Last month, when U.S. Treasury Secretary Hank Paulson announced the U.S. Government’s support for a traditionally European securitization instrument, many mortgage industry insiders began to wonder “what is a covered bond?” As we are now aware, the U.S. Treasury in conjunction with the FDIC efforts in June and July represented the adoption of new financial tools to aid a catatonic securitization environment albeit a small initial step to ease the rising strain on the GSE’s. From an innovation perspective, do covered bonds truly represent the first “use-case” for private securitization efforts that demand robustly delivered and managed “e” documents and processes?
Is the deployment of the covered bond and its potential future allocations and permutations represent the forward and reverse mortgage supply chains that could not be achieved without the current market’s catharsis? Does the “Americanization” of these centuries old iconic instruments usher in a permanent watershed event or merely symbolize a temporary market ripple?
Lost among the headlines and the countless industry coverage in July 2008 was a report issued by the U.S. Department of the Treasury “Best Practices for Residential Covered Bonds.” It should be a required read for any lending institution, vendor, or outsourcer who is contemplating the deployment or inclusion of covered bonds within their downstream residential operations and offerings. Whereas, covered bonds have been around since the 1770’s with current market capitalization exceeding $3 trillion USD, American investors and regulating bodies have traditionally shunned this financial instrument.
So why should we discuss covered bonds in an innovation column, if they have been in existence for hundreds of years? Simple. Because they potentially represent the first of many new financial “tools” that leverages and legitimizes the decade of mortgage standards and data improvements fought for by industry and association personnel. For innovative ideas to be relevant, they need a market that is willing to “pay for” the investment and innovation or its ideas. Let me use an analogy from another industry. The transistor was an innovative idea and product. Nevertheless, it was a product in search of a market and hence acceptance. A watershed event for the transistor was when Sony electronic included it into an end-user product that its mass-appeal skyrocketed the Sony Walkman.
You see, the mortgage industry clearly recognizes that “e” capture, delivery, and management of origination, servicing, and securitization delivers immediate cost savings and life-cycle operational improvements. However, in 2007 when private MBS securitization approached 60% total market share, few organizations were effectively implementing “e” anything regardless of what they publically said. Fast-forward 18 months, and we now have an industry rushing into “e” options in droves. The end-result of these standards, including MISMO, demands an outlet within the financial and investor community that is willing or needs to “pay for” their deployment. Covered bonds demand a continuous robust data and operational linkage. Without the decade of standardization and “e” efforts already behind us, it would be nearly impossible to efficiently met the covered bond components and characteristics assembled within the following illustrative diagram.Covered bonds are not a panacea for our ailing industry they are a good first step in a new direction. They do represent a much needed option for greatly diminished MBS instruments. Why not a panacea? They will probably not appeal to institutions that seek out and tranche risk to investors who want a higher return (e.g., hedge funds). Most covered bonds by their definition carry AAA ratings and they will remain on the balance sheet of the issuing institution at least for now. For the leadership lending institutions that stood behind the U.S. Treasury Bank of America, CitiGroup, JP Morgan Chase, and Wells Fargo they clearly recognized the market opportunities and shifting investor demands. Other institutions will quickly follow.
For vendors and outsourcers, the challenge will be to adopt and implement with their clients the forward and reverse supply chains that reach beyond a single product or service offering. The downstream impacts and cross-correlated touchpoints will be many compliance, reporting (including investor), servicing, origination, fraud, registration, and many other functional and process areas. A clear implication of these new market ideals is that orchestration of solutions will be paramount among the accountable IT and business process personnel. Competitive partnerships will be more commonplace as time will favor those innovatively nimble providers. For forward-looking groups, covered bonds may represent a robust, vertically integrated (and cross-discipline) knowledge process perhaps those providing KPO solutions should take note?
