Washington Mutual is preparing to price the first covered bond program by a U.S. issuer. While the transaction is not structured as a genuine securitization and is being marketed overseas, it is eventually expected to have implications on the way that the Seattle-based thrift - as well as other peer companies - finances its operations.

The Washington Mutual Covered Bond Program will allow the Seattle-based bank to float about 20 billion ($25.6 billion) of senior debt secured by a portfolio of mortgage bonds. Those bonds are collateralized by 5/1 hybrid ARM home loans. ABN Amro, Barclays Capital and Deutsche Bank are acting as lead managers on the transaction, which is expected to price by Sept. 18.

Covered bonds are essentially the senior debt of an issuing company, for which a specific portfolio of assets is pledged for repayment. The issuer must pay principal and interest from its corporate proceeds, but in the case of the issuer's insolvency, the asset portfolio is tapped to repay the bonds. The deal will be structured and marketed in the U.K. and Europe, where most covered bond transactions are executed.

The bonds are not true securitizations, because the assets typically remain on the issuer's balance sheet. Still, Washington Mutual's deal is turning heads in the ABS market, because it borrows a couple of structural techniques from the ABS market. Each series of covered bonds will be secured by a related series of mortgage bonds. Washington Mutual Bank will grant a first priority perfected security interest in the cover pool to the mortgage bond trustee, and the cover pool will secure all of the mortgage bonds. If Washington Mutual Bank falls into insolvency, fails to pay on the mortgage bonds and appoints Federal Deposit Insurance Corp. as receiver, then any proceeds subsequently received from either the FDIC or the liquidation of the cover pool will be made available to make payments on the covered bonds.

Market players say the deal might nudge other U.S. issuers off the fence and into the covered bond arena. WaMu itself is expected to come to market about four to six times a year under the current program. Further, if all goes well with the deal in Europe, it might issue covered bonds inside the U.S., according to a statement from Standard & Poor's.

"The bank will look to issuing non-European mortgage-backed covered bonds out of this program in the future, notably in its local U.S. market," said Todd Niemy, a Standard & Poor's credit analyst. The rating agency gave the deal a triple-A rating.

In absolute terms, WaMu's transaction is structured differently from traditional covered bonds, because mortgage bonds collateralize the senior debt. In most covered bond deals, mortgages or other assets from the issuer's balance sheet are directly pledged to the repayment of the bonds. Covered bond deals from the U.K. are an exception. In that jurisdiction, mortgage assets securing covered bonds are transferred to a bankruptcy-remote vehicle, because English law currently forbids pledging balance sheet assets for such deals.

Market professionals do not expect the transaction to reduce demand for securitization or materially impact deal production.

"I wouldn't bet the ranch that this would tighten spreads for lack of supply," someone familiar with the situation said. If the covered bond market does take off among U.S. thrifts, it might significantly impact demand for Federal Home Loan Bank advances. Although the financing option is common among thrifts, they are a costlier form of financing than covered bonds, one market player said.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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