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US Covered Bonds May Provide Liquidity for Mortgages: Rep. Garrett

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A push for covered bonds in the US does not seek to replace securitization, industry veterans said in a teleconference ahead of the House Financial Service Committee's scheduled hearing on covered bonds Tuesday. Heading up the call was Rep. Scott Garrett (R-NJ), who recently introduced covered bond legislation that outlines statutory framework to facilitate the broad domestic use of covered bonds -- debt instruments covered by a pool of loans that remains on the issuer's balance sheet. Pioneered as Europe's Pfandbrief in the 1700s, covered bonds offer investors dual recourse in both the assets used as collateral and the underlying institution. This dual recourse system where the issuer maintains all the risk, along with the high underwriting standards of the loans in the covered bond pool, give investors confidence and can provide for liquidity in the US mortgage market, Garrett said. "The concept of risk retention is a good thing to strive for," he said. "Because of the current problems with the US secondary mortgage market and the lack of liquidity for the securitization process, we really must continue to look for new and innovative ways to provide increased funding for credit markets over here." Garrett's legislation is the latest effort in the US to facilitate covered bonds after a move in mid-2008 failed to get a US covered bond market off the ground only months before the current economic crisis escalated. Although there are currently only several dollar-denominated issuances in the US -- one by Bank of America (BAC) and another by Washington Mutual -- Garrett said an increase in investor demand over the last few months brought about seven new European issuances totaling around €20bn (US$29.3bn). European covered bonds so far in 2009 generated €120bn of new issue volume, according to Tim Skeet, a managing director and head of covered bonds at Bank of America Merrill Lynch. "The lessons from Europe have clearly shown that where the legislators, the regulators and the market could work together, tremendous results can be achieved in terms of mobilizing private money to fund mortgage and public sector funding markets," Skeet said in the call. He also said investor interest may be ripe for a covered bond market in the US, particularly as government-sponsored enterprise (GSE) funding declines. Garrett's legislation to establish a legal framework and spell out eligible asset classes would provide a "necessary prerequisite" for a vibrant covered bonds market in the US, according to Skeet. "In the US today, there's a window of opportunity to establish a version of this asset class, but tailored to fit US market requirements," he said. "We have a shot at creating an additional source of funds to provide liquidity to the consumer finance and mortgage markets." Skeet added that a push by the industry to introduce covered bonds into the US "is not a plan to replace the securitization market, nor other established sources of funds." Bert Ely, a principal at financial institutions and monetary policy consulting firm Ely & Co., also said covered bonds would provide an additional funding source for residential mortgage loans. A US covered bonds market has great potential to gain investor interest, he said, as the high credit quality and investment potential of covered bonds opens the market for another class of high-quality, highly-rated debt. Write to Diana Golobay.

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