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Capital Markets

Covered bonds: The mortgage conundrum

Covered bonds have always been viewed as a funding tool to supplement the securitization market, but while RMBS new issuance remains patchy there are signs that the market is gaining traction and going global. Could this be at a tipping point? Hamish Risk reports.

Business in the European covered bond market was brisk in the first quarter of 2010. Indeed, issuance volumes reached a record high for the first quarter of any previous year of $127 billion, an almost four-fold increase from the same period a year ago, according to Dealogic. A clear trend is developing here that is seeing covered bonds emerge from the shadows of the RMBS market, with larger investors showing a clear preference for them as an asset class in their own right. The argument has been reinforced by legislative developments outside Europe. Together, these two factors mean that a greater proportion of mortgage financing in future years should be through covered bonds.

This is nowhere more prevalent than in the UK and the US, the two countries whose property bubbles burst most spectacularly and that are most in need of diversified mortgage funding options as their securitization markets face an uphill battle to restore their capacity to fund future mortgage lending.

Take the UK first. The Bank of England’s special liquidity scheme, which is due to be phased out between April 2011 and January 2012, and the Treasury’s credit guarantee scheme, which will be wound down by 2014, have provided support to 25% of the UK’s stock of residential mortgage lending, amounting to more than £300 billion.

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