Treasury Issues 'Covered Bond' Guidance

Hoping to revive the private-label mortgage-backed securities market, the Treasury Department on Monday issued a best- practices guide aimed at underwriters that are interested in issuing "covered bonds" backed by nonconforming loans. "The private-label market is severely constrained," said Treasury Secretary Henry Paulson at a news conference. "Fannie Mae and Freddie Mac are funding more than 70% of all mortgages today." A covered bond is a debt instrument backed by a specific pool of mortgages. The underlying collateral is held on the balance sheet of the institution issuing the security. Mr. Paulson called covered bonds a "new funding source" for nonagency loans and said he is hoping the Treasury's guidance will create "greater risk awareness and investor discipline." He said his agency is looking to support the nascent market for covered (housing) bonds, and noted that four major banks -- Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo -- are creating covered-bond programs for mortgages [see item below]. Capital Research and Management of Los Angeles, an investment adviser, said, "We expect the covered-bond initiative will provide an important new source of long-term funding in the mortgage market. We also believe that the Treasury Department's best-practices guide, especially its requirement for high-quality collateral, will provide the structure needed for the covered-bond market to develop over time."