With the current stall in the securitization markets and the issue of liquidity gaining predominance, it may be a good time for banks to explore a different option for leveraging the mortgage collateral held on their balance sheets. Covered bonds offer a vehicle for a financial institution to issue debt that is backed (or covered) by a pool of mortgages. Unlike in securitization, these mortgages remain on an issuer's balance sheet, but the collateral security that they provide allows the debt to be issued at a lower cost than other funding vehicles. Covered bonds are a mature product in Europe, but are just starting to draw interest in the United States with both Seattle-based Washington Mutual (WaMu) and Charlotte, North Carolina-based Bank of America (BofA) having dabbled in the market over the past few years. The Federal Deposit Insurance Corporation (FDIC) also recently weighed in with a long-awaited policy statement on their treatment. Covered bonds have a long history in Europe for financing various asset classes dating back to the 1700s. Contemporary use of covered bonds for mortgage funding took off in 1995 with about 20 billion euros in issuance, and has since grown rapidly with more than 200 billion euros in issuance in 2007. * To give a sense of the growth potential for covered bonds in the United States, today 17 percent of the total European Union (EU) residential mortgage volume is funded by covered bonds, according to the European Mortgage Federation, Brussels, Belgium. If funding of U.S. residential mortgages via covered bonds were to grow to this level, it would translate to almost $2 trillion of covered bond issuance, based on an overall home mortgage volume outstanding of $11.1 trillion (as per the Federal Reserve Board's Statistical Supplement to the Federal Reserve Bulletin, June 2008).
