DBRS Comments on U.S. Covered Bond Market Developments

DBRS has today commented on the recent developments in the U.S. covered bond market.

On July 28, 2008, Treasury Secretary Henry Paulson and four major U.S. banking institutions announced plans to expand mortgage financing options in the domestic market through the issuance of covered bonds. The announcement coincided with the Treasury’s release of a “Best Practices for Residential Covered Bonds” statement. In addition, the Federal Reserve announced the same day that highly rated covered bonds are eligible as collateral for loans at its discount window.

A covered bond is an on-balance-sheet, full recourse, senior secured debt instrument issued by regulated banking entities. Covered bond holders not only have a senior claim on the issuing bank’s assets, but also benefit from additional protections provided by a pool of high-quality collateral assets (the cover pool) in case of default, insolvency or liquidation of the issuing bank.

The Treasury’s best practices substantively conform to the final policy statement from the Federal Deposit Insurance Corporation on July 15, 2008, which clarified its treatment of a covered bond in the event of a receivership of the issuing bank. These statements addressed a key issue concerning U.S. covered bond policy and established a preferential claim that covered bond investors are entitled to the cover pool and, if necessary, an unsecured claim on other assets of the issuing bank.

DBRS believes that covered bond issuances provide an efficient funding mechanism for banks’ on-balance-sheet mortgage portfolios, thus enabling these banks to make more mortgage financing available in the stagnant domestic housing market. In addition, recent federal banking regulatory efforts to develop a U.S. covered bond market should promote liquidity in the debt capital markets and inspire confidence in the federal banking system.

DBRS also hopes that a covered market will stimulate the traditional mortgage market, which is largely represented by conservatively underwritten loans with well-documented income and verification of the ability to pay at the fully-indexed rate.

For DBRS’s rating methodology on covered bonds, please go to www.dbrs.com.