Although covered bonds are seen as a safer funding alternative for mortgages, there are still some hindrances to the growth of the sector in the U.S, according to participants at last week's Information Management Network ABS East conference in Hollywood, Florida.
Law firm Morrison & Foerster's (MoFo) presentation at the conference said that one of the impediments holding up this type of financing is that current covered bonds are structured contemplating a fire sale of mortgage pools. This becomes a significant risk, considering the current lack of a liquid mortgage loan market. This, according to representatives from MoFo, suggests the need for a revision of the structure.
One of the principal problems is developing an investor base for the product, especially in light of the overall lack of confidence in the housing markets. Also, thus far, only two U.S. issuers have come to market with their own covered bond programs.
Some panelists said the development of government-guaranteed structures is a positive for increasing the reach of covered bond instruments in the U.S. Covered bonds are a "natural transition" for interest rate investors, or those looking for government-backed collateral, but they would not be an obvious choice for buyers of senior-unsecured securities.
A panelist at the conference said that his team is not particularly excited about doing road shows for unsecured investors, since such buyers can only purchase so much of a certain company's debt.
Uniformity of product and structure is critical as well, said panelists. "You might see some minor tweaks but at the end of the day, it should be 99% the same," a conference speaker said.
Winning investors over has been a hard task though, especially following a negative ratings event. In March, Moody's Investors Service downgraded its ratings on the covered bonds issued by Washington Mutual to 'Aa1,' keeping them on review for possible further downgrade. According to an investor on the conference panel, this resulted in bonds that he owned gapping out five basis points, and institutions closing their doors on him.
Despite these obstacles, issuers are still rearing to tap the vast liquidity that the U.S. offers. French credit institution Compagnie de Financement Foncier, for instance, is planning to build a U.S. framework to issue covered bonds. There is also a U.S.-based deal that is likely to come early next year, according to one of the panelists.
There are various advantages to the covered bond structure, one of the more important being that covered bonds have proven to be less vulnerable to credit spread widening in times of stress compared with senior secured funding, the MoFo presentation highlighted.
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