9-209-093
REV: OCTOBER 22, 2009

DANIEL B. BERGSTRESSER
ROBIN GREENWOOD
JAMES QUINN

Wa ashingt Mu ton utual's C
Covered Bond ds September of 20 was not a calm time fo the world’s capital mark
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or s kets. On Sept tember 7 fede erallybacke mortgage loan compani Freddie M and Fann Mae were placed into c ed l ies Mac nie conservatorsh by hip the U.S. governme a move de ent, esigned to sta abilize the em mbattled lenders. On Mond day, Septemb 15, ber global investment bank Lehma Brothers filed for Cha an apter 11 bank kruptcy protection. Broa US ad equity market inde y exes dropped by as much as 5 percent as rumors s d h t spread about potential liqu uidity crises at other majo financial in
or
Thus with $7.78 Billion in bonds outstanding under the covered bond program, the required size of the cover pool for the WaMu covered bonds had risen from roughly $8.98 Billion (8.98 x 86.6% = 7.78) up to $11.61 Billion (11.61 x 67.0% = 7.78).
Covered bond trustees usually relied on the ratings agencies to establish the quality of the underlying collateral.3 In recent market turmoil, this task had become more difficult. As mortgage default rates increased, the ratings agencies became increasingly conservative in assigning value to mortgage pools, valuing them at substantial discounts to face value. A variety of models could be used to assess the market value of a mortgage pool, all considered measures of asset quality such as the loan-to-value ratio and the credit quality of the borrowers as summarized by their FICO scores.4
In the event of a collateral downgrade, the trustee would ask the issuer to replenish assets in the pool. The inability or refusal to update assets at the trustee’s request would constitute issuer default.
While new in the United States,5 covered bonds were a long-standing part of the housing finance system in Europe, dating back to bonds issued in 1769 in Prussia. In Continental Europe these bonds, called ‘Pfandbriefe’ or (‘Pledge letters’) in the German-speaking countries, amounted to €2.1 trillion
(see Exhibit 2). By 2008, covered bonds were the second largest fixed income market in Europe.6 Part of the