshold," said one market source.

Northern Rock and Bradford & Bingley will not be required to repurchase loans that are under three-month delinquent from the pool, but they are required to hold these on balance sheet at 40% of indexed property value. HBOS, however, is required to repurchase these mortgage assets. Both Northern Rock and Bradford & Bingley have 12-month extendable maturities.

Covered bonds continue to be issued side by side with these lenders' securitization programs. Just last week, Northern Rock was marketing a new issue from its Granite master trust series. Each structure appeals to a completely different investor base, sources said. Covered bonds offer U.K. mortgage lenders an alternative to traditional securitization - and with the new Basle Accord around the corner, the structure addresses the need for issuers to tap a broader investor base.

Covered bonds provide cheap funding, but industry sources said they show relative value in RMBS, which is pricing in the low teens. The inaugural seven-year structure launched under HBOS Treasury Services priced its triple-A rated bond at 10 basis points over mid-swaps, amounting to almost seven basis points cheaper than a prior unsecured deal with the same average life earlier in the year, said market sources. And Northern Rock's latest covered bond issue priced at seven basis points over mid-swaps. "On the key question about pricing, we would expect the present differential to disappear under the new BIS regulatory capital guidelines - with reduced weighting for RMBS - and we do not rule out a possibility it may even invert," reported analysts at Merrill Lynch.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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