Panellists at the American Securitization Forum conference in Las Vegas said on Tuesday that the credit crisis had opened up new opportunities for covered bonds in the US, even as it had called into question the idea that they are a rates product rather than a credit product.
Participants from the buy-side and the sell-side said that the resilience of structures even in the face of events such as the failure of Washington Mutual demonstrated the potential of covered bonds, but that it was essential to ensure liquidity to attract traditional rates investors.
"It was a product that was supposed to withstand any kind of significant market troubles and also market interruption," said Elizabeth Padova-Hanson, director at RBS Greenwich Capital. "As we all know, the credit crisis was so tremendous it hit the covered bond market as well. The structures do hold up and have held up under stress.
"But the liquidity went away and one of the big criteria for covered bonds is that it’s a very liquid product. They were large deals; there were market-making agreements in place to keep the liquidity going. So when the liquidity dried up, it hit the core of the covered bond market and it shouldn’t have."
Despite this market failure, the ability of some European banks to resume issuance this year showed that covered bonds could be a valuable tool for funding lending, she added.
The possibility that the Federal Deposit Insurance Corp might extend its Temporary Liquidity Guarantee Programme to include secured debt of up to 10 years was hailed by the panellists as a way to wean rates investors off guaranteed bank debt and into a renewed unguaranteed US covered bond market, although it was unlikely to be in the same form as the previously existing market and may need government intervention.
"From the FDIC’s perspective, it makes a lot of sense," said Scott Stengel, partner at Orrick, Herrington & Sutcliffe. He pointed out that the FDIC was probably keen to give itself the extra protection of secured debt, even if it had been happy to guarantee unsecured debt, given that its primary concern was to keep liquidity flowing.
He said that the move to some type of secured issuance guaranteed by the FDIC could be a "stepping stone" to covered bonds.
"As you see the market generally move in risk appetite, you could see a secured TLGP as a launching pad to a covered bond programme that perhaps will look very different from covered bonds as we have known them," said Stengel. "They’ll be fitting into a regulatory framework that’s changing a lot, regulation of the GSEs that’s changing a lot, the banking regulations are changing a lot, accounting changes that are going to result in very large changes to risk based capital, and so covered bonds have a unique place in all the changes that are going to happen this year."
The fate of covered bonds in the US is inextricably tied to the status of the government sponsored entities, Fannie Mae and Freddie Mac, and dependent upon the wider crisis settling down.
"We are very dependent on the GSE market," said Wesly Phoa, senior vice president at The Capital Group Companies. "It’s very difficult to bring any new product in this environment, because we’re so busy running around putting out fires.
"It’s been extremely difficult to devote time and resources to getting up to speed on anything new. It’s going to continue to be a problem for a while, but it should become less of a problem as things stabilise."
And he said that he was looking forward to the possibility of having an opportunity to diversify away from the GSEs.
"One reason we’re very interested in the development of this asset class is that we are very dependent as investors on the GSE debt markets," said Phoa. "As we’ve been discovering, it is extremely difficult to assess the credit quality or the behaviour of the GSEs. It involves too many policy factors that are difficult to get a handle on.
"It would be great to be able to move back into a sphere where we think we can understand pools of assets, we can understand the influence of management. It may be necessary to have some form of government support to get it off the ground."
Others were less optimistic.
"It’s going to be very difficult for covered bonds to compete with the GSEs," said David Power, vice president, strategy and execution, at Royal Bank of Canada. "There has to be a very high level policy decision to move away from the agency model."
Another area of potential concern was Standard & Poor’s proposal, announced last week, to change its criteria for rating covered bonds.
Even beyond the potential for downgrades of existing deals Padova-Hanson pointed out that S&P has estimated that 60% of the market could be affected and the potential for greater rating volatility in future would be extremely off-putting to rates investors, said Phoa.
