http://globaleconomicanalysis.blogspot.com/2008/02/borrowed-reserves-and-tin-foil-hats.html

Covered bonds won’t replace securitization – BofA

http://www.reuters.com/article/fundsFundsNews/idUSN0846274820080208

The nascent market for U.S. covered bonds will complement, not replace, traditional mortgage securities despite the crisis in many off-balance sheet transactions, the biggest U.S. issuer said this week.
Losses in mortgage debt sold by Wall Street issuers and government-sponsored enterprises have put a spotlight on covered bonds, which also are backed by pools of assets but are perceived as less risky because the assets stay on the issuer’s balance sheet.

Fitch Ratings has today ( July 3, 2007) assigned BA Covered Bond Issuer (BACBI) series 4 covered bonds a final rating of ‘AAA’. These securities are issued under BACBI’s EUR20 billion covered bonds programme. The bonds will have a size of EUR1.5 billion, with a maturity of three years.
In the absence of dedicated legislation for covered bonds in the US, the programme rests on contractual agreements and the pledge of assets under the US Uniform Commercial Code. The issuer is a Delaware statutory trust specifically established for the covered bonds programme while the sponsor of the programme is Bank of America NA. (BANA, rated ‘AA/F1+’ by Fitch), one of the largest US mortgage lenders.
Under this programme, BANA will issue floating-rate, USD-denominated US mortgage bonds secured on a portfolio of residential mortgage loans originated or acquired by its branch network. The mortgage bonds will be direct and unconditional obligations of BANA, ranking pari passu and without priority among themselves. Each series of mortgage bonds will be purchased by BACBI, which will finance this acquisition through the issuance of contractual covered bonds. USD-denominated proceeds from the mortgage bonds will be swapped in exchange for interest and principal due under the covered bonds in the relevant currency. The programme is designed to protect covered bondholders against the risk that, in an insolvency of BANA, the Federal Deposit Insurance Corporation (FDIC) elects to accelerate the bank’s obligations.

http://ecbc.hypo.org/Content/Default.asp?PageID=327

Furthermore, S&P welcomes the trend to mitigate market risks in the cover pools through the use of derivatives. However, to ensure that market risk is not simply replaced by the credit risk of the swap provider and to take into account the specifics of swaps used for covered bond transactions, S&P has issued a consultation paper on Swaps in cover pools in March 2006. This should facilitate the use of derivatives in the cover pool and further improve the safety of covered bonds going forward.

In the covered bond analysis S&P focuses on 4 core areas:
Review of the legal framework to ensure…..

A commitment to the Covered Bond compliance test is regarded as an adequate practical application of the above.

Irish Covered Bonds Primer:

http://www.aibifs.com/brochures/Intro%20to%20covered%20bonds%20July%202005.pdf

Substitute assets with a maturity of up to three months and up to a limit of 20% of total
cover assets are allowable

The Act provides for the issue of two types of covered bonds by designated financial
institutions according to the nature of the covering assets, namely mortgage credit securities
and public credit securities. The covering assets must be divided accordingly into two
separate pools – mortgage and public – and listed in two separate registers, to be maintained
by the designated credit institution. The register must include details of the covered bonds,
cover assets hedge contracts and the credit assets and substitution assets that form the
cover assets pool. The IFSRA and Covered Assets Monitor must have access to this register
at all times

The Act defines substitute assets as
deposits with eligible banks or tier one assets. The Act also provides that any other specified
kind of property may be designated by Ministerial order as a substitution asset

Over-collateralisation is required by the legislation. The Act provides that, for both mortgage
and public credit pools, the prudent market value of the credit assets, including any
substitution assets, shall at all times exceed the aggregate principal amount of the
outstanding Irish CB.
In addition, the aggregate interest payable in any calendar year on the asset pools, including
any substitution assets, shall not at any time be less than the aggregate interest payable on
the Irish CB.

Third, the legislation is flexible in many respects, including
the relatively wide geographical base for qualifying loans, provision for the use of
substitution assets and derivatives, and the scope for overcollateralisation. Fourth, Irish
covered bonds trade broadly in line with German Pfandbriefe, reflecting the high quality
of both the legislation and the issuers

Please be on the look out for this evolving scam, which IMHO is one of the next synthetic goldmines:

he nascent market for U.S. covered bonds will complement, not replace, traditional mortgage securities despite the crisis in many off-balance sheet transactions, the biggest U.S. issuer said this week.

Losses in mortgage debt sold by Wall Street issuers and government-sponsored enterprises have put a spotlight on covered bonds, which also are backed by pools of assets but are perceived as less risky because the assets stay on the issuer’s balance sheet.

I used to follow Irish Covered Bonds and IMHO, these are not good good play toys!!!